Emerging markets (EM) have had a bit of a rough ride since the mid-2013 "taper tantrum" demonstrated their vulnerability to policy actions overseas, specifically the stance of the US Federal Reserve.
Considering that they were meant to be the trail-blazers — representing the fast-growing alternative to the secularly slowing, so-called advanced nations — that came as quite a shock to the system to many observers.
One key factor that was meant to play to their advantage, and central to the familiar story of the East taking over from the West as the world economy’s locomotive, was the commodity ‘supercycle’, featuring in many an analyst’s research note and institution’s marketing literature.
Not only did it become plain that China could not keep expanding at double-digit annual rates, hoovering up primary resources, nor the Asian region generally in its wake, but the extent to which the Pacific Rim and others had become dependent on cheap money (sponsored by the Fed’s commitment to exceptionally low interest rates for a prolonged period) was a chicken that really came home to roost.
It’s a remarkably dollarised world now, and a phenomenally indebted one too, putting banking, sovereign and even supranational creditors in some jeopardy. Everyone is on tenterhooks as to the Fed’s next move — like an overshadowing albatross with distinctly ‘black swan’ connotations.
Market sentiment
For the Gulf, the global doldrums (the US notably aside) have combined with the shale energy revolution to make a massive dent in regional receipts via oil prices, one which cannot easily be consigned as purely transitional.
And it is that which tends to keep market sentiment slightly on the back foot even while endlessly easy credit maintains business and investment momentum, GCC governments’ commitment to interim stimulus apart.
At last week’s Middle East Investment Summit in Dubai’s DIFC district, participants received conflicting signals as to what is likely to transpire for the emerging market segment in asset allocation, given both immediate cyclical risks and abiding structural concerns, overlaying the obvious, continuing potential inherent in the developing world.
It’s a critical issue for portfolio managers, given the need to find forms of diversification in the event of a deep shock arising for mainstream, benchmark stock and bond markets. Can there still be pockets of outperformance available for the canny or nimble investor in a situation now where risk seems to be getting ahead of the reward outlook?
As of this moment, “the prospect of rising [interest] rates and the current trajectory of the climbing US dollar portend further weakness in the EM space,” such that those “with vivid memories of the 2013 summer sell-off … are content, for the time being, with narrow exposures to the asset class,” confirms Ash Rajan, session chairman and formerly chief investment strategist at Merrill Lynch Wealth Management, responding to queries.
While “contrarians are pounding the table citing stimulative campaigns in many EMs as a preamble for recovering GDP,” that’s not enough to invest upon, considering the “further layers of scrutiny” required in respect of issues, for instance, of financial resilience and credibility of governance, he maintains.
Capital flows
Christian Gattiker-Ericsson, head of research at Bank Julius Baer & Co, explained further why emerging markets have lost their edge.
Whereas “disillusionment with the returns in mature markets” have kept capital flows from disappearing, over-investment in productive capacity, at a minimum 8 per cent per annum, has created an excess of supply over demand, so that rebalancing has only just started, triggered by the strong dollar and weak commodities.
“The fall in commodity prices was a hurtful wake-up call to emerging corporates in the sector”, promising “painful, chaotic and tedious adjustments.” Consequently, pressure will remain on many emerging economies reliant on that income source, he advises.
To others, though, it’s difficult to look past the prior attraction of emerging markets, and support for the case can be found amid market mechanics and comparative value ratios.
Daniel Tubbs, head of global emerging markets (GEMs) at Mirabaud Asset Management Ltd, argues that the headwinds are already priced into EM equities, which trade at a 30 per cent discount to US stocks. This recent underperformance “is a buying opportunity for those who want exposure to the most dynamic parts of the world,” he ventures.
The good news for the Gulf is that international investors will increasingly focus this way, he says, “particularly with the opening up of the Saudi market”.
An institutional step-change is vital to that expectation, though. “Saudi Arabia will ultimately be added to the MSCI Emerging Market index at around 4 per cent, [and] will be too large to ignore, bigger than Russia in the index”.
Mirabaud has put its money where its mouth is in this belief. “We have had positions through owning participation notes since launching our fund in 2012,” says Tubbs. “We believe others will follow us. In due course, ETFs (exchange-traded funds) will be forced buyers of the market when it is reclassified.”
