Lost Decade in Emerging Markets: Investors Already Halfway Thereby
Emerging stock markets have been flat over past six years
Risks are commodity rout, China slowing and higher U.S. rates
Just 14 years ago Wall Street fell in love with the BRICs, the tidy acronym for four major emerging economies that, to many, looked like sure winners.
Today, after heady runs and abrupt reversals, most of the BRICs -- in fact, most developing nations -- look like big-time losers.
The history of emerging markets is a history of booms and busts, but the immediate future may hold something more prosaic: malaise. Investors today confront what could turn out to be a lost decade of returns, with four or five more meager years ahead.
“These are very much the lean years after the bonanza decade,” said Harvard Kennedy School economist Carmen Reinhart, one of the world’s top experts on financial crises and developing economies.
Not long ago the BRICs -- Brazil, Russia, India and China -- were celebrated as engines of global growth. Now Brazil and Russia face deep recessions brought on by the collapse in global commodities, while China is slowing and struggling to prop up its fast-sinking stock market.
The prospect of higher U.S. interest rates only adds to the gloom. Currencies from the South African rand to the Malaysian ringgit fell anew on Wednesday amid worries the U.S. Federal Reserve might move as early as September.
To Ruchir Sharma, the turnabout suggests the outsize investment returns of the early 2000s -- the MSCI Emerging Markets Index nearly quadrupled between 2002 and 2010 -- now look like an anomaly.
“Very few emerging markets historically have ever been able to make it to the developed countries,” said Sharma, head of emerging markets at Morgan Stanley Investment Management Inc. “This is a return to normalcy.”
The numbers are certainly sobering. All told, developing-nation currencies have fallen to their lowest levels since 1999, and bonds denominated in those currencies have wiped out five years’ worth of gains.
Meantime, in the stock market, the emerging world and developed one are diverging sharply. Since 2009, the MSCI index has fallen 10 percent while developed markets have soared about 50 percent. Based on estimated price-to-earnings ratios, the emerging markets are trading at their biggest discount to developed ones since 2006 -- 31 percent.
The good news is that few strategists foresee full-blown crises like the ones that shook East Asia in the late 1990s or Latin America in the early 1980s.
Yet a confluence of powerful forces -- notably a strong dollar, weak commodities prices, China’s slowdown and higher U.S. rates -- will, at minimum, bridle growth.
For much of the past 15 years, easy credit from the Fed and a robust Chinese economy combined to drive investment dollars into emerging markets and power growth. Now, the risk is that the twin “suns” of the Fed and China will become out of sync, as the U.S. starts raising rates and the Chinese economy slows, according to Stephen Jen, co-founder of London-based SLJ Macro Partners LLP and a former International Monetary Fund economist.
If that happens, as SLJ predicts, there will be more trouble for emerging markets, Jen wrote in a July 23 note to clients.
Even as China cools, its exporters are grabbing market share from competitors elsewhere, including those in other emerging economies, according to David Lubin, Citigroup Inc.’s head of emerging market economics. At the same time, Chinese manufacturers are increasingly procuring components at home, rather than importing them. Both developments are bad news for other emerging economies. Excluding China, growth in developing countries was virtually flat during the second quarter.
The IMF still expects the world’s emerging economies to grow 4.2 percent this year, even as Brazil and Russia sink into recession. But that’s only 0.9 percentage points faster than the world economy as a whole, the smallest gap since 1999.
In many developing economies, politics and policy are also big worries. In recent weeks, Chinese policy makers have taken unprecedented steps to shore up the nation’s stock market, leaving many investors wondering what Beijing might do next. In Brazil, President Dilma Rousseff, besieged by a sweeping corruption scandal, has back pedaled on efforts to cut the budget, potentially jeopardizing her country’s credit rating.
Granted, emerging economies are in far better shape than they were when past crises hit. While many companies have taken on debt, governments overall have reduced borrowing relative to their economies.
Still, many analysts see more trouble ahead. Fourteen of 23 major emerging-market currencies are forecast to decline against the dollar by the end of June 2016, according to data compiled by Bloomberg. Forecast earnings for companies in the MSCI index have fallen to their lowest since the end of 2009.
“It’s a slow-motion crisis,” said Bhanu Baweja, London-based head of emerging market cross asset strategy at UBS Group AG. “Real challenges lie ahead of us.”