What do investors do when things turn bad in Spain? Sell Russian assets. At least this was the case in the first half of the year, when usually any piece of bad news from the euro zone triggered a selloff in emerging markets such as Central and Eastern Europe, Asia, Africa or even Latin America.
But investors going with this trade in the second half of the year will be losing money, according to analysts, who say that emerging markets are actually well placed to withstand the weakness in developed ones.
“Russia remains a market which is hostage to foreign investor sentiment,” Charles Robertson, global chief economist and head of macro strategy at Renaissance Capital, told Emerging Markets.
“If global investors get more risk-averse in the next six months, they may sell Russia because they’re worried by the US budget deficit, they may sell Russia because they’re worried about Spain. To protect their capital, they buy Northern European bonds, which promise to take away your capital, rather than buy Russian stocks,” Robertson added, pointing out that some emerging market assets are undervalued because of the fear of risk.
The outlook for the euro zone and the world economy as a whole remains depressed as the debt crisis has engulfed bigger economies and shows no sign of easing.
“The world looks likely to remain in a mess, with sluggish economic growth and frequent flare-ups of the sovereign debt crisis,” HSBC’s strategist Gary Evans wrote in the bank’s recently-published strategy for the third quarter.
EURO SITUATION WORSE
In the euro zone, various indicators – such as manufacturing PMI data or business confidence surveys – show the situation has worsened, and some analysts say a recession in the area’s engine growth Germany may be on the cards.
The weakness in the economy is putting off the fiscal consolidation needed in order to fix the euro zone’s debt crisis, with Germany and other Northern economies baulking at the idea of sharing debt costs and risks with southern countries.
“Against this background, we stick to our position that a limited euro zone break-up could commence before the end of this year,” analysts at Capital Economics wrote.
In Greece, even after the election in June of a pro-euro coalition, public debt is forecast to remain high despite this spring’s major debt restructuring - and the austerity-fatigued Greeks are unlikely to accept further belt-tightening to bring it down. Deposits in Greek banks are falling, with residents afraid of the consequences of the crisis and seeking to protect their wealth.
“By threatening the stability of the banking sector, such a process could prove self-fulfilling,” according to the Capital Economics analysts.
Yields on Spanish and Italian debt have spiked again, despite a 100 billion euro ($123 billion) bailout promised for Spanish banks.
PAY FOR SAFETY
But in the north of the continent, recently, yields went negative – forcing investors to pay for the privilege of buying the debt – for government paper with maturities of less than two years in Austria, Denmark, Germany, Finland, the Netherlands and Switzerland.
Despite all this, Evans wrote, “it’s wrong to be too bearish,” as the crisis will trigger a response and politicians will be pushed to make progress on reforms, while central banks are likely to take measures that would support equity markets.
The HSBC strategists prefer emerging markets, where they expect economic growth to speed up in the second half, especially in China.
“We stay committed to our preference for emerging markets over developed markets,” they wrote. “A key attraction of emerging markets for us continues to be the stronger growth outlook.”
Other analysts concur, saying developing countries are the place to be for the long term, especially as in some of them valuations are really cheap.
Among the better placed, analysts mentioned China – where bank loans have risen – Russia – still “very cheap” in terms of valuation – and even some Central and Eastern European countries and Turkey as well placed to withstand the storm.
UNCERTAINTY ELSEWHERE
India’s domestic-grown problems – slow investment in the public sector and red tape for large-scale investment projects – coupled with the global slowdown mean that, after seeing growth slowing down in the first quarter to 5.3 percent, “the second quarter will be no better,” according to Capital Economics’ outlook.
For other countries in the Asia- Pacific region, the uncertain outlook for the global economy and the prolonged euro zone crisis are the biggest risks, the analysts also said.
Latin America may be reaching the limits of its “twin-speed” consumer-led growth, the Capital Economics analysts said, also pointing to weak global growth which may weigh on exports and a weak outlook for commodity prices.
But stimulus policies in China might help some Latin American countries as well as commodities exporters in Africa and the Middle East, the analysts said.
Even though the outlook for the third quarter and second half of the year is mixed, over the years investing in emerging markets is likely to pay off, as their pace of growth will be much faster than that of developed markets.
“I think all emerging markets are well placed to outperform developed markets in the next five to 10 years,” Simon Quijano-Evans, head of research and chief economist for EMEA at ING, told Emerging Markets.