Emerging market stock exchanges outperformed expectations in the first half of 2017 after a multi-year slump, with MSCI’s core and frontier indices up 17% and 12%.
Local government bond gains, at 8%, outstripped external sovereign and corporate ones at around 5%. All emerging market debt and equity asset classes rallied, replicating advanced economy minimum yield flight in 2016 despite marginal central bank benchmark rate increases.
Resurgent fund flows of more than $100bn into financial markets have strengthened momentum since the end of the first quarter, when tremors related to Donald Trump’s trade and immigration policies began to fade. The dollar retreated from previous highs and commodity prices stabilised. Investors subsequently spent money with scant geographic and asset class distinction. The second half of the year will determine if markets can again begin to rise and fall according to their own virtues in their own long-delayed ‘normalisation’ process, coinciding with the 20th anniversary of Asia’s financial crisis.
The International Monetary Fund in April raised its growth forecast for developing economies to 4.5% for 2017. The Fund, however, continues to warn about the threats posed by high fiscal deficits, monetary strain from bank deleveraging, and balance of payments pressure caused by capital outflows. The IMF recommends another phase of business and financial sector liberalisation in emerging markets. Stalled concepts, such as state-owned bank and enterprise privatisation, should be reinitiated as well.
Over the last six months Russia’s stock market was the only loser, down 15%, among the bourses of the largest emerging economies. China and India were each ahead 20%, while Brazil was essentially flat with a 2% rise. Brazil and Russia exited recession, though continue to contend with stagflation.
China reported annualised growth of 6.9% in the second quarter, which is welcome news for stock exchanges and President Xi Jinping in the lead-up to the 19th Communist Party congress this autumn. The well-telegraphed incremental inclusion of China A-shares in MSCI’s emerging economies index was another catalyst for market strengthening. India reported similarly auspicious GDP growth of 7.1% for the fiscal year up to March 2017. The country is a worthy example of the benefits of expansive structural reform, in spite of the mixed reaction to its large-scale demonetisation and tax unification programmes.
The rebound in these leading emerging economies was instrumental in lifting external corporate and sovereign bond markets, with issuance reaching a record $100bn and $250bn respectively through end-June. China’s largest state-run and real estate companies accounted for 40% of corporate bonds and Brazil’s Petrobras, the largest individual corporate debtor among oil companies, rebounded after its stock price fell to a historical low of $4.41 in January 2016.
Despite lingering international sanctions, Russia returned in force to both corporate and sovereign bond markets. A spate of new entrants and returning participants, including Gulf countries and Argentina, lifted lacklustre sovereign activity. IMF programme negotiations renewed interest in bonds from frontier markets in Africa and elsewhere, including Ghana, Zambia, Cameroon and Mongolia.
A budding global fixed income sell-off, which began in early July, may lead to a comprehensive correction in emerging market bond prices. Falling profits in many sectors of the economy are likewise causing a mispricing of equities. Nevertheless, in the light of modest growth in advanced economies and the likelihood of further increases in benchmark interest rates in key countries like the US, emerging market stocks and local currency debt should remain buoyant as a key element of investors’ long-term strategies.
Gary Kleiman is Co-Founder and Senior Partner at Kleiman International.