Receive Developing Insights by Email
A number of news and research outlets have framed this transition as the “third wave” of the global financial crisis with the first breaker engulfing the U.S. and the second overwhelming Europe. A housing bubble and credit crisis crippled the world’s largest consumer while bank impairments and sovereign debt crises hobbled the second.
In both circumstances, the policy response to unleashed deflationary forces was quantitative easing, and this did not go unnoticed in developing markets. By some estimates, up to $7 trillion QE dollars flowed into emerging and frontier markets since 2008, an unambiguous boon to banking sector liquidity in these regions, making the U.S. unwinding of QE and prospect for liftoff from the zero bound quite destabilizing. Meanwhile, China’s reaction to a damaged export model was a doubling down on investment spending, largely funded with debt. Since 2008, China’s share of global investment spending exploded from 15% to 30%, the largest share in the world; hence the current market jitters as this too shows signs of exhaustion. Not alone in levering up to counter faltering demand, a credit bust in developed markets led to a credit boom across emerging markets with total non-financial debt currently at 160% of GDP, up from 100% pre-crisis.
The consensus view seems to be that developing markets will get worse before they get better as commodities and currencies continue to depreciate and growth slows further in 2016. However, for the more extreme downside scenario of “secular stagnation” to take root market adjustments must be severely blunted or frustrated altogether, as was arguably the case with select sovereign bailouts. Despite muted deleveraging in some corners and outright increases elsewhere, the lag effect from a multitude of significant currency and balance-of-payment adjustments in the developing world will begin to manifest next year and form the basis for a recovery.
While the exact timing is speculative, what’s unassailable is that the growth gap between developed and developing will widen again on the strength of some very fundamental demographic, consumption and investment trends that remain unaltered today. Along with every potentially concerning debt story, like the Chinese corporate sector, there are counterparts elsewhere such as Vietnam that managed to modestly deleverage. Similarly, for every poor adjustment to new terms of trade like Brazil or Columbia, there are others like Chile and Peru that seem to be on the cusp of rebalancing. This only serves to highlight a truism in the space, it’s almost impossible to generalize about the performance of developing markets.
Of course, a major problem for investors is that some of the biggest names are currently in the penalty box (read: BRICs). With Brazil and Russia in outright recession, India going gangbusters but in the early innings of an uncertain reform process and China experiencing a tidal wave of investor skepticism about its growth, the majority of BRICs will continue to weigh on perceptions about an asset class comprising more than fifty nations. It’s important to note that even for these erstwhile stalwarts there is a plausible path forward that will benefit investors. Over the next months we will publish a series of posts about the road ahead for the developing market investor.
Our first segment will look at valuation and sentiment in the asset class while the second and third section will delve into the fundamental issues that are driving the valuation story and attempt to chart a course for 2016 and beyond. As we proceed through this adjustment period a profound certainty is that selectivity will become increasingly critical as the “rising tide” narrative fades completely into the past. We channel Sir John Templeton in asserting that developing markets are no longer an optional allocation, they’ve become too integral to global market performance. Another certainty going forward is that developing market investors will have to be equally savvy in both country and stock selection and any deficiency in either skillset will be punished enthusiastically by leaner, meaner markets in the offing. We continue to be excited about the asset class and hope to convey some of the extraordinary dynamism that we witness every day as investors in these markets.
Alexander Schay is a Managing Director at Ultima Thule, an equity research company focused on developing markets and an equity partner at WK Associates, a boutique energy consulting firm with a specialization in emerging market oil and gas.
Alex holds both an MS in Risk Management and an MBA from the Stern School of Business at New York University.