One look at the headlines today, and readers may think that the world is imploding, taking emerging markets with it. Yet despite the negative news headlines, emerging markets remain as strong as ever–a rare, bullish prospect in an otherwise bearish world. In fact, the long term outlook is very optimistic.
Sustained, resilient growth
The major strength of emerging market economies is sustained levels of high economic growth. Even in the face of interest rate hikes by the US Federal Reserve, which threaten to raise corporate defaults, lower foreign direct investment, and drive down currency, emerging markets are exceedingly resilient. For one, previous rate hikes in 2004 (when the Fed raised rates from 1 percent to 5.25 percent) led to an emerging markets rally of nearly 135 percent.
Yet another reason for the sustained growth and general resilience of emerging markets is currency and debt. In short, because of continuing growth (a result of which is improved global GDP) and strong emerging market currencies, investors have more incentive to seek out debt funds. Much of this has to do with structural reasons: despite short-term bumps, emerging markets are simply set up for higher and faster growth, in marked contrast to more developed nations.
Nonetheless, just as not all emerging markets were created equal, not all markets will be similarly affected by rate hikes. Indicators of a vulnerable emerging market include: less diversified, smaller economies that depend only on a handful of industries, and furthermore, rely on large flows of capital (which would be stemmed by an interest rate hike). For the most part, this means emerging nations which rely heavily on FDI and very few sectors, such as manufacturing or export.
What about timing?
We all hear stories of investors who make risky gambles on supposedly failing stocks–which then rally in unexpected ways, thereby netting this clear-eyed investor a fortune. Or we hear of a VC who makes a long shot investment on a startup (or industry) no one believes in–only to be validated much later.
Those anecdotal evidence does exist, timing doesn’t necessarily apply to emerging market investments. After all, emerging markets are simply too volatile to predict, as Ashutosh Sinha of Morgan Stanley explains. A better strategy, Sinha suggests, is to weather the bumps and rough going (which there will inevitably be), and strengthen long-term investments.
By way of example, Sinha and his team modelled a hypothetical investment: if someone invested $10,000 in the MSCI Emerging Markets Index in 1988, holding it for the next three decades, how much would it be worth today? The short answer is approximately $80,000–with a few major caveats. For instance, if the investor had withdrawn and entered the market in accordance with volatility and current events, they would have earned far less, losing anywhere from $20,000 to $6,500.
That’s not to say that investors should only keep their money in the same assets within emerging markets, however. Sinha warns against commodities with volatile earnings, like copper and steel, which are highly vulnerable to global pressures. Instead, Sinha recommends solid consumer industries, such as healthcare, pharmaceuticals, and even financial services–though the latter is highly dependent on location, as some nations have better debt to GDP ratios than others.
Indeed, market developments bear out the veracity of Sinha’s advice. Steel, for example, saw a 4-6 percent drop in March 2017 (not doubt due to slowing Chinese demand)–only to post a 7 percent gain (and a 38 percent rally overall since mid-June) five months later, in August 2017. Commodities, overall, have been a victim of reduced construction, as China and other large, emerging economies shift from manufacturing and heavy industry to more service and consumer-oriented sectors.
What about North Korea?
Yet as is often the case with emerging markets, there is a wildcard: North Korea.
However, in this case, it seems that the more things change, the more they stay the same. True, the threat of war is higher now on the Korean Peninsula than previously before, given the hot tempers involved; it’s harder to imagine previous American presidents (especially the dispassionate, measured Obama) reacting so strongly to North Korean provocations.
All the same, the situation is remarkably similar to a year ago, so much so that I wrote a detailed article covering North Korea around that time. Even if this year seems to be tinged with an extra urgency and danger (both sides seem intent on ratcheting up the rhetoric), the truth is that provocations are part of a well-worn cycle. On a fairly regular basis, the Kim regime threatens, blusters, and rattles its saber; in turn, it wins concessions (or perhaps is hit with sanctions), and quiets down as a result–until the next cycle begins. Though there’s always the danger of miscalculation, barring a shooting war, there’s little to worry about. After all, North Korea has been haggling over nuclear power since the days of the Clinton administration.
In the end, there are fewer asset classes with a positive, long-term outlook than emerging markets. Despite talk of geopolitical instability, interest rate hikes, or slowing manufacturing and other sectors, many emerging markets remain resilient, continuing their strong, impressive growth.