Rama Krishna Vadlamudi,
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Since the beginning
of this calendar year 2013, emerging markets are down. Various reasons can be
attributed to the steep decline. Predominantly, the perception of the US Federal
Reserve tapering its bond buying program (QE 3) has rattled the world markets
in the last two months. This has resulted in large outflow of money from
emerging markets to developed markets. Of course, emerging economies have their
own domestic problems, ranging from street protests, currency depreciation,
large deficits, and steep fall in commodity prices. Global investors have
started realigning their portfolios, moving from emerging markets to developed
ones. The trend may continue for another few quarters, before investors flock
back to emerging markets—which are currently down, but not out.
Comparing Equity Returns of Developed & Emerging
Markets (2003-2012):
Notes: S&P 500 index
represents US equities; MSCI EAFE - MSCI Europe, Australasia and the Far East
index (excludes US and Canada); and MSCI EM - MSCI Emerging Markets index.
The MSCI EM index has
outperformed both the S&P 500 and MSCI EAFE indices in eight out of ten
years between 2003 and 2012. The equity returns are depicted in the above
graph. Only in 2008 and 2011, the emerging markets equity returns
underperformed both the US
equities; and world equities (ex-US and Canada ).
During the current calendar year
2013, the emerging markets have underperformed the US equities, as well as other
developed markets. What is troublesome for market participants now is that the
underperformance is very large. While the MSCI EM index has fallen by about 10
percent, the S&P 500 has surged by 18 percent, indicating an overall underperformance
of about 28 percent for emerging markets in 2013 so far. This underperformance
is due to fall, in the range of 10 to 20 percent, of equities in Brazil , Russia ,
China and India .
In Japan , the Prime Minister Shinzo
Abe has vowed to double the country’s monetary base in two years—with Bank of
Japan injecting massive doses of liquidity into the markets, in order to boost
the crippled economy and tackle the entrenched deflation. Following this, the Japanese
Yen has depreciated against the US dollar by 11 percent in 2013, while the
Nikkei stock market index has shot up by 31 percent. Stock markets in the UK , Germany
and France
too have gone up this year.
What Caused this Underperformance of EMs in 2013?
In May this year, the US Federal
Reserve had hinted at tapering of its bond buying program (QE3). It was
perceived that the tapering would start in September this year and would end by
the middle of 2014. The markets have taken this news of US Fed tapering very
negatively. Even though attempts have been made to assuage the markets
subsequently, the market perception has not changed. The US Fed, the IMF and
the ECB have tried to calm the nerves of financial markets, by saying that
they’ll try the easy money policies as long as their economies remain weak. The
reality is that one day these central banks have to stop their massive
liquidity injection programs, resulting in large money outflows from emerging
to developed markets.
With the hint of US Fed tapering,
global investors have started selling securities, both equity and bond, in
emerging markets and taking their funds back to the developed markets. The
yield of 10-year US Treasury note has increased from 1.6% in May to the current
2.58%, attracting funds back to the US markets, in some sort of trend
reversal.
(As
part of its Quantitative Easing 3 or QE3 program, the US Fed is committed to
buying bonds worth $85 billion per month. When central banks buy bonds, they
inject liquidity into the banking system. The massive monetary stimulus from
developed economies since the 2007/2008 Global Financial Crisis, particularly
the US Fed, has resulted in enormous liquidity, said to be about $12 trillion,
in the world fuelling price inflation in the emerging market equities/bonds and
world commodities. This excess money has been circulating around the world,
chasing returns and yields.)
Weakness in BRICS markets:
With the BRICs markets grossly
underperforming the developed market indices, investors have started focusing
on risks in emerging markets. In general, investors demand higher equity risk
premium to invest in emerging market securities, due to higher risks in them as
compared to developed markets. Even debt market returns in emerging markets are
negative this year. Brazil
and Turkey
have faced massive street protests recently—impacting the investor sentiment
negatively. (Interestingly, Turkey ’s
sovereign rating was upgraded to investment grade by Moody’s in May 2013).
