The Emerging Markets rollercoaster... where to now?
A great deal happened in Emerging Markets
during that long period whilst we were away, and it strikes us that we haven't
really pointed you towards anywhere that directly addressed that huge and
complicated subject since we got back. Attention has been focussed on the
prospect of climbing inflation, and the likely responses in central bank
monetary policy to it... most crucially of course by the US Federal Reserve. But
then the future for Emerging Markets and US rates is always inextricably
linked, even if a cocktail other factors are also at play when trading EM
markets.
So it's back to Robert Armstrong's newsletter,
and his opinion of what has been behind the strong EM performance during the
pandemic and of what may decide where we go from here.
One thing to always bear in mind when taking an
overview of EM performance is that very often the progress or otherwise of a
wide range of countries (which may be in very different states of health) are
lumped into various EM indices. Since those indices mostly include China, those
indices are skewed in that direction. There is understandable debate about the
helpfulness of still including the planet's second largest economy in an EM
index - is it still "emerging", or should we consider it
well and truly "emerged”? - but while that situation remains there are
obvious caveats to be observed. Most crucially, if taking a view on the assets
of a particular nation or region, make sure you look beyond any pan-EM index
and consider the factors particular to that area.
Anyway... Mr Armstrong tells us that EM stocks
have performed strongly since March last year (after an early blip), and much
of the reason for that is the close link to the performance of EM currencies.
If EM investors were buffeted by currency weakness for decade or more, the
pandemic era has seen the EM currency index perform strongly as the US dollar
fell on the back of near-zero official short-term rates interest rates, which
have moved into negative territory further down the curve once inflation is
taken into account, and by the remarkable rally in commodity prices.
Remembering that caveat, the index figure hides
some pretty arresting contrasts between individual nations. China and those
most closely involved in its supply chain (e.g. Taiwan, South Korea) have
performed best, reflecting a quick and comparatively successful handling of the
pandemic. At the other end of the scale, Turkey remains a basket-case, the
Turkish Lira continually undermined by a president who is a serial sacker of
central bank governors who might attempt to raise interest rates to fight that
country's rocketing inflation. Surprisingly perhaps given the pandemic, the
Indian rupee has fared not too badly and even some pretty disastrous handling
of the pandemic in Russia and Brazil has been mitigated by the strength in
commodities.
Another reason for EM currency strength has
been (Turkey aside) a willingness to start raising rates to counteract rising
inflation forces. That's not surprising (though faintly reassuring) when one
considers how inflation has damaged EM currencies (and therefore assets and
ultimately economies) in the past. But if you're talking inflation-induced rate
rises, you've got to ask yourself what might happen if, or rather when, the US
starts along that path?
This subject is the main reason why many are
wary of EM assets. The US Fed is already beginning to talk about tapering asset
purchases even if actual interest rate rises look to be some way off yet.
People say that investors' memories are short, but you can bet your bottom
dollar that they'll all remember the Taper Tantrum of 2013. Some poorly-communicated
more hawkish comments by Fed boss Ben Bernanke about tapering and the prospect
of higher rates induced a melt-down in bond markets, which took other assets
with them. The effect was global, but the worst hits were in emerging
markets.
If you believe that a strong dollar and rising
rates are likely to coincide with a fall in commodity prices (which have
already shown signs of topping), well... you'd be right to be wary at the very
least. As Mr Armstrong points out, such a fall in commodities would be pretty
disastrous for the likes of Brazil and Russia, and China's recent move to
tighten credit conditions makes that more rather than less likely.
On a more optimistic note, for EM markets, the
Fed itself points out that not all rate-tightening cycles are accompanied by
damage to emerging markets. Its assertion is that if the cycle is a response to
economic growth (which encourages imports) rather than a reaction to inflation
worries, EMs can still prosper... and it uses the mid-2000s cycle as an
example.
The jury is still out on which kind of
tightening cycle it will be... or even if we're certain to see one worth the
name at all. If that's the case, and conceivably even if it’s not, the future
for EMs is likely to be decided by the great issue of the era... COVID 19. We
MIGHT see widespread vaccination ensuring continued growth on a global scale
and the future could be rosy. On the other hand, to paraphrase Simon
Quijano-Evans of Gemcorp who is quoted in the piece, many EM nations in
particular are way behind on meaningful vaccination programmes, so we MIGHT
also see increasing rates of illness, deaths and economic shutdown. If that
should be accompanied by falling commodity prices, well... watch out.
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