“Emerging markets are now top risk to market stability...”

This article is part of
Spring Investment Monitor - March 2014

Figures from the OECD in its latest economic outlook in November 2013, still show projected Chinese GDP growth of roughly 8.2 per cent in 2014, before dropping to 7.5 per cent next year.

While this is well below the 10.4 per cent peak in 2010 and the average 9 per cent growth in 2011, this is still almost three times more than the 2.9 per cent forecast for the US this year.

The OECD highlighted in its report that the slowdown in emerging market economies could have a significant impact on the global economy, as it points out the six Briics’ economies of Brazil, Russia, India, Indonesia, China and South Africa, account for roughly 30 per cent of world GDP and approximately 15 per cent of global equity markets.

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It explains: “Tighter financial conditions as US Treasury yields rise and a slowdown in trend growth would have noticeable trade spillover effects. Global macro-model simulations suggest that a one-year, 2 percentage point decline in domestic demand growth in all non-OECD countries apart from China could lower OECD GDP growth by roughly 0.4 percentage points in the first year.”

This uncertainty about the effects of continued US tapering will have on the region is highlighted by the results of the latest Bank of America Merrill Lynch emerging markets and Asia fund manager survey.

It notes: “In a complete reversal from five years ago, emerging markets are now the biggest risk to financial market stability, while developed market counterparty and default risk is seen as minimal. Indeed, GEM equity allocations are now the lowest on record, but with a net 43 per cent saying GEM equities are undervalued, a contrarian rally may be approaching.

“To own EM, we would need to see: US bond yields peak, China growth expectations trough, and an end to EM capital flight.”

Retail investors seemed to share this statement in January. The latest IMA figures show that while equities was the best-selling asset class in the month with net retail sales of £464m suggesting investors do have risk appetite, it is not for emerging markets.

The IMA Global Emerging Markets sector was the fifth worst-selling sector in the month with net retail outflows of £105.2m, while the recently launched IMA Global Emerging Markets Bond sector was only just above it with net retail outflows of £79.2m. In contrast to the drag on EM sentiment, Europe has seen a reversal in fortune, with it ranked as the second best-selling region for equities in January with net retail sales of £261m, behind the UK.

Performance figures support this investor move, with the MSCI Europe ex UK index outperforming the major MSCI regions for the 12 months to March 4 with a return of 14.89 per cent, according to FE Analytics.

Even the MSCI North America index lagged behind with a return of 11.79 per cent, although the MSCI Emerging Markets index was firmly in the rear, recording a loss of 14.87 per cent in the period.

It’s not just equities where Europe is throwing up some potential opportunities, the previous no-go area of peripheral bonds is looking more interesting.