Headlines on emerging markets (EM) have been almost universally negative of late. In May, Argentina was forced to ask the IMF for help after aggressively hiking domestic interest rates, and on 8 June the IMF agreed a loan of up to USD 50bn. Turkey, too, has been under severe stress and has also been forced to enact emergency rate hikes, the latest, an unexpected 125bps hike on 7 June.
We don’t believe these pressures are indicative of a widespread problem. What Argentina and Turkey have in common are large current account and/or fiscal deficits and large US dollar liabilities coming due for rollover in the next few months. It is encouraging that both are taking positive action to address their problems. Yet, on the whole, emerging markets show significant strength.
- Hard currency sovereign liabilities as a percentage of total government debt are at an all-time low, as governments have increasingly successfully managed to gain funding in the local bond markets.
- Inflation in most emerging nations is under control, limiting the need for growth-harming rate rises in many cases. The GDP-weighted aggregate inflation rate was 3% year-on-year in April, versus an average of 3.9% since 2012.
- Foreign exchange reserves for most emerging markets have been rebuilt and are now at or near pre-financial crisis levels, providing a buffer to external shocks.
The gap between EM and developed market growth has historically been positively correlated with EM outperformance, but EM has recently had a patch of below-expected growth according to PMI data. This is a risk we need to monitor, but our projections (and the IMF’s) are for the growth spread to widen over the next two years. So we remain overweight on EM equities in our global portfolio and prefer EM equities to corporate bonds in our EM portfolio.
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