“Ten years ago, emerging markets would have been very badly hammered in market conditions like this”, as Charlie Metcalfe of First State Investments points out. But the MSCI Emerging Markets index has bounced back from August’s slide amid subprime-induced global jitters and is 2% up on the beginning of July, while the S&P 500 index is down.
This is because developing economies are “much more robust than a decade ago”, says Andrew Ness of Scottish Widows Investment Partnership. They have reduced inflation and interest rates, amassed a collective $484bn in current account surpluses, and lowered government debt to 39% of GDP, compared with 89% for developed nations. Better fundamentals and greatly reduced dependence on foreign capital means emerging economies are now less vulnerable to a liquidity squeeze. Indeed, they no longer deserve to be deemed risky, reckons Allan Conway of Schroders. Growing talk about Asian countries in particular decoupling from the West has also underpinned the asset class of late, says Steve Johnson in the FT.
Still, while the long-term outlook remains promising, it’s too soon to declare the party back on. Emerging market equities are highly sensitive to global growth, which has been above trend for five years, notes Gray Newman of Morgan Stanley. Nor has the decoupling thesis yet been tested by a US recession. So emerging markets investors could be shaken if the US slowdown “morphs into a patch of below-trend global growth”. According to one forecast, a US recession would slash global growth to 3.5% from today’s near-5%, says Bloomberg.com.
Veteran investor Marc Faber says that valuations are “not very compelling” while “over-extended” emerging markets look vulnerable to foreign fund withdrawals as the downturn in the credit cycle prompts widespread deleveraging; some could drop by 40%, he told CNBC last month. Throw in global markets’ enduring tendency to take their lead from Wall Street, especially when US stocks slide, and there are likely to be better entry points ahead.