25 September 2018

Collateral Damage

While investors in the US have been buoyed by impressive economic growth and low unemployment, other parts of the world have been less sanguine over the effects of the President’s actions


While investors in the US have been buoyed by impressive economic growth and low unemployment, other parts of the world have been less sanguine over the effects of the President’s actions. Emerging market indices technically slipped into bear territory, recording falls from the peak of more than 20%. Many nations in the developing world have seen their currencies savaged in foreign exchange markets as investors distance themselves from these potentially damaged economies.

But is such a bearish stance justified? After all, these are countries that remain set to deliver economic growth on a scale that the developing world can only dream about. China should deliver a rise in their gross domestic product of 6.5% this year – India an even greater increase. And many other Asian nations will not be far behind. Indeed, the long term case for investing in emerging markets – large populations eager to play catch up on the West, with cheap labour allowing competitive industrialisation - remains intact, despite the imposition of swingeing trade tariffs.

Unfortunately the bigger long term picture fails to take into account the shorter, more challenging reality of what is presently going on. A stronger US dollar and rising interest rates there are sucking out cash from the emerging world and starving them of credit. Moreover, there are pockets of real concern within this particular universe. Populous countries like Brazil and Turkey have been suffering extreme economic hardship. Venezuela has imploded, despite having some of the largest oil reserves in the world. Argentina’s foreign debt crisis is leading to real hardship. And geo-political uncertainty continues, most notably in the Middle East.

So, perhaps unsurprisingly, we have been seeing a wholesale withdrawal of cash from these markets – a reflection of the perceived higher levels of risk they now contain. According to the Institute of International Finance, foreign investors sold more than $12 billion worth of stocks and bonds in May alone this year and the outflow grew even more in June. Interestingly, China saw much of the selling pressure, yet they remain a massive holder of US government paper – something that Mr Trump needs to bear in mind as he reviews which other products from the world’s second largest economy are worthy of being hit with punitive tariffs. 

It seems the risk-off attitude of investors has had some merit. The question is, has the correction gone far enough or is this simply the beginning of the end of the long term argument for backing these markets? Much will, of course, depend on whether the unpredictable US President continues his mission and the success or otherwise of his actions. Only time will tell, but the likelihood is that sentiment could turn on a sixpence if it looked as though a trade accord was in the offering or if a gentler approach was emanating from the White House. 

However, there are other elements in the mix that suggest some emerging markets may prove less vulnerable to upsets generated by the developed world in the future. In particular, technology will undoubtedly play a much larger role in how some of these nations prosper in the future. While US companies like Apple, Google, Facebook and Amazon may be considered the market leaders in their respective fields, China is already playing a significant role on the world technology stage and has some world class players capable of competing internationally. 

A stronger US dollar and rising interest rates are sucking out cash from the emerging world and starving them of credit.

There are other straws in the wind too. According to Franklin Templeton, a prominent investor in this field, emerging nations purchased more than two and a half times the number of smart phones last year than the developed world. And China and India both outpaced the US in terms of their use of the internet. Moreover, Dr Mark Mobius, who once headed the Franklin Templeton emerging markets team, is coming out of retirement to launch a new investment trust to take advantage of what he sees as an opportunity created by the setback.

These markets are clearly a riskier option than those of the developed world and would undoubtedly suffer if world trade is further impacted by a deepening tariff war. But they contain great potential and are likely beneficiaries of the greater use of technology in a widening array of spheres. Emerging markets may have been damaged in the fall out from US policy changes, but they remain worth watching. 


Illustration by Andrew Rees


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