Emerging-market investors turn cautious

Bulk carrier being loaded with grain — Ukraine is a major wheat exporter

(Image credit: © Elena Larina / Alamy)

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.

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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.

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Alex is an investment writer who has been contributing to MoneyWeek since 2015. He has been the magazine’s markets editor since 2019.

Alex has a passion for demystifying the often arcane world of finance for a general readership. While financial media tends to focus compulsively on the latest trend, the best opportunities can lie forgotten elsewhere.

He is especially interested in European equities – where his fluent French helps him to cover the continent’s largest bourse – and emerging markets, where his experience living in Beijing, and conversational Chinese, prove useful.

Hailing from Leeds, he studied Philosophy, Politics and Economics at the University of Oxford. He also holds a Master of Public Health from the University of Manchester.