Chinese economy has slowed down
in the past few years. The new Chinese government is worried about local
government debt and trying to put restrictions on budget deficits and bank
credits. Global commodity prices have corrected. Year-to-date, gold has
corrected by 20 percent and silver by 34 percent approximately. Even copper, zinc
and aluminum have corrected between 10 to 13 percent. Commodity-producing
countries such as, Brazil
and Russia ,
have suffered following the commodity price decline. However, crude oil prices
have remained firm.
The commentary from experts
indicates that the fancy for emerging market stocks and bonds has faded away
for the time being, as the focus has shifted to developed markets and investors
seem to have shifted their loyalty away from emerging markets.
Brazilian real, South African
rand, Indian rupee, and Turkish lira have fallen anywhere between 8 to 12
percent since May this year, after the talk of US Fed tapering hit the markets.
These currency depreciations have prompted selling in emerging markets.
Convergence between Emerging and Developed
Markets:
Over the years, emerging markets
have evolved with gradual opening up of their economies, achieving superior
economic growths and creating a sense of political maturity. One interesting
development in recent years is that it is difficult to distinguish between
companies in the developed markets and emerging markets. For example, a large
number of US and European multi-national companies (MNCs) derive their revenues
from outside their countries, including those in the emerging market group. The
US-based companies, IBM, Accenture, Coca Cola, and Pfizer generate more than 50
percent of their total revenues from non-US countries. So are Swiss-based
Nestle and UK-based Unilever.
Even companies in the emerging
countries have acquired a global status by acquiring companies in the developed
world. India ’s
Tata Motors has acquired JLR, the Birlas have acquired Novelis, and Apollo
Tyres is taking over US-based Cooper Tire and Rubber.
There was a time when different
economies used to follow different monetary and fiscal policies. After the
Global Financial Crisis, most of the developed economies have been following
similar monetary policies—that is, buying bonds and injecting money into the
financial markets. The US Fed, the ECB and the BoJ have followed these massive
bond buying programs.
Convergence in the world markets
has gone up. Correlations across equity markets have increased in recent years,
especially in the last decade following increased globalization, massive surge
in cheap money and interdependence of global trade.
Still Differences Exist:
While differences have narrowed
down, there remain still a lot of differences between developed and emerging
economies. Emerging markets still carry higher risks—ranging from volatile
political/social environment, heavy dependence on commodities, weaker capital
market regulation, higher market volatility, unsustainable current account
deficits and currency risks. Global wealth is concentrated in developed
countries.
Emerging Markets: Poised for Comeback:
At one end, global investors
chase growth and/or yield. They’re quick to withdraw or invest their money at
very short notice. But at the other end, large institutional investors, like
pension funds, insurance companies and foundations, look for stable and long
term returns. They lend stability to financial markets—be it equity or bond. They
play an anchoring role in markets.
Emerging markets will continue to
attract investor interest. Unilever increased its stake in Hindustan Unilever,
its Indian subsidiary, from 52% to 68% by pumping in $3.2 billion. Diageo of
the UK bought India ’s
United Spirits and UK-based BP invested in Reliance Industries’ gas blocks.
While emerging markets have not
been doing well as compared to the developed ones at present, there exists a large potential for emerging markets to grow much faster than developed
markets. Of course, there will be some rotation in the list of emerging markets.
The focus of global investors will shift to newly emerging markets, where the
prospects would be much better. The future of developed and emerging markets is
interlinked. Higher fertility rates, advances in technology, education &
healthcare, favorable demographic changes, and domestic consumption are still
the star attractions for emerging markets. The negativity surrounding developing
countries is justified, but no one can deny their potential for future and
faster growth.
They’re down, but it’s not time
to write them off.
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Notes:
BoJ
– Bank of Japan
BRICs
– A grouping of Brazil , Russia , India
and China (sometimes South Africa is also included)
DMs
– Developed Markets
ECB
– European Central Bank
IMF
– International Monetary Fund
Disclaimer:
The author is an investment analyst and freelance writer. This write-up is for
information purposes only and should not be taken as investment advice.
Investors are advised to consult their financial adviser before making any
investment decisions. The author’s articles on financial markets and Indian
economy can be reached at:
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