Emerging markets are hard work for investors

Some lost ground has been made up by emerging markets - but don't expect a roaring rally.

The MSCI Emerging Markets Index has made up most of the ground it lost during its summer swoon. And September marked the first month in six that more money flowed into emerging market equities than flowed out. Still, don't expect a roaring rally.

The commodities supercycle has ended now that China is slowing. And while the US Federal Reserve has delayed easing up on money-printing, "the direction of travel" for US yields is up, says Fidelity's Tom Stevenson in The Sunday Telegraph, as markets begin to anticipate monetary tightening.

Higher interest rates in the US drag up emerging market rates too, and draw money away from developing states as the relative appeal of these risky assets dwindles.

Capital flight is worst for economies with current-account deficits. They spend more abroad than they take in from overseas, and depend on foreign capital to cover this external deficit. "The past five years' positive capital flows, appreciating currencies and falling interest rates are about to go into reverse."

The receding tide has uncovered structural problems that were ignored by both governments and investors during the good times, but continue to hamper countries' growth potential.

Take India, says Victor Mallett in the FT. Pervasive red tape means it takes years to acquire land for factories and projects, while onerous labour laws deter hiring. This weakens manufacturing, so India's industrial imports are high.

That in turn widens the current-account deficit, making India's economy all the more vulnerable to foreign capital exiting. Meanwhile, slow developed world growth means tepid emerging market export growth. The International Monetary Fund's 2013 emerging markets growth forecast is now 4.5%, down from 5% in July.

But none of this means investors should flee the asset class. Emerging markets have reduced their foreign currency debt in recent years and built up their foreign exchange reserves, so they are better able to withstand a slump in their currencies amid fleeing foreign capital. And in many cases the mounting headwinds are in the price.

The MSCI is on a wide price/earnings discount to developed markets. Making money in emerging markets in the next few years will be harder than in recent years, but not impossible. We still think Brazil, Vietnam, Mexico and the Philippines are among the best bets.

Recommended

Russian stocks suffer as the world fears it will invade Ukraine
European stockmarkets

Russian stocks suffer as the world fears it will invade Ukraine

Despite a booming economy, Russian stocks look extraordinarily cheap – but if it invades Ukraine, the Russian stockmarket will become all but uninvest…
14 Jan 2022
Erdogan’s risky bluff to save the Turkish lira
Currencies

Erdogan’s risky bluff to save the Turkish lira

Turkey's autocratic president has said the government will guarantee lira deposits against further deterioration in the exchange rate. Few people are …
7 Jan 2022
Myanmar: a coup, a civil war, a crisis and China
Emerging markets

Myanmar: a coup, a civil war, a crisis and China

Myanmar was heading in the right direction after decades of isolation before the army seized control again in February. Now the outlook is increasingl…
24 Dec 2021
Will emerging markets have a better 2022, or is it downhill from here?
Emerging markets

Will emerging markets have a better 2022, or is it downhill from here?

Emerging market equities had a dismal year in 2021. John Stepek asks if 2022 will be any better, and takes a look at some of the most promising areas …
23 Dec 2021

Most Popular

Ask for a pay rise – everyone else is
Inflation

Ask for a pay rise – everyone else is

As inflation bites and the labour market remains tight, many of the nation's employees are asking for a pay rise. Merryn Somerset Webb explains why yo…
17 Jan 2022
Temple Bar’s Ian Lance and Nick Purves: the essence of value investing
Investment strategy

Temple Bar’s Ian Lance and Nick Purves: the essence of value investing

Ian Lance and Nick Purves of the Temple Bar investment trust explain the essence of “value investing” – buying something for less than its intrinsic v…
14 Jan 2022
US inflation is at its highest since 1982. Why aren’t markets panicking?
Inflation

US inflation is at its highest since 1982. Why aren’t markets panicking?

US inflation is at 7% – the last time it was this high interest rates were at 14%. But instead of panicking, markets just shrugged. John Stepek explai…
13 Jan 2022