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Will the pressure on emerging markets persist in 2019?

Declines across investment classes prompts allocation reconsideration.

Last year was tough for emerging markets as currencies and equity investment classes struggled to keep up with investment options in developed countries, leading to the question: should emerging market (EM) assets make the cut for any portfolio in 2019?

With a stronger US dollar and the US Federal Reserve normalising rates, 2018 will be remembered as the year the Indian rupee reached historic lows, the Argentinian peso fell 52% and the Turkish lira shed 14% in a single day. There was the massive rand selloff too. For South Africa, the fiscal stimulus announced by President Cyril Ramaphosa only raised more questions on the pressure this will add to the economy’s fiscal space and ultimately how it will impact rating agencies’ actions.

On the political front, populism has become the new norm, with right-wing rhetoric fast replacing patriotism. EMs have had to adjust to the geopolitics that have evolved into a trade and aid skirmish between Washington and Beijing.

“In emerging markets, politics drives the economy,” says Vestact portfolio manager Michael Treherne. “In the developed world, the economy drives the politics. Geopolitics are always a risk for EM markets. I am optimistic that the US and China will resolve their issues, resulting in a boost to global growth. As for EMs, let us hope there are no more politicians behaving impulsively.”

The financial predicaments in Argentina and Turkey raised the question of whether more buffers could have been in place to counter the fiscal and monetary woes. Could structural safeguards have prevented the Turkish lira crisis? “The problem in both Argentina and Turkey were the politicians,” says Treherne. “I’m not sure you can set up buffers to counter poor policies.”

Contagion may spread, but for now EM indices remain in the crossfire of developed market policies. A worst-case scenario involving an escalation in the Beijing-Washington trade war talk would decimate world markets, unlike the version a decade ago when spillover risks were contained to their respective regions.

Last week, the International Monetary Fund further downgraded its 2019 growth forecast to 3.5% with South Africa’s growth outlook surprisingly revised from 0.8% to 1.4%. Consequently, foreign trade and investment into major emerging markets is projected to reach at $1 trillion, according to the Institute for International Finance.

“I have seen a number of international money managers saying they are increasingly looking at EMs as a place for investment – which is good news for us,” says Treherne. “I think the big factor in our FDI [foreign direct investment] will be the outcome of our election – who is appointed to the cabinet, and then what the focus for government is. Settling the land issue quickly is also vital for having long term capital flow into South Africa.”

Emerging markets brace for QE tapering

As a monetary antidote to the 2008 financial crisis in the US, Fed chair Ben Bernanke rolled out a quantitative easing (QE) programme that saw easy money flood emerging markets. But with easy money coming in, many emerging markets that had been reforming their monetary systems hit the pause button, channeling all efforts in attracting all the easy money they could.

Accordingly, EM debt has grown exponentially over the past decade. “I think we were lucky Bernanke was running the Fed in 2008,” says Treherne. “He understood what not to do and how bad things were, probably better than most. Thanks to him, the Fed acted quickly and we only had a great recession, instead of another depression.”

Treherne also argues that corporate and household debt might be higher now than 10 years ago, but this is directly proportionate to their net asset value.

“For most the debt levels are not out of sync when looking at the rest of their balance sheet. Added to this, interest rates are very low, and expected to stay low for years to come. In a low interest rate environment you can afford to have a bit more debt sitting on your balance sheet.”

Meanwhile, investment fund trackers project stock and bond inflows at less than $40 billion in 2018, with a slight increase predicted this year but much of that is destined for China and South Korea given their large weight in the MSCI index. The question is, how much of the $40 billion will South Africa garner in an election year?

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Thanks Arnold. Always insightful articles from you.

Your easy-reading style allows one to set aside local market “noise” for a moment, and to stand back & let global markets sink in to provide a distant perspective. One can feel your passion for macroeconomics. Cudos!

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