Emerging world has further to go

Girls playing with VR headsets © Rex Features
Alibaba looks lofty, but far from absurd

If you’re searching for signs that investors are thinking of running for the hills, take a look at emerging markets and think again, says Benjamin Dow on Bloomberg. These countries are traditionally seen as risky assets, which nervous investors tend to sell first if the mood turns bearish on global markets. Yet the benchmark MSCI Emerging Markets index has just reached a two-year high.
It has gained more than a fifth this year. 

The rally could well continue, as emerging markets are in something of a sweet spot. On the one hand, growth in the developing world has improved in recent months, with heavyweights Brazil and Russia climbing out of recession, China looking steady, and global growth accelerating – always especially good news as developing countries tend to rely on exports more than developed markets. 

Meanwhile, “a faltering dollar has injected further momentum into the rally”, notes Steve Johnson in the Financial Times. A rising dollar usually draws money away from risky assets, and is often accompanied – and reinforced – by the prospect of higher interest rates on US assets. So riskier securities such as emerging-market stocks and currencies appear less attractive. But this headwind has faded since the dollar has risen far in recent years and the eurozone’s momentum has grabbed forex traders’ attention.

More broadly, there is still little sign of tighter monetary policy outside the US, where rates are rising in baby steps. Loose global liquidity is always good news for emerging markets. And for all the sound and fury from the White House, there has so far been little sign of the damaging protectionism traders were expecting from the US when Donald Trump became president.

His inability to get anything done has emboldened investors. It’s also worth noting, as Dimitra DeFotis says in Barron’s, that the technology sector is pivotal, because it is driving the index. The sector now accounts for more than 25% of it, triple the proportion of a decade ago.

So keep an eye on sentiment surrounding the likes of Baidu or Alibaba. As far as that goes, valuations look “lofty”, but far from absurd, given that the biggest emerging-market tech groups are profitable – they are cashing in on the rapidly swelling ranks of the new middle classes. Emerging markets as a whole, moreover, look far from stretched. The cyclically adjusted price/earnings ratio of the MSCI Emerging Markets index is 16, below the historical average of 24.

Ukraine turns the corner

Ukraine has had a rough ride in the past decade. The global financial crisis and commodities downturn dented demand for its steel exports, while in recent years political turmoil has progressively undermined business and consumer confidence. Russia’s incursion into the east of the country in 2014 triggered a civil war between local Russian-speaking forces and Ukrainian loyalists that has claimed 10,000 lives. The economy shrank by 10% in 2015, with the collapsing currency causing a spike in inflation and adding to the (largely dollar-denominated) debt burden. 

But things are starting to look up, says Szu Ping Chan in The Daily Telegraph. A key feature of the four-year, $17.5bn bailout package from the International Monetary Fund was a clean-up of the notoriously inefficient and corrupt banking sector to bolster foreign investors’ confidence and pave the way for healthy credit growth. This process, which on occasion involved “cops-and-robbers-style chases across the country”, led to the closure of half the country’s banks; the rest are gradually being recapitalised.

The rule of law has strengthened and the sense of chaos has dissipated to some extent. The World Bank’s annual Ease of Doing Business index ranks Ukraine 80th out of 190 countries this year, compared with 128th in 2007. Meanwhile, the pensions system is being overhauled, which should rein in long-term state spending. The government is raising the retirement age from the late-50s to the EU average of 63. The macroeconomic backdrop is improving now that confidence has returned. Inflation, which reached 50% in 2015, is set to hit 5% by the end of the decade, while GDP growth of 2% has been pencilled in for 2017.

Swedish krona wakes up

The Swedish krona, comatose for most of this year, has awoken with a jolt, jumping to a nine-month high around SKr9.50 against the euro. In recent years the Swedish central bank, the Riksbank, has been among the most dovish in the world, lowering interest rates to -0.5% and engaging in quantitative easing – or money printing – to bolster growth.

It raised interest rates prematurely in 2010, and is wary of doing so again, says The Economist. It has also been worried that if it tightens policy before the European Central Bank, money from investors wanting to cash in on Europe’s growth could flood in, as the Swedish economy has close links to the eurozone.

But now it will become increasingly difficult for the Riksbank to keep monetary policy loose. Not only is the economy expanding at an annual pace of 4%, but core inflation reached 2.4% in July, exceeding the Riksbank’s 2% target for the first time since 2010. Currency traders “are starting to pay attention”, says Katie Martin in the Financial Times. Expect more talk of normalising monetary policy, implying a higher krona. “Krona bears should be getting hot under the collar.”