Is a storm brewing in the Emerging Markets?

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06/11/2018
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Emerging Markets are a fascinating area of global equity markets and often cause confusion as to which geographical area they refer to. Countries seem to remain in the ‘emerging’ phase forever and never actually emerge! For example, China firmly resides in the region but we are all told that the Chinese economy is almost as big as the USA, so when will we actually invest separately in China as a developed economy?

There are also other economies such as Vietnam, Nigeria and the UAE which are incomparable but with similar limited democracy in place, whilst the last is actually very developed. Then there are the likes of Venezuela, Mexico, Brazil and Argentina – all with their own problems and periodically very unstable.

Asia-Pacific is another area of confusion. Where do the likes of Malaysia, Indonesia, Taiwan and Singapore sit? Some of these present as very developed economies but they overlap with the likes of Hong Kong, a highly developed principality which is part of China.

We all know about President Trump and his quest to rebalance the trade deficit with China via the use of tariffs. No matter how ill-founded we may consider the economic thinking of this, Trump is pushing it through, even if it inflicts pain and objection from US corporations. He shows no signs of weakening his bombastic approach and is unlikely to back down. Quite simply, Trump doesn’t do U-turns and appears to take plaudits and credit for anything if he can fabricate achievement. Meanwhile, during 2018, Emerging Markets as a segment of the equity investment universe has underperformed the US significantly as Trump upped the ante in May, and within this, China has been particularly weak - see below:

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We can see that the influences on the Emerging Markets index are varied. The likes of Venezuela and Argentina have had their own unique problems, largely of their own making and nothing to do with tariffs. Turkey has decided to fight its own battle with the US on an entirely different front, whereas China really has been in the crosshairs of Trump’s trade policy. However, before getting too granular on which country is most or least affected, investors do tend to approach Emerging Markets as a bucket and treat all countries somewhat similarly. For example, when the Turkish lira was getting pummelled due to the US spat over Syria. This also affected South Africa and Latin America more generally, as investors suddenly decided that all Emerging Markets were more risky than before.

A diversified approach to investing in Emerging Markets is important. The investment thesis is such that, in theory, economic growth in emerging economies is higher than in developed economies. However, politically the countries are far more unstable, corruption is higher, currencies are more volatile and legal structures more fragile. China may be approaching superpower status, but it should not be forgotten that western capitalist rules and laws do not apply. An assumption that profits and dividends will be fairly distributed to shareholders, as in the west, would be naïve. That said, returns can be attractive but they are also volatile and international investors’ capital can leave the region just as quickly as it arrives, causing big swings in performance.

The biggest Emerging Market is China and the Shanghai composite is almost 17% cheaper than it was at the start of the year for a sterling investor, despite all the positivity around the opening up of the domestic ‘A’ share market to overseas investors. Does this present an attractive buying opportunity? Undoubtedly it will at some point but how bad is the trade dispute with the US going to get? Some believe Trump will end up putting tariffs on all Chinese imports into the US, possibly as much as 25%. Others believe he desperately wants the showcase triumphant handshake of doing the deal to gain as much political kudos at home as possible. Besides, no-one will really understand whether the deal has added much to the US economy. One thing we can be sure of is that Donald Trump will claim that it is the deal of the century and no other President has achieved such a thing!

So, as with all investment decisions, there is the decision to buy but most importantly when to buy. We believe the tariffs will become more acrimonious and more draconian before a deal is done as the Chinese are showing no signs of backing down and are refusing to even talk. We should sit tight and observe from the side-lines, but monitor closely because there will be a buying opportunity into a region that offers superior returns over the longer term for those with the stomach for the risk.

Now that we have had the latest installment of economic growth from China, we know that the official numbers are unlikely to reveal anything of concern. However the US is relentless in its imposition of economic pressure, now scrapping the postal treaty which enabled Chinese shipping costs to dramatically undercut the West. This could be a real game changer which could benefit other regions such as Vietnam. A diversified approach utilising experts within the region is vital to avoid the worst of any stormy conditions.

 

Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.