Emerging market assets could lose their appeal as safe havens for global investors despite their recent rally, as mounting global risks threaten to undermine sentiment in the remainder of the year, leading industry players have warned.
Emerging market stocks, currencies and bonds surged this week after Greek prime minister George Papandreou (pictured left) secured approval for a new set of austerity measures, with the MSCI Emerging Market Index up 2.8% on the week to 1143.68 as of Thursday lunchtime.
But experts say that returns on emerging market equities and bonds – sought after assets since the financial crisis – are likely to be subdued for the remainder of the year as fears resurface over the eurozone’s debt crisis and rising inflation across emerging economies. The MSCI Emerging Market Index remains down 1.8% ytd and has fallen 2.3% since the beginning of Q2.
“While we maintain our long bias on emerging markets, the outlook for the second half of the year is not especially bright, so our advice to investors is to be defensive,” Guillermo Mondino, head of emerging markets research at Barclays Capital, said at a gathering this week of the Emerging Markets Traders Association in London.
“We expect a fairly mediocre Q3, as investors head off on holiday waiting to see whether a Greek default can be kicked down the road and if the US government can avoid a shutdown. However, once investors return to their desks from September onwards and if there is more clarity on Greece and the US, we could see a stronger Q4.”
Mounting developed world risks and ongoing overheating concerns across many emerging markets mean that emerging equity and bond markets are likely to remain flat, as global investors adopt increasingly defensive positions, experts say.
Disappointing returns across debt and equity markets during the first half of this year may prompt fund managers and investors to tolerate greater risk appetite during the final few months of the year in order to chase higher year-end returns, which could have a positive impact on emerging market, Mondino said.
But returns on emerging currencies and stocks are likely to turn negative, while fixed-income investments will see only modest gains over the year as a whole, he said.
“We don’t see a black-swan style event on the horizon but there’s no doubt that we’re in a soft spot right now,” said Timothy Ash, head of EM research at RBS. “In this environment, it’s a hard grind and investors will have to do their homework.”
The fallout from an increasing likely Greek default is the most pressing concern facing emerging market investors. “If there is a Greek default, there will be spillover into emerging markets for sure,” said Rob Drijkoningen, global head of emerging markets at ING Investment Management.
“The first to be hit will be those countries with high fiscal deficits and balance of payments deficits; Turkey is a great example – it has limited FDI, huge deficits and has seen strong portfolio flows, so there are clear contagion risks, but they’re not just confined to Europe.”
But others maintain that emerging markets are well placed to weather an increase in global risk aversion.
“Investors are increasingly realising that the real risk assets are developed markets rather than emerging markets and ridding themselves of their prejudices, so I predict a stronger second half [of the year],” said Jerome Booth, head of research at Ashmore Investment Management.
“Some investors may continue to see EMs as risky and sell off, but more and more people are getting it. So any short-term sell-off in emerging markets would provide a tremendous buying opportunity, it would be a gift.”