Sell-off shunts some emerging markets into bargain territory
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Successive bouts of pessimism and optimism have characterised emerging markets over the years and the past few months have not deviated from this pattern.
Negative factors such as rising US interest rates, a stronger dollar, heightened global trade tensions and a possible rejigging of global supply chains have brought a shift in sentiment. Slowing growth in China and Europe have been added to the list of concerns more recently.
A somewhat indiscriminate sell-off led to a bear market — a decline of more than 20 per cent — in EM equity between January and August. The equity market, measured by the MSCI EM index, is now down to 10.3 times forward earnings, from 13 times, with trailing earnings growing in double digits annually. While this receding tide has lowered all boats, the upside is that this has created attractive entry points for some emerging market countries.
Several situations merit attention. For instance, Brazil’s political orientation has shifted markedly following the presidential election victory of Jair Bolsonaro in October. Markets rallied in the run-up to the votes and in their immediate aftermath, despite the fact Mr Bolsonaro comes from a military background, a scenario that has often led to state interventionist policies.
Investors have taken comfort from the key role given to Paulo Guedes, a liberal economist trained at the University of Chicago and a former banker, who will become Brazil’s economic tsar. Mr Bolsonaro will need all the help he can get from such experienced individuals because the task at hand is challenging.
The days when Brazil was the shining star of the Brics — Brazil, Russia, India and China — seem long gone. After riding the wave of the commodity supercycle during most of the 2000s, growth has been subdued since 2011. Unemployment and public debt have risen alarmingly. It is still unclear whether Mr Bolsonaro will have the political courage to follow through on his campaign promises; he has already indicated his preference for a more diluted version of fiscal reforms.
Yet if the new administration succeeds in implementing even a watered-down version of its reform programme, Brazil could surprise again on the upside and market enthusiasm may be justified.
Other countries are forging ahead with ambitious reform plans. Egypt, with the help of a $12bn IMF programme, is delivering on fiscal consolidation, debt stabilisation and structural reforms. The country has also adapted regulation to attract foreign investment and has floated the currency — changes that have improved its competitiveness and reduced market distortions. Egypt has a robust level of foreign exchange reserves, which will help manage volatile capital flows should sentiment towards EM assets change — a comfort for investors on the sustainability of this turnround.
Turkey and Argentina, which have seen very sharp depreciations in their currencies, may be perceived as bargains. Argentina recently passed an ambitious 2019 budget that targets a fiscal balance before interest payments, and some stability has returned. The peso gained 10 per cent in October and bonds rallied after an improved IMF deal and a more orthodox monetary policy.
Turkish assets have also rebounded but challenges persist. If policies were put in place to allow sustained macroeconomic rebalancing, the equity market has the potential to double. Yet, instead, the slowdown in growth will be sharp and external financing needs remain elevated — public and private debt redemptions total about $65bn for 2019. Neither Argentina nor Turkey is out of the woods yet and risks continue to run high.
Powerful trends continue to play out in emerging markets, such as the expansion of the middle class in Asia. In the next seven years, another 1bn people are expected to join the emerging middle class, according to the Brookings Institution. Of this, about 90 per cent are likely to be Asian, of which about 500m will be Indian and 300m Chinese. This should continue to support not only the consumer and infrastructure sectors across Asia, but also the materials and commodity-producing countries, such as Brazil and Russia.
Meanwhile, emerging markets remain the largest group of greenhouse gas emitters and will need to invest massively in renewables, and in low-carbon and climate-resilient infrastructure.
These broader themes will help ensure that emerging markets provide compelling investment opportunities in the coming years.
The writer is the co-director of the BRICLab at Columbia University and a managing director at HSBC
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