The 2016 rally in emerging market bonds and stocks skidded in the final quarter in the light of the Federal Reserve’s interest rate hike and Donald Trump’s tough currency and trade positions. The Mexican peso and Chinese renminbi were especially under fire in the immediate aftermath of Trump’s victory. They recovered somewhat in the new year as early Trump tremors gave way to lingering anxiety over Washington’s new direction and developing economies’ faltering growth and reform efforts.
Despite recession, Brazil and Russia enjoyed impressive bounces from 2015 crisis lows. Conversely, Turkey-related portfolios were slashed in the aftermath of July’s attempted coup. Frontier share markets also disappointed with a flat composite index.
For years, investors have tended to look at relative global asset class and valuation rationales for inspiration, rather than emerging market fundamentals. With the looming tests of Trump’s presidency and the fading of quantitative easing, investors may continue to be guided by overall macroeconomic considerations. However, governments and companies may finally be motivated to seize upon underlying supportive factors that have been missing for the last decade.
The International Monetary Fund has revised downwards its forecasts for several emerging markets, though the expectation of global GDP growth for 2017 remains unchanged at 3.4%. Monetary policy will have to contend with higher world interest rates and another likely bout of depreciation of emerging market currencies against the dollar after mixed results in 2016.
Fiscal positions may be equally constrained by prevailing deficits, as both state and private banks curtail double-digit credit expansion against rising bad loan ratios and recapitalisation requirements. In external accounts, trade could plummet in the short term – according to the World Trade Organisation, trade in goods and services is already in secular decline. Cross-border remittances from the Gulf are slowing, while foreign direct investment should remain steady as many major economies, such as China, graduate from being net recipients to net investors.
Agricultural, energy and industrial commodities have rebounded but are far below former peaks. Infrastructure projects will face more competition as the US, Europe and Japan ramp up spending after relative austerity. Asian and Middle Eastern economies continue to hold trillions of dollars in reserves but must increasingly turn to foreign borrowing as backstops against persistent capital outflows. Standard and Poor’s sovereign ratings picture for 20 large emerging markets, with the exception of Indonesia, points towards downgrades.
Favourites such as India stumbled under the weight of national tax delays and the demonetisation of large-denomination banknotes in November. In the Middle East and Africa, Egypt drew new interest after ending its currency peg and receiving $12bn in IMF support, while Nigeria was removed from the local Government Bond Index-Emerging Markets for foreign exchange access limits. Even before securities in Mexico and China were battered by Trump’s rhetoric, state enterprise reforms had begun to waver.
A decade after escaping financial crisis, emerging markets as a whole face a credibility crunch that they can best addressed by own making advances in their economic structures and systems. The companies most likely to do well this year will probably be relatively little-known stocks in smaller and mid-tier emerging markets, rather than in the more exposed economies of Brazil, Russia, India and China.
Gary Kleiman is co-founder and senior partner at Kleiman International.