For the past year, Emerging Market equities have been weak, but a 5-month high could be a sign of a comeback. Emerging Market equities have rallied with over $1.5 trillion of additional value relative to February’s low (according to Bloomberg). Additionally, in the last three months ending May 31, the MSCI Emerging Market Index increased 9.07%.
While Emerging Markets have been weak relative to the U.S. for over a year, this current upshift makes many wonder: can the category mount a sustainable comeback?
Uncertainties Remain
Uncertainties about the macroeconomic fundamentals of the developing world still loom, leading to speculation that the recent comeback is a result of fund reallocation in response to factors not related to Emerging Markets, such as the U.S. Fed’s recent dovish stance on rate hikes and further easing in Japan and Europe.
Significant issues in some of the world’s emerging economies would suggest that the shift was fueled by something other than optimism about growth and earnings stability:
1. Brazil’s Political Turmoil
Plagued by political scandals and economic stagnation, Brazil is currently a picture of heightened uncertainty. Throughout December-January, its unemployment rate swelled to 10.2% from 7.4% according to government data from IBGE. After a -3.8% contraction last year, Brazil’s economy is predicted to further plummet by -3.5% this year. Moreover, a massive public sector deficit of almost 11% of GDP doesn’t help either.
Now that Dilma Rousseff has been stripped of her presidential duties for six months as she undergoes impeachment trials, the country’s leadership situation is cloudy at best—just when certainty is needed the most. The Olympics is in just a few weeks and the country seems far from prepared.
What’s more, the global commodity rout has badly hit Brazil, which thrived on rising commodity prices from 2003 to 2011. Absent a huge rebound in commodity prices, it’s uncertain where a growth revival will come from for Brazil.
2. China’s Waning Demand a Growing Concern
China recorded year-on-year +6.7% GDP growth in Q1 2016, slightly down from the preceding quarter which came in at +6.8%. Nevertheless, it remains within policymakers’ target range of +6.5%-7% for 2016. Real estate emerged as the fastest growing sector with +9.1% growth, and retail sales of consumer goods and industrial output registered strong growth in March from the same month a year ago.
Against these positive developments, the Chinese economy still struggles with issues of overcapacity in its steel industry. China has faced a barrage of charges from foreign authorities on their exports of cheap steel as these are undercutting other countries’ domestic producers and, effectively, exporting deflation. In the event that China fails to curb excess capacity, other countries could contemplate trade barriers—a serious threat for a country that’s still in the developmental stages of restructuring into a consumption-driven economy from a manufacturing-led one.
3. India Shines for Now, but Some Concerns Remain
Based on data from Central Statistics Office, GDP growth came in at +7.6% for the fiscal year ending in March, which puts India in the category of one of the world’s fastest expanding economies. Also, even as IMF lowered its global growth forecast, it kept India’s growth unchanged at +7.5% for 2016 and 2017. What’s more, India has surpassed China with the largest volume of FDI inflows in 2015, attracting $63 billion worth of projects from abroad.
However, the nation still has some long-standing obstacles to overcome, such as its glaringly low per capita GDP—around $1,582. The Indian consumer is not as big a global force as it could be.
4. Russia Crushed by Lower Oil, Set to Restructure
According to the Russian Economy Minister, Alexei Ulyukayev, the nation’s GDP is expected to contract by -0.2% this year, which would be an improvement over last year’s -3.7%.
While plummeting oil prices took its toll on the Russian economy, its policymakers are reportedly looking to shift focus on development outside the oil industry into areas such as technology and industrial sectors. The goal of restructuring, much like we’re seeing today in China, is to create sustainable long-term growth instead of relying on short-term upswings in crude oil.
Bottom Line for Investors
The IMF has revised its 2016 growth forecast for Emerging Markets and developing countries down to 4.1% (from the previous estimate of 4.3%). It has, however, indicated a possibility of global growth improving from 2017 onwards, driven by eventual stabilization of developing economies.
As such, the picture for Emerging Markets is mixed at best. Slowing growth rates, commodities sensitivity, a stronger dollar and rising interest rates all remain headwinds. Emerging Markets tend to follow the rest of the world, so there’s growth yet. Perhaps just not as compelling as it once was.
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