Author: Maarten-Jan Bakkum, Senior Strategist, Emerging Markets at NN Investment Partners
It took a while, but a new positive trend for emerging markets finally seems to have started. Emerging equity markets bottomed in January. Strong Chinese housing data and weak US economic data reversed the 6-year-old negative trend. In the following months the much-feared poor Chinese data did not materialise, and there was increasing confidence that the Fed would continue to postpone rate hikes. At the end of June, UK’s Brexit vote proved to be a new positive factor. The subsequent uncertainty was perceived as a specifically European problem and resulted in an improved relative risk profile of emerging markets. Moreover, Brexit was an additional reason for the major central banks to ease their monetary policy stances further, or at least not to tighten for now.
So emerging markets have benefited from Chinese growth stabilisation and the growing realisation among investors that the ultra-loose monetary policy in the US and Europe will be here for an extended period of time. Meanwhile, figures in the emerging world are improving as well. The improvement in capital flows in recent months has resulted in stronger exchange rates and lower interest rates. This is now beginning to be reflected in the growth figures. For the first time since 2014, the average growth momentum in the emerging world has turned positive. In other words, growth rates are no longer falling.
Without growth improvement, emerging markets would remain extremely vulnerable, as growth is badly needed to keep the high debt ratios manageable and to improve companies’ profitability. Accelerating growth, coupled with appreciating currencies, makes it easier for investors to commit to emerging markets again. We had not seen this combination for six years and it certainly is a positive sign.
There are obviously still risks. The current Chinese growth stabilisation has only been possible thanks to a new, strong acceleration in credit growth. This has a downside. The number of bad loans and defaults is already increasing sharply. The resilience of Chinese banks will not be infinite. Another risk facing the emerging world is that Chinese growth is less and less driven by investments, so growth is becoming less commodity-intensive. This could keep commodity prices low for an extended period of time and reduces the likelihood of a significant growth recovery in large parts of the emerging world, especially in Latin America and Africa.
But we can worry about that later. For now, growth momentum is positive and outflows have come to a standstill. Since Brexit and the postponement of US interest rate hikes, investors’ search for yield has intensified. After years of falling share prices and depreciating currencies, the emerging world now offers a lot of potential returns.