Emerging equity markets began the year strongly following a dismal 2000. The main reasons for the po...
Emerging equity markets began the year strongly following a dismal 2000. The main reasons for the poor performance were the continued decline in forward-looking global growth estimates, the high oil price and the strong decrease in global technology valuations, as shown by the price action on Nasdaq.
Furthermore, two emerging economies Argentina and Turkey had to approach the International Monetary Fund for rescue packages.
The unanticipated Federal Reserve's easing of 50 basis points on 3 January, followed by the anticipated 50 basis points on 31 January, changed the global interest rate outlook and underlined Greenspan's commitment to avoid a hard landing in the US economy. This provided the catalyst for exceptional returns during January 2001.
The shape and duration of the impending US slowdown will be vital in determining future market performance. Is it going to be 'L', 'U' or 'V' shaped?
The 'L' scenario poses a threat to risky asset classes as the US slowdown becomes a prolonged recession, and monetary stimuli are not enough to avert a global hard landing. Risk aversion rises and the flight to quality results in large investment outflows from emerging markets.
The 'U' scenario occurs when monetary stimuli manage to avert a prolonged recession, but not before global economies slow. Global interest rates are cut significantly, but leading indicators of industrial production turn positive soon afterwards.
The 'V' scenario is the most bullish for emerging markets in that the slowdown is short and sharp before central bankers inject substantial liquidity into the global economy, and this drives strong emerging market equity performance. However, it may also be the most dangerous in that the 'V' could become a 'W' if premature recovery leads to inflationary overheating and renewed policy tightening.
The outlook for emerging equity markets is more positive than during 2000 in that we can see the risks of a global slowdown being adequately priced in. The central case is that the easing in global interest rates, coupled with weaker oil prices and a weak dollar, are beneficial to emerging economies.
The easing in global interest rates should dominate any immediate concerns over further decreases in global economic growth. Emerging markets have historically outperformed during periods of global interest rate easing and abundant global liquidity.
Asian techs at the cutting-edge of new technology will outperform in the medium-term, but at the same time they are the most exposed to a sharp global slowdown.
The key risks facing emerging equity markets remain the veracity and duration of the global economic slowdown. In addition, the poor earnings visibility of technology-related companies poses some serious challenges.
Neil Hobson is a fund manager at Investec AM
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