The past 12 months have been tumultuous for emerging markets across both fixed income and equities. By most measures, emerging markets look oversold, but do they represent good value? What else do we need to see for a recovery? Here is my wish list for 2019. Let's hope Santa is listening.
#1: US economy: strong, but not too strong
A strong US economy is typically good for emerging markets but it is a fine line. Too strong growth forces the central bank to apply the brakes, hiking interest rates and further bidding up the dollar. This hurts emerging markets, especially those that have to service their external debt in US dollars.
As Figure 1 shows the US dollar is looking overvalued, as has been the case for a few years now. Therefore, looking forward to 2019, I hope for a softening of the dollar to offer some relief to emerging markets.
FIGURE 1: HEADING FOR A FALL?
US dollar (nominal trade-weighted exchange rate)
Source: Pictet Asset Management, Datastream, Bloomberg, October 2018
#2: A cooling of global trade tensions
The threat of a trade war has been the biggest risk to global economic growth in 2018. Whether we see an escalation in coming months from the Trump administration remains to be seen. What is clear (see Figure 2) is that the GDP growth of emerging markets is today more strongly linked to global real export growth than the growth of developed markets. Any abatement in current trade tensions would be a greater boost for EM.
FIGURE 2: EMerging MArkets are more trade sensitive
World real exports (% Y/Y) & real GDP growth (% Y/Y) for emerging and developed markets
Source: Pictet Asset Management, CPB Netherland, CEIC, Datastream, July 2018
#3: More stimulus in China
China has reacted to US trade policy so far with a series of concrete countermeasures to support its economy that encompass monetary, fiscal and trade levers. We have not been able to fully estimate their full impact but it should be in the region of 2 per cent of GDP (see Figure 3 below).
Figure 3: pushing the PEDAL
Chinese stimulus measures announced to counter US trade policy
Admittedly, this is a tactical switch away from President Xi’s long-term goal of re-balancing the economy towards a more consumption-driven growth path.
But the re-balancing is a long road and we think China’s short term pragmatism is to be welcomed by emerging market investors. China will remain the growth engine of emerging markets for years to come so any slowing of its economy had better be gradual than abrupt.
#4: Robust commodity prices
If all of my wishes above are granted – or at least the majority –my fourth should happen automatically. Robust commodity prices are typically good for emerging markets, especially those economies that are net commodity exporters.
As Figure 4 shows, the recovery in Chinese construction activity driven by the recent measures is expected to spur a recovery in industrial metals in coming months.
FIGURE 4: RE-ENTER THE DRAGON
Chinese construction activity & metal prices
Source: Pictet Asset Management, CEIC, Datastream, September 2018
#5: Emerging markets policy stance
It has been a tumultuous 12 months for many emerging markets, especially Argentina and Turkey as we have covered extensively in this publication. Overall though we believe the authorities’ policy response in both of these markets has been mostly competent and reasonably well handled in extreme conditions of monetary stress.
So as a final wish for 2019 I would ask for similarly sound reactions from EM authorities in the year ahead, wherever they may be required.
FIGURE 5: Fighting the good fight...
Left chart: Argentina policy rate and CPI inflation / Right chart: Turkey policy rate and CPI inflation
Source: Pictet Asset Management, CEIC, Datastream. Argentina includes October 2018 data, Turkey includes November 2018 data.
MARKET WATCH
MARKET WATCH DATA
Source: Datastream, Bloomberg, data as at 30.11.2018 and in USD. Equity indices are quoted on a net dividend reinvested basis; bond and commodity indices are quoted on a total return basis. The currency rates evolution is treated as a performance calculation based on FX rates.
Patrick Zweifel joined Pictet in 1997. He is Chief Economist at Pictet Asset Management. Before assuming his current position in 2009, he was head of the “Macro Research Team” at Pictet Private Wealth Management. In particular, he had economic research responsibility for emerging markets and Japan, and for the development of quantitative models on major asset classes, primarily foreign exchange models. Before joining Pictet he was a research assistant in econometrics and monetary theory and worked on international research projects for the World Bank and the European Union. He holds a PhD in econometrics from the University of Lausanne.
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