The storm in emerging markets spreads West

So much for the developed and developing worlds ‘decoupling’. Just as emerging markets couldn’t escape the credit crunch in 2008, so emerging-market angst is now hitting Western stocks. But how worried should investors really be?

The last time there was an emerging-markets crisis, in the late 1990s, developing economies were only worth around 20% of global GDP. Now they comprise 40%.

It won’t be clear for some time how much impact the market turbulence will have on emerging growth, as Capital Economics points out. But with the turmoil so far concentrated in a few trouble spots and Asia looking reasonably solid, overall emerging GDP growth seems unlikely to fall sharply from its recent pace of around 4% a year.

Meanwhile, says Goldman Sachs, the effect on developed markets should be limited. As far as trade is concerned, the developed world’s exports to emerging markets are worth only around 8% of GDP. In Britain the figure is just 4%; in Germany, which has the biggest exposure, 11%. Note too that there has already been a considerable slowdown in emerging-market demand in recent years.

Lower commodity prices resulting from weaker emerging growth could even bolster Western GDP. There is more risk through financial channels (like the banking system), reckons Goldman, but is it “still manageable”, not least because it is “relatively dispersed”.

Developed-market banks have less exposure to the troubled economies than they do to the troubled European periphery nations. For example, in Italy’s banks, emerging markets comprise a manageable 3.5% of total foreign claims – and this is among the highest exposures in Europe.

In sum, when it comes to economic links, “what happens in emerging markets (mostly) stays in emerging markets”, concludes Goldman.

Stock markets look slightly more vulnerable than economies, however. Emerging-market-related earnings are worth 31% of the total in the Swiss market, the highest figure in Europe, where the average is 18%. The S&P’s figure is 15%.

Still, developed-country equities face two bigger problems than emerging markets’ angst for now. One is the latest weak run of data in the United States, which highlights the second: that markets “raced ahead on loose money in 2013”, as Ian Campbell puts it on Breakingviews. As a result, markets need to adjust to the lacklustre fundamentals now that the tide of liquidity is starting to recede.

Merryn

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