Since the start of the year stock indices in emerging markets have fallen significantly, with no end in sight. The MSCI emerging markets index saw a fall of 6.6 percent in dollar terms last month, while MSCI’s South African index has lost 10.2 percent, or 4.2 percent in rand terms.
Brazil, Argentina and India have all seen sell-offs, which some leading strategists feel is a downward trend that will continue for some time.
The common thread is investor nervousness. With the withdrawal of quantitative easing (QE) in the US, these countries will find it hard to borrow money to finance fiscal and current account deficits.
At the end of last year every stock market analyst I met was bullish but now, with the tapering of QE, investors have become more cautious, despite the economic recovery we are witnessing in the US, the UK and parts of the EU.
Global output and economic growth are accelerating, according to recent International Monetary Fund (IMF) world gross domestic product (GDP) forecasts, which have been revised upwards from 3.6 percent to 3.7 percent, as the developed world recovery picks up. The US economy, still the largest globally, is braced for growth.
US GDP growth could exceed 3 percent this year. The US treasury market looks reassuringly stable, despite tapering of QE, and growth is underpinned by low inflation and interest rates.
Other areas such as the euro zone and Japan have not reached their “escape velocity”, that is, self-sustaining growth, with GDP growth for both being predicted at about 1.4 percent this year.
As QE is withdrawn, the dollar should strengthen, in response to high US interest rates, making local current account deficits harder to finance. Brazil, India, Indonesia, Turkey and South Africa (the so-called BIITS countries) have been particularly affected by this.
In addition to the problems facing all emerging markets, South Africa faces particular structural problems, such as a highly regulated labour market, barriers to new company formation, particularly in consumer products and services, corruption and fiscal policy that does not stimulate productive growth.
The major risks to the developed markets’ recovery are that the juggernaut of growth in China may slow or that there may be deflationary pressure in the EU.
China’s efforts to rebalance the economy towards consumption are desirable but carry risks.
In addition, bad loans in the banking sector and a shadow banking sector could jeopardise Chinese financial stability.
In the euro zone, the risk of deflation was highlighted last month by Christine Lagarde, the head of the IMF, who said: “If inflation is the genie, then deflation is the ogre that must be fought decisively.”
However, the European Central Bank has asserted that it will do “all it takes” to save the euro, which should include preventing outright deflation.
We are in an upward global economic cycle which does not look like being knocked off course by these risks.
Therefore, we recommend a pro-investment strategy, even if the near-term stock market outlook is uncertain.
We favour developed over emerging stock markets for 2014. Although returns may be modest, they should still outperform the bond markets.