In­vestors back into emerg­ing mar­kets as storm lingers

The Pak Banker - - MARKETS/SPORTS -

Emerg­ing mar­kets may well ap­pear cheap again af­ter years of at­tri­tion, but there's con­sid­er­able trep­i­da­tion about ven­tur­ing back out to the de­vel­op­ing world un­til the fi­nan­cial and po­lit­i­cal storms have fi­nally lifted.

Global in­vestors have tip­toed back into emerg­ing as­sets over the past six weeks at least partly on hopes that the gut-wrench­ing New Year shake­out may have been a fi­nal ca­pit­u­la­tion af­ter three years of down­drafts and dis­ap­point­ments. Ac­cord­ing to the In­sti­tute for In­ter­na­tional Finance, for­eign­ers ploughed some $36.8 bil­lion back into emerg­ing stocks and bonds in March - the highest in­flow in nearly two years and well above monthly av­er­ages of the past four years.

And yet these are baby steps. To put it in con­text, that port­fo­lio pop com­pares with a to­tal net cap­i­tal out­flow from emerg­ing economies in 2015 of some $730 bil­lion.

For the coast to clear, three clouds have to evap­o­rate. First is a lin­ger­ing fear of higher U.S. in­ter­est rates and dol­lar ap­pre­ci­a­tion that squeezes hard-cur­rency bor­row­ers in emerg- ing economies, stresses lo­cal cur­ren­cies and forces credit to be far tighter than needed to buoy weak­en­ing economies.

The sec­ond is China's eco­nomic slow­down and its slip­stream ef­fect on com­mod­ity prices and emerg­ing mar­kets at large.

And third is a spike in po­lit­i­cal risks in many coun­tries such as Brazil, Tur­key and South Africa - pres­sures mag­ni­fied by re­ces­sions and ris­ing job­less­less but which, in turn, com­pound the eco­nomic malaise and pol­icy paral­y­sis on the ground. Nei­ther of the first two global is­sues have been re­solved. The world mar­kets fil­lip of the past month has been rooted in the U.S. Fed­eral Re­serve's hes­i­ta­tion in adding to De­cem­ber's first in­ter­est rate rise in al­most a decade and the re­sul­tant dol­lar re­coil.

But rekin­dled Fed hawk­ish­ness as the quar­ter ends puts a po­ten­tial re­lapse on the dash­board - par­tic­u­larly if the re­bound in emerg­ing as­sets is lit­tle more than a re-bal­anc­ing of port­fo­lios from ex­treme aver­sion and if you be­lieve that cy­cles of dol­lar ap­pre­ci­a­tion his­tor­i­cally last far longer than this.

JPMor­gan strate­gists re­main op­ti­mistic about emerg­ing mar­kets out­per­form­ing over the next three months - not least be­cause funds are starved of in­come in de­vel­oped economies. But they ac­knowl­edge that there's no out­right im­prove­ment in the eco­nomic pic­ture and that price moves are built solely on re-po­si­tion­ing. "Given the al­most five years of emerg­ing mar­kets eq­uity and FX un­der­per­for­mance - and re­cent con­ver­sa­tions with in­vestors - it could take at least a few months be­fore the av­er­age in­vestor is again neu­tral," they told clients. So the move may have some legs, but it's highly vul­ner­a­ble if the global cli­mate turns in­clement again. For a start, JPMor­gan's rosier view hinges some­what on the fad­ing of 'China tail risk' in­volv­ing messy yuan de­val­u­a­tion. And while Bei­jing has been force­ful on the is­sue, few in­vestors can muster much con­vic­tion about China's mar­kets.

Christophe Donay, head of as­set al­lo­ca­tion at Swiss firm Pictet's Wealth Man­age­ment unit, said that China may hold the line for now but that there was a high risk over the next three years of a 'Min­sky mo­ment' - a sud­den col­lapse of as­set prices due to credit and cur­rency pres­sure named af­ter econ­o­mist Hy­man Min­sky.

"We are stay­ing well away from emerg­ing mar­ket as­sets be­cause of that and hold very lim­ited EM ex­po­sure," he said.

With such scep­ti­cism about the in­ter­na­tional en­vi­ron­ment, the re­turn to mar­kets riven by a host of dis­parate but highly dis­rup­tive do­mes­tic po­lit­i­cal risks seems brave at least. Mired in a deep re­ces­sion, Brazil's po­lit­i­cal strife has yet to reach a crescendo. Dilma Rouss­eff is strug­gling to save her pres­i­dency and fight­ing an im­peach­ment process amid a widen­ing graft in­ves­ti­ga­tion into state oil firm Petro­bras. While mar­kets have ral­lied on the prospect of a new gov­ern­ment, it could still take sev­eral more weeks or even months for a clear out­come. Tur­key's econ­omy and gov­ern­ment too are un­der strain given the war in neigh­bor­ing Syria, the re­sul­tant refugee cri­sis, in­ter­nal con­flict with Kur­dish sep­a­ratists, a clam­p­down on lo­cal me­dia and a diplo­matic show­down with Rus­sia.

The strug­gling South African econ­omy and its buck­ling in­fra­struc­ture are com­pounded by pres­sure on Pres­i­dent Ja­cob Zuma, his finance min­is­ter Pravin Gord­han and the rul- ing African Na­tional Congress amid a va­ri­ety of ac­cu­sa­tions and probes about un­due po­lit­i­cal in­ter­fer­ence and graft.

More au­thor­i­tar­ian gov­ern­ments in China and Rus­sia may seem less vul­ner­a­ble than their demo­cratic coun­ter­parts, but slow­down and re­ces­sion heighten the po­lit­i­cal risks there, too. An oil hit and for­eign sanc­tions con­tinue to ham­per over­sees re­fi­nanc­ing by Moscow and its ma­jor com­pa­nies.

While the pic­ture in Brazil may mask a brighter hue in Mex­ico or the slow­down in China hide the re­silience in In­dia, a still size­able slice of the emerg­ing uni­verse re­mains in fo­ment. China, Brazil, Rus­sia, South Africa and Tur­key to­gether make up more than 42 per­cent of the mar­ket cap­i­tal­iza­tion of MSCI's bench­mark emerg­ing mar­ket eq­ui­ties index.

As­set man­ager Black­rock's sovereign risk in­dices mea­sur­ing the like­li­hood of de­faults across the world con­tain a po­lit­i­cal risk sub­set called ' will­ing­ness to pay'. This re­mained the big­gest neg­a­tive for the coun­tries record­ing the big­gest over­all index de­clines in 2015 - Brazil, Rus­sia, Peru and Colom­bia.

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