Don’t tuck into the emerging-market leftovers

published 22 December 2017

876-Erdogan-634 — "Each day it gets worse. We don't know who Erdogan listens to"

It's been an excellent year for emerging markets, with the benchmark MSCI Emerging Markets index up by more than a fifth. But even in stellar years there are always a few laggards, and this time round the most conspicuous ones are Russia and Turkey, whose equities have slipped or gone nowhere in the past 12 months.

"As with self-service buffets, there can be a reason why leftovers appear unloved," as James Kynge says in the Financial Times. For now, Russia's prospects look better. The higher oil price will "lift all boats", says Morgan Stanley, while construction growth related to the 2018 World Cup will give investment a boost.

Following a nasty recession owing to the oil-price slide, consumers are regaining confidence, especially as the central bank, having squeezed annual inflation to 2.6%, is cutting interest rates.

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But while the economy is looking up, many investors are concerned that its long-term prospects are unappealing. Without structural reforms to bolster the economy's potential growth rate, Russia is unlikely to be able to expand by more than 1.8% a year over the long term, estimates Morgan Stanley.

The government says it is working on reforms to lift the economy's speed limit to 3%, but so far little has happened. And its illiberalism and capricious approach to property rights are recurring headaches.

Autocratic and erratic

The main fears about Turkey are also political. Its authoritarian president, Recep Tayyip Erdogan, "has become a huge problem for everyone interested or invested in Turkey", Atilla Yesilada of GlobalSource Partners, a consultancy, told the FT's Jonathan Wheatley. "Each day it gets worse. We don't know who he listens to." One worry is his tendency to criticise the central bank for raising rates, or failing to cut them, undermining its supposed independence.

The economy, set to expand by around 5.5% this year, looks overstimulated due to state spending and cheap credit, while robust consumption is increasing the current-account deficit, now worth almost 5% of GDP.

While many developing countries have been able to reduce their deficits with the rest of the world in recent years, Turkey is becoming ever more reliant on foreign capital to plug its own gap, and is thus especially vulnerable to money leaving emerging markets, as occurs when the US raises interest rates. "In the event of any Fed-related sell-off," says Capital Economics, "it is likely to be the Turkish lira that suffers the most."

Ignore the Mystic Megs

At this time of year, the financial media is full of stockmarket analysts' forecasts for the year ahead. Don't pay any attention. As James Mackintosh points out in The Wall Street Journal, it's hard to see why they bother. "Only rarely" is the average S&P 500 forecast, for instance, "anywhere near the actual result". More than half the time since the turn of the millennium, "the miss has been either too high or too low by an amount bigger" than the S&P's 9% long-term average annual gain.

Analysts tend to miss bear markets completely (the average 12-month forecast for 2008 suggested moderate gains for the S&P 500) and underestimate upswings. The big-picture people are no better. The International Monetary Fund pencilled in GDP growth of almost 2% for the US in 2008, when the crisis struck.

Market predictions are an exercise in marketing; being bearish would deter customers. While we can get a reasonable idea of long-term price movements from starting valuations, a year is a very short space of time, in which all sorts of random events can cause sharp ups and downs. Don't base any decisions on market forecasts for 2018.

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.