Once the darlings of the investment world, emerging markets fell from grace this year as the US Federal Reserve threatened to scale back its quantitative easing programme and the growth engines of China, India and Brazil spluttered.
The days of double digit returns have faded but the more discerning investor will still find relatively attractive opportunities in 2014. All emerging markets though went into a tailspin when Fed chairman Ben Bernanke hinted last May that it could start reducing its $85bn monthly bond programme. Shares plunged by 17% in dollar terms while currencies fell by up to a fifth and bond yields climbed two to four percentage points on the fears of rising rates.
These markets recovered their equilibrium in September after the central bank postponed their plans, but institutions have remained skittish ever since because it is only a matter of time before the contraction begins. At the moment there is no concrete date, but a spate of stronger than expected employment, housing and consumer spending news combined with the recent budget deal means tapering is likely to occur sooner rather than later. Before the year closed, the US House of Representatives approved a two year federal budget bill in a strong showing of cross-party support. This means that the shutdown scenario in October will not be repeated.
Rush for the exit
The spectre of rising rates however has kept investors at bay or heading for the exit. The latest figures showed that they withdrew $4.7bn from emerging market stock funds in the week ended November 13, marking the biggest exit from the funds in 20 weeks, according to the latest Bank of America Merrill Lynch report, citing data from fund tracking firm EPFR Global. Their bond counterparts suffered extractions of $1.8bn, which were their largest outflows in 10 weeks.
Overall, as of mid-November, investors had drained cash from these funds in 24 of the past 25 weeks. The Fed’s actions are not the only reason for such wariness. The economic outlook for these nations has also been a worrying factor. The International Monetary Fund recently noted that many of these countries were already experiencing a slowdown in growth and a shrinkage in the combined current account to just 1% from the seemingly healthy 5% before the financial crisis.
One of the main issues is that they are overly dependent on a relatively narrow base of economic activity such as exports of manufactured goods or the availability of cheap credit. For example, China has relied too much on domestic investment while the Gulf States and Russia have been over dependent on high oil and gas prices to stimulate their economies. South America, on the other hand, has relieved too heavily on feeding the Chinese infrastructure engine with their natural resources.
According to Gary Greenberg, head of Hermes Emerging Markets, “the old model of debt fuelled overconsumption in the West is over, and central bank stimulus cannot be relied upon to support growth indefinitely. Domestic consumption and South-to-South trade have been widely mooted as part of the new paradigm, but more is needed. To remain viable investment destinations, emerging markets must streamline bureaucracy, modernise logistics and address environmental sustainability. Not least, companies in these countries need to modernise operations and take advantage of technology to become more efficient. Although this can fly in the face of a government’s goal of full employment, it is the only solution in the global marketplace over the long term.”
Political change
The call for structural change though comes at a time when the political sands could potentially shift in many jurisdictions. “There is a great deal of pressure for these countries to reform but there are elections being held everywhere next year, most notably in Indonesia, Turkey, India, Brazil and South Africa,” says Sergio Trigo Paz, head of emerging markets fixed income at BlackRock. “This will delay any changes and is not constructive for emerging markets.”
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