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 Global investors have tiptoed back into emerging assets over the
past six weeks at least partly on hopes that the gut-wrenching New
Year shakeout may have been a final capitulation after three years
of downdrafts and disappointments.
According to the Institute for International Finance, foreigners
ploughed some $36.8 billion back into emerging stocks and bonds in
March - the highest inflow in nearly two years and well above
monthly averages of the past four years.
And yet these are baby steps. To put it in context, that portfolio
pop compares with a total net capital outflow from emerging
economies in 2015 of some $730 billion.
For the coast to clear, three clouds have to evaporate.
First is a lingering fear of higher U.S. interest rates and dollar
appreciation that squeezes hard-currency borrowers in emerging
economies, stresses local currencies and forces credit to be far
tighter than needed to buoy weakening economies.
The second is China's economic slowdown and its slipstream effect on
commodity prices and emerging markets at large.
And third is a spike in political risks in many countries such as
Brazil, Turkey and South Africa - pressures magnified by recessions
and rising joblessless but which, in turn, compound the economic
malaise and policy paralysis on the ground.
Neither of the first two global issues have been resolved.
The world markets fillip of the past month has been rooted in the
U.S. Federal Reserve's hesitation in adding to December's first
interest rate rise in almost a decade and the resultant dollar
recoil.
But rekindled Fed hawkishness as the quarter ends puts a potential
relapse on the dashboard - particularly if the rebound in emerging
assets is little more than a re-balancing of portfolios from extreme
aversion and if you believe that cycles of dollar appreciation
historically last far longer than this.
JPMorgan strategists remain optimistic about emerging markets
outperforming over the next three months - not least because funds
are starved of income in developed economies. But they acknowledge
that there's no outright improvement in the economic picture and
that price moves are built solely on re-positioning.
"Given the almost five years of emerging markets equity and FX
underperformance - and recent conversations with investors - it
could take at least a few months before the average investor is
again neutral," they told clients.
STAYING WELL AWAY
So the move may have some legs, but it's highly vulnerable if the
global climate turns inclement again.
For a start, JPMorgan's rosier view hinges somewhat on the fading of
'China tail risk' involving messy yuan devaluation.
And while Beijing has been forceful on the issue, few investors can
muster much conviction about China's markets.
Christophe Donay, head of asset allocation at Swiss firm Pictet's
Wealth Management unit, said that China may hold the line for now
but that there was a high risk over the next three years of a 'Minsky
moment' - a sudden collapse of asset prices due to credit and
currency pressure named after economist Hyman Minsky.
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"We are staying well away from emerging market assets because of
that and hold very limited EM exposure," he said.
With such scepticism about the international environment, the return
to markets riven by a host of disparate but highly disruptive
domestic political risks seems brave at least.
Mired in a deep recession, Brazil's political strife has yet to
reach a crescendo. Dilma Rousseff is struggling to save her
presidency and fighting an impeachment process amid a widening graft
investigation into state oil firm Petrobras.
While markets have rallied on the prospect of a new government, it
could still take several more weeks or even months for a clear
outcome.
Turkey's economy and government too are under strain given the war
in neighboring Syria, the resultant refugee crisis, internal
conflict with Kurdish separatists, a clampdown on local media and a
diplomatic showdown with Russia.
The struggling South African economy and its buckling infrastructure
are compounded by pressure on President Jacob Zuma, his finance
minister Pravin Gordhan and the ruling African National Congress
amid a variety of accusations and probes about undue political
interference and graft.
More authoritarian governments in China and Russia may seem less
vulnerable than their democratic counterparts, but slowdown and
recession heighten the political risks there, too. An oil hit and
foreign sanctions continue to hamper oversees refinancing by Moscow
and its major companies.
While the picture in Brazil may mask a brighter hue in Mexico or the
slowdown in China hide the resilience in India, a still sizeable
slice of the emerging universe remains in foment.
China, Brazil, Russia, South Africa and Turkey together make up more
than 42 percent of the market capitalization of MSCI's benchmark
emerging market equities index.
Asset manager Blackrock's sovereign risk indices measuring the
likelihood of defaults across the world contain a political risk
sub-set called 'willingness to pay'. This remained the biggest
negative for the countries recording the biggest overall index
declines in 2015 - Brazil, Russia, Peru and Colombia.
"Politics and institutional capabilities will play a big role in EM
going forward," said Kamakshya Trivedi, Goldman Sachs managing
director for emerging market research. "Those factors become more
important in a world of sluggish growth and tightening credit, they
are easier to overlook when growth is accelerating and credit is
plentiful."
(Additional reporting by Sujata Rao; Graphics by Vincent Flasseur;
Editing by Hugh Lawson)
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