InvestmentsMar 17 2014

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

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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.

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.

David Lebovitz, global market strategist at JPMorgan Asset Management, notes: “With growth finally turning positive in the final two quarters of 2013, the European economy has continued its steady improvement so far this year. This has led interest rates, particularly in the periphery, notably lower, with 10-year sovereign bond yields for Italy, Spain and Ireland having fallen to pre-crisis levels.”

He points out the rally in peripheral bond yields has been partly driven by a combination of declining perceptions

of risk and improving economic fundamentals. This has been helped by Mario Draghi’s ‘whatever it takes speech’ but also through government’s introducing necessary structural reforms.

But while there is seemingly light at the end of the tunnel for Europe, and even perhaps emerging markets, Jason Hollands, managing director at Bestinvest, points out most of these statistics do not reflect the current crisis in the Ukraine.

He adds: “It is easy to see how private investors can get consumed by the white noise of current events. Should investors avoid the markets? Should they rush for ‘safe havens’ such as gold? Are ‘cheap’ Russian equities now a buying opportunity?

“The truth is that we live in a fast changing world and no one has a crystal ball to accurately predict the future, so it is important to hold your nerve when markets experience a bout of hysteria and to do what makes sense over the long term.”