By Gerald Smith, head of emerging markets Baillie Gifford The performance of the broader emergin...
By Gerald Smith, head of emerging markets Baillie Gifford
The performance of the broader emerging markets indices in the year to date has been disappointing and the strong relative outperformance at the end of last year is being eroded.
Look a little more closely, however, and you start to see a slightly different picture.
The FSTE All-World Index series divides emerging markets into two categories: advanced emerging and emerging (which in combination become the All Emerging index).
At the time of writing the Advanced version was down 0.6% in dollar terms, while Emerging was up 9.7%, which compares with an increase of 4.2% for the FTSE All-World Developed index. A number of the largest advanced emerging markets countries, such as Korea, South Africa and Taiwan, have performed badly since the start of the year; offsetting strong gains in Brazil, Russia and many of the smaller emerging markets.
This marked divergence in the performance of emerging markets makes it more than usually difficult to generalise about the outlook for these markets taken as a whole. It is however possible to distinguish a few general themes that are likely to affect their prospects in the coming six months.
The first of these is the search for yield in a world of falling nominal interest rates. This has led to large inflows into emerging market bonds and currencies where interest rates are high, such as Brazil and South Africa, which has caused their currencies to appreciate. This appreciation is disinflationary and increases the prospect of interest rate cuts, and this should boost domestic economic activity. The second major theme concerns the impact of dollar depreciation on countries whose currencies remain pegged to it.
Most significantly, the Chinese economy, already the most competitive in the world in terms of manufacturing costs, is becoming more competitive by the day.
A third theme is that commodity prices have been rising and, as western companies such as BP have recognised with their purchase of Russian oil reserves, emerging markets contain some of the most attractive assets. There is therefore scope for prices to rise through corporate activity as well as re-rating towards global norms.
Against these positives for emerging markets there are some, at least partially, offsetting concerns. The first of these is that much of the money that has come into emerging market bonds and currencies is probably hot money that could quickly reverse direction, creating the potential for greater instability. Given the various political risks in these markets there are plenty of potential triggers for sharp reversals in such flows.
Another problem is exporters in countries with appreciating currencies, such as South Africa, are also facing a severe margin squeeze because the wage rises conceded when the currencies were weak will prove impossible to reverse.
There is also the heavy exposure of certain companies and countries to global investment in information technology. While there are isolated pockets of strength, the overall situation is one of excess capacity and margin pressure.
Smaller markets have performed well.
Large inflows into high interest rate countries.
Countries pegged to dollar more competitive.
Emerging markets indices disappointing.
Inflows could easily dry up, causing instability.
Appreciation causing margin squeezes.
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