EMERGING markets were hit hard in September, with shares on average unwinding the year's gains.
Few exchanges in developing economies escaped the rout, which also hit currencies.
The average emerging market fall in the month was 8 per cent. So far, events look like a re-run of the sell-off in May and June 2013, after which markets quickly recovered.
But, now geopolitical risks are much higher. Should investors be so confident of a recovery?
Investors in emerging markets look for much faster growth than is typical of mature Western economies. But, while the view on long term economic trends might be right, many other factors come into play in stockmarket performance. The overall level of global growth and the value of the US dollar matter more than most realise. The quarter to September 30 has seen the second biggest jump in the US dollar in the last 20 years. The last time the currency strengthened this quickly was six years ago, in the early stages of the banking crisis. The consequences of recent dollar strength are not necessarily yet factored into stockmarkets, or even company results.
The dollar move was largely unexpected, given US money-printing. A ready supply of dollars has meant a cheap currency. But US quantitative easing (QE) will end shortly, having done its job of boosting the American economy. The end of QE also brings forward the time at which US interest rates will rise, making it a more attractive currency than the euro. Indeed, the current negative interest rate for the euro makes it costly for depositors. Additionally, demand for dollars is now being driven by fear and a wish for liquidity. These forces may last for some time.
The backlash is being felt in emerging economies, where a supply of cheap dollars has helped growth. Even though many emerging markets have sound central banks, their businesses have been helped by the ease of borrowing in dollars. Business finance has suddenly become more expensive. And, many emerging economies are still struggling with the imbalances created by an inflow of Western capital in recent years. Competitiveness has not yet been restored and many currencies are overvalued. The boom in emerging markets sucked in hot money, and only now can we see some of the bubbles that this created.
China is struggling to pop some of these bubbles in a controlled way. Bank lending in property is being reined-in, to cool a hot market.
Warehousing of metals that had been bought purely for speculation, or use as security against dollar borrowing, is being unwound. And, the shadow banking system that had lent in a largely unregulated way has been cut back. As a result, China's growth is slowing, and metals prices have collapsed. As the mining businesses that supply China are also heavily represented in the FTSE 100 index of London's largest list companies, the impact spreads beyond China. Unrest in Hong Kong adds to other tensions in that region, and investors are also unnerved by the challenges in Eastern Europe. Europe may not yet have felt the full impact of Russian sanctions.
Most of the current geopolitical pressures stem from the same problem. Global growth is disappointing, and many believe that pain is not evenly shared. Populations that had seen significant growth in living standards from 2000 to 2008, have seen slower progress since. In emerging markets, as with peripheral Europe, this frustration at lack of growth and real incomes has a political impact.
Political tensions and trade frictions have come at a point where global recovery is still fragile. A strong US dollar and cheap commodities are a headwind for emerging markets that could persist. Investors should recognise the risks in emerging markets, and also that their impact can be felt closer to home.
Colin McLean is managing director, SVM Asset Management
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