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

3 emerging-market stocks to watch
Share tips

3 emerging-market stocks to watch

The top emerging-market stocks to keep an eye on, according to Union Bancaire Privée’s Eli Koen.
1 Dec 2022
Three of emerging Asia’s best value stocks
Share tips

Three of emerging Asia’s best value stocks

If you’re looking to boost your investment in Asia, then here are the stocks you should be considering, says Nitin Bajaj of the Fidelity Asian Values …
22 Nov 2022
Invest in Brazil as the country gets set for growth
Emerging markets

Invest in Brazil as the country gets set for growth

It’s time to invest in Brazil as the economic powerhouse looks set to profit from the two key trends of the next 20 years: the global energy transitio…
3 Nov 2022
Shining a light on India
Advertisement Feature

Shining a light on India

Despite some short-term challenges, India remains very attractive for investors. Here’s why.
2 Nov 2022

Most Popular

Is it cheaper to leave the heating on low all day?
Personal finance

Is it cheaper to leave the heating on low all day?

The weather is getting colder and energy bills are rising, but is it really cheaper to leave the heating on low all day or should you only turn it on …
1 Dec 2022
Radiator vs electric heater – which is cheaper?
Personal finance

Radiator vs electric heater – which is cheaper?

We compare the costs, pros and cons of radiators and electric heaters and see which one will help keep your energy bill as low as possible.
28 Nov 2022
The pros and cons of smart meters – should you switch?
Personal finance

The pros and cons of smart meters – should you switch?

A smart meter can help you keep tabs on your energy usage, but is it better than a regular meter? We take a look at smart meters vs regular meters.
2 Dec 2022