Emerging Markets

The world’s emerging markets offer investors the opportunity to seek that additional yield they crave in an era of low returns. But that extra pick-up from nations like Brazil, India, South Africa and Mexico, will always come with some additional risk.

The world’s emerging markets offer investors the opportunity to seek that additional yield they crave in an era of low returns. But that extra pick-up from nations like Brazil, India, South Africa and Mexico, will always come with some additional risk.

These risks have been well demonstrated by events such as the Asian currency crisis of 97-98. That saw a number of fast growing economies in the region such as Thailand, Indonesia and South Korea, suffer a huge downturn as they didn’t have enough reserves to cover their dollar denominated debt.

Within emerging markets, Russia was one of the infamous BRICs (Brazil, Russia, India, China) and stock market investors enjoyed some outsize returns there in the years after that acronym was coined. But those gains only came after the sharp losses of the Russian financial crisis of 1998, when the government defaulted on its debt and devalued the ruble.

China meanwhile is perhaps the best example of an emerging market that has fulfilled its potential and could now be considered more of a world leader than a developed market after two decades of powerful growth and huge transformation. However, it could also be argued, that after the largest credit creation in history, with some $40 trillion of debt added in the last ten years (equivalent to 50% of world GDP), the risk now is that if China falls, then the rest of Asia’s emerging markets will be under serious threat.

Investors still have a major desire (and need) for additional yield in a low growth environment so emerging markets fit the bill for outsized returns. This is despite the risks of an uncertain political environment, as well as macro and fiscal policy risks, not to mention geo-political risks as tensions rise around the globe.

For these reasons, investors tend to participate in emerging markets through the broad basket MSCI index, rather than investing by particular themes. When a country is included in the MSCI then it can expect significant capital inflows, as funds follow that index. Saudi Arabia’s advance to the watch list for inclusion in the MSCI, for example, is hoped to provide a major boost to the nation’s equity market.

Once you go beyond emerging markets into the ‘frontier markets’, then you start to look at countries with relatively small GDPs, but not necessarily small populations. Frontier markets include Bangladesh, many countries in Africa, and Vietnam (which is highlighted by many as a particularly fast growing economy).

For now, all emerging market investors remain fixated on the dollar’s fortunes, This is because, typically, a weak dollar provides the sort of environment required for emerging market economies to outperform.

The other issue likely to dictate the prospects of emerging markets going forward is the all important commodities cycle. Simply put, a bull market for commodities like iron ore, copper, and oil, provides major investment inflows into the commodity rich emerging market nations and helps their economic development. We saw how Chinese demand for commodities propelled the last great commodity supercycle and commodities trading legend Dwight Anderson said in his Real Vision interview that we would never again see a bull market – led by China’s development- on that scale again.