Emerging markets are throwing tantrums

This article is part of
Global Emerging Markets - March 2014

The underperformance of emerging markets, particularly three of the much talked about Bric economies – Brazil, China and India – continues to worry many investors.

Talk of tighter monetary policy in the west, coupled with higher expectations for returns on risky assets in the developed world, has caused hot money to flow out of emerging markets and this has raised questions about their ability to withstand market upheaval.

Interest rates have been raised in many emerging markets to stem currency depreciation and control inflation. Added to this, the central banks of India and Turkey have implemented unanticipated rate rises in response to market conditions, while peso panic recently hit Argentina.

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Many continue to be concerned about debt levels in China, with the shadow banking system in particular coming under increasing scrutiny. Short term interest rates have again been volatile, although intervention by the People’s Bank of China has kept them from equalling the levels that were seen during the middle of last year.

However, amid the turmoil, there are opportunities for those who can stomach them, especially as these equities are likely to be significantly cheaper than they have been in recent years.

Of course, a slowdown was always inevitable, irrespective of US policy – it’s called growing pains. It is only natural that after a good few years of uninterrupted growth, some of these economies should contract: this is what happens elsewhere – and it would be unreasonable to expect some of these markets to continue at the rate we have become accustomed to seeing.

After all, emerging markets are like teenagers: they may be full of potential but not all develop as quickly, or in the same way, and setbacks can be brutal. Investors with a long investment horizon, and therefore a moderately high capacity for risk, may find that current valuations will have been a good entry point for emerging markets.

Of the three economies mentioned above it is China that is by far the most influential. The market itself has been fairly subdued of late, only approximately 5 per cent lower over both six and 12 months, compared with, for example, falls of 15 per cent and 27 per cent in the same periods in the Latin American markets. In Europe, however, an apparently endless supply of credit encouraged speculators to generate dramatic rises in the likes of the Greek and Turkish stockmarkets.

The muted returns in the Chinese stockmarket demonstrate that some slowdown in the rate of growth had already been well flagged, with the authorities taking firm action to prevent an inflationary bubble. The main concern in markets generally has been over how the US Federal Reserve tightening will be implemented, and if it does prove to be too drastic or premature, could it then end up killing the proverbial golden goose?

There will always be wild cards where emerging markets are concerned, and these will inevitably attract the most attention. The message is clear then: if investors can weather the teenage tantrum storms from these emerging markets, the rewards are there for the taking.