New Model Adviser - Emerging Markets
13 October 2009
During a global recession, it is no surprise that investors have looked around for any sources of growth, and seized upon emerging market stocks, debt and currencies as one solution. For many people, the focus of attention has been on China, seen as a major source of resilience for the global economy. The successful pump priming of its economy, buoyed also by the US finally stabilising, has led some investors to become a little complacent about the risks in terms of the emerging market outlook. While there are solid long-term arguments for seeking to benefit from trends in these countries, it also behoves us to take a look at the world through a somewhat less rose-tinted prism. A number of emerging economies markets, including China, face complex challenges.
China’s economy growing around 8% a year is still a far cry from its boom-time acceleration above 12% a year. It continues to face problems. The major destination markets for its exports, such as the US and Europe, are weighed down by impaired balance sheets. China is responding by spending a large portion of its fiscal firepower to shore up its domestic economy through major infrastructure projects. However, this causes further policy dilemmas. The amount of determined, aggressive state directed bank lending is causing many commentators to fear the prospect of asset bubbles forming, in property or shares. The Chinese stock market rose over 40% in the first half of the year before falling over 25% in the summer, recovering into the autumn. Bursting any such bubbles could have nasty consequences. Given lop-sided growth, it is difficult for China to stoke activity without creating further imbalances. Furthermore, China’s commodity intensive ‘old economy’ growth is by its very nature likely to put upward pressure on raw material costs, stoking inflation fears. China’s long term demographic headwinds add to the tough job on its hands re-shaping its economy as being ‘consumption led’, away from the unsustainable investment led model employed today.
Moving to other emerging markets, we can see that Eastern Europe still has major imbalances, both current account and fiscal. The correction required a sharp contraction in industrial output and consumption. The Baltic States and the Ukraine are good examples of Eastern Europe’s hangover from a decade long credit expansion. Latin America, too, is not without its problems. Whilst Brazil is in good shape, countries such as Venezuela serve as a reminder of the risks of an unconventional economic policy at a time when the country is overly dependent on a single commodity, oil, when production capacity is declining. The same problems affect a range of countries across Africa and the Middle East.
Going forward, we can say that whilst the emerging market countries are likely to continue to offer superior prospects in terms of economic growth to their Western or OECD counterparts, it is important to realise that the paths of many emerging economies are likely to markedly diverge. We cannot look at the emerging markets as a homogenous entity. It is likely to be a profitable strategy to enact ‘relative value’ investment strategies between different countries. For example, in our Global Absolute Return Strategy (GARS) fund, we have looked for ‘pairs trades’. By analysing the different economic drivers of different countries, and assessing what is priced into market expectations, we can benefit from interest rate differentials via currency positions.
After last year’s global bear market, emerging economies do offer good investment opportunities. However this is not simply a one way bet on all such countries, and investors are warned of continued volatility along the way.
Jason Hepner, Investment Director – Global Strategy, Standard Life Investments
This article was first published within New Model Adviser on 19th October and again on Citywire on Wednesday 21st October.
