The term Emerging Markets (EM) was coined in the 1970s to provide a ‘cover all’ description for countries and economies that were at that time not deemed first world.
However no one has ever created a specific metric or set of parameters (such as a minimum level of GDP) which promotes a country to ‘Emerged’. This means that economic powerhouses such as Holland, Belgium and Luxembourg form part of the G10 and Estonia and Finland are members of the Organisation for Economic Co-operation and Development (OECD). Whilst China and India are still in 2014 deemed “emerging” because they were in 1973!
This has led some to regard the term as highly misleading and it’s not difficult to understand why.
The 8 largest countries classified as emerging are:
China
India
Brazil
Russia
Mexico
Indonesia
South Korea
Turkey
The league table of countries ranked by size of GDP (gross domestic product) are:
1 US
2 China
3 Japan
4 Germany
5 UK
6 Brazil
7 Russia
10 India
14 Mexico
15 South Korea
16 Indonesia
17 Turkey
18 Holland
25 Belgium
41 Finland
So 4 of the top 10 and 8 of the first 17 largest global economies are still lumped together in the “emerging markets” sector.
Given that growth in these countries is generally more dynamic the tables are likely to feature even more of them, and with higher rankings in coming years.
EM Volatility
One of the great mysteries of markets is why a problem is not a problem until suddenly ….. it is, without any apparent significant catalyst.
The mid 2013 rout of EM markets which occurred when Ben Bernanke hinted that QE was close to winding down (tapering), didn’t reoccur when in December 2013 the start of tapering was confirmed, in fact markets continued to rise.
They continued to rise further in January until last week when, all of a sudden, they started to fall??
Why?
The main economic concern around certain Emerging economies is that they run large current account deficits, amongst the main being Indonesia, Turkey, India and South Africa.
They have funded these deficits with international borrowed money, which whilst QE was in full swing was plentiful and cheap. Investors were looking for yield; EM debt yielded more than US or UK debt so funds flowed their way.
The ending of QE however potentially changes this flow state; yields have risen in the US with the 10 year treasury now yielding close to 3. So when International investors decide to repatriate funds they sell EM debt, this then causes currencies to fall, asset prices to fall, which then (if this is rapid) spooks markets causing increased selling. This was what played out for a time in mid-2013.
The time lag between the December tapering and the mid-January falls however is instructive. There was no will to sell in December so no selling momentum was created so nothing happened. Then last week China issued some weak data, there were a couple of other bad news stories and selling started. Once momentum picks up the hot money starts to get out, it does it quickly which creates a lot of selling all at once, prices gap down, people panic, more selling and so on.
Over this weekend there were rumours of a potential Argentinian devaluation, that Turkish interest rates would be jacked up etc etc. Asian markets react first on Monday; the Nikkei falls 2.5 % which Europe reacted to in kind followed by the US.
It is probably true that a more valid cause for market concern is the slowing Chinese economy, the previously turbo charged growth was the locomotive that pulled the Asian train, this is not so at the moment and no one is clear on whether it’s just a pause for breath or it has more serious problems.
Conclusion
The EM situation is possibly an unintended consequence of QE (the side effects of a previously untested drug) the next bout of market anxiety (which is regular) an excuse to take profits, the consequence of hot money flows (which took down gold and the Nikkei in chunks last year) or a combination of all the above.
It is the way of markets, long slow upticks followed by quick more violent downturns.
It is important however not to think of Emerging Markets as a raggedy bunch of impoverished small nations; the likes of Mexico, China and South Korea are vibrant growing economies. Indonesia has a population of 250 million and Brazil and Russia have enormous natural resource wealth. By 2030 it is expected these economies will make up 50% of all global trade and they may still be classified as “emerging”.
These are proper grown up economies and far be it for me to question market logic but in times of stress what is the safe haven currency everyone buys?
The Yen
The most indebted major country on earth.
Japan!
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.