Emerging-market investors turn cautious

Russia's invasion of Ukraine has sparked a selloff in emerging markets as investors head for safe haven assets.

Many developing economies entered 2022 contending with high inflation, slowing growth and stretched public finances because of the pandemic, says The Economist. Then Russia invaded Ukraine. Now they can add soaring commodity prices into the mix: “Large importers of wheat and sunflower oil across north Africa and the Middle East, most notably Egypt” could be heading for hunger and civil unrest. 

The war may also prompt companies and investors to take a more cautious approach to overseas investing in future for fear of further geopolitical upsets. That would mean less investment in emerging markets (EMs) – which are perceived as riskier – and steeper capital costs for local businesses.

High risk, low growth 

“The start of the war sparked a sell-off across many EM financial markets,” says William Jackson of Capital Economics. This reflects “financial contagion” as investors turn towards safe haven assets. But EMs had been struggling before the invasion, with the MSCI Emerging Markets index falling more than 10% in the year to the end of February, even as the developed market equivalent gained more than 10%. That’s partly due to a regulatory crackdown in China, which accounts for almost one-third of the index.

Tighter US monetary policy is another headwind, says Jonathan Wheatley in the Financial Times. Higher interest rates on dollar assets tend to cause investors to pull cash from emerging market stocks and bonds. It also usually boosts the dollar, and a stronger greenback makes it more expensive for companies in emerging economies to raise and service dollar-denominated debt.

Emerging economies have less reliable legal and economic institutions than developed ones. Investors accept that when growth prospects are strong, but “the difference between the pace of growth in developing and advanced economies is set to narrow to its lowest level this century”. As David Lubin of Citi bank puts it, “without growth, it’s just [all] risk”.

Nevertheless, emerging markets look well-positioned, says Reshma Kapadia in Barron’s. Most have lower reliance on foreign borrowing and higher foreign exchange reserves than during previous periods of US monetary tightening. India’s foreign exchange reserves have more than doubled over the past decade. MSCI EM company profits “are expected to grow by 10.2% in 2022”, faster than the 8.9% predicted for US stocks.

That growth comes much cheaper too, with the index trading on 12 times 12-month forward earnings, compared with 19 in the US, “the widest valuation gap in nearly 20 years”. Brazil and Indonesia, which both stand to gain from the commodities boom, look intriguing bets.

Recommended

Is it time to pick up growth stock bargains yet?
Investment strategy

Is it time to pick up growth stock bargains yet?

If you’re thinking of picking up some bargains from the tech stock crash, beware – there are still plenty of “growth traps” out there. John Stepek exp…
26 May 2022
A fund that should give good returns from investing in good deeds
Share tips

A fund that should give good returns from investing in good deeds

Schroders BSC Social Impact Trust has made a solid start and looks more attractive than it did at launch, says Max King.
26 May 2022
Wall Street’s sell-off has further to go
US stockmarkets

Wall Street’s sell-off has further to go

The current stockmarket sell-off has been led by tech stocks, but the pain is spreading. The bear market has further to go – US stocks are still expen…
25 May 2022
Law Debenture investment trust update: premium over net assets slips
Investment trusts

Law Debenture investment trust update: premium over net assets slips

Saloni Sardana looks at the latest update from the Law Debenture investment trust, one of the six funds in MoneyWeek’s model investment trust portfoli…
25 May 2022

Most Popular

The world’s hottest housing markets are faltering – is the UK next?
House prices

The world’s hottest housing markets are faltering – is the UK next?

As interest rates rise, house prices in the world’s most overpriced markets are starting to fall. The UK’s turn will come, says John Stepek. But will …
23 May 2022
Everything is collapsing at once – here’s what to do about it
Investment strategy

Everything is collapsing at once – here’s what to do about it

Equity and bond markets are crashing, while inflation destroys the value of cash. Merryn Somerset Webb looks at where investors can turn to protect th…
23 May 2022
Three high-yielding FTSE 250 dividend stocks I’d invest in right now
Share tips

Three high-yielding FTSE 250 dividend stocks I’d invest in right now

The average FTSE 250 dividend yield is around 2.4%, but many stocks yield much more. Rupert Hargreaves picks the best FTSE 250 stocks for income inves…
23 May 2022