Column: Emerging markets may enjoy secular stagnation - James Saft
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By James Saft
(Reuters) - (The opinions expressed here are those of the author, a columnist for Reuters)
A low-growth world won’t be an easy one for emerging markets, but at least the Federal Reserve will keep the water in the bath warm.
That means returns to riskier assets like those from emerging markets could do relatively well in the near term, as the Fed is forced to recalibrate interest rate policy for a stubbornly less economically vibrant world. The longer term, with low demand from developed markets and a potentially protectionist upsurge, could be more difficult.
Stanley Fischer, Federal Reserve Vice Chair, performed a delicate balancing act in a speech on Sunday, both preparing the market for a rate increase, possibly in December after the U.S. presidential election, while also speaking frankly and not encouragingly about the productivity slowdown which lies at the heart of the phenomenon of slow growth and low inflation.
Fischer’s analysis leads to the conclusion that lower productivity, which has more or less halved from its post-war World War 2 norms in the last decade, is not amenable to lower interest rates but may be in itself a reason they stay in a historically low range.
If developed market central banks remain trapped at very low rates, and must become more forthright about the matter, we can expect emerging markets to get a material benefit. Yield-seeking investors will continue to pile into emerging market debt, as they have this year, desperate for a bit more compensation for the privilege of lending their money. Equity investors will come flocking too, attracted by lower valuations and less worried about a potential shock due to a rapid rise in interest rates.
All of this is quite new for emerging markets, just as it is for the rest of the world. As recently as the “taper tantrum” in 2013, emerging markets, especially those which need to attract a steady flow of capital, tended to be hurt quite badly when interest rates in developed markets, especially the U.S., looked poised to rise. Not only does tight money make it more difficult for them to attract capital, it also often goes hand in hand with an appreciating dollar, something that can leave dollar borrowers in emerging markets caught short.
A point worth noting is that since the 2008 crisis we have not had a proper emerging markets crisis, of the kind seen in Asia in the late 1990s, but rather distinct country-specific sell-offs, such as in Argentina after its default. The asset class, especially its financing ability, has been insulated by the generosity of developed market central banks.
REACHING FOR YIELD, OR JUMPING FOR IT?
The real key will be for investors to become comfortable with the idea that the Fed buys into a secular stagnation argument and is prepared to make policy accordingly. In that respect Fed chief Janet Yellen’s speech this Friday at the Jackson Hole monetary policy conference may prove to be extremely important for emerging market assets.
If Yellen signals that rates may rise but will stay structurally lower than we previously thought likely, then emerging markets should rally, safe at least from a U.S. tightening.
And a secular stagnation argument, especially one that is based in part on demographics, has an immediate read-across for emerging markets, many of which, like China, are heading for their own demographic busts.
That may imply that the trend we’ve seen towards lower interest rates in the U.S., Europe and Japan will spread elsewhere.
“While the worry in developed markets is monetary policy exhaustion, most emerging market central banks have ample room to ease if needed as inflation is either below target or, where it is not, has peaked and is on its way down,” Joachim Fels, global economic advisor at fund manager PIMCO wrote in a note to clients.
“Most risky developed market assets are expensive, and investors have to come to grips with 'lower-for-longer' developed market rates. This, together with better emerging market fundamentals underway, suggests to me that the emerging market rally that started earlier this year has legs to run.”
Fund managers at Alliance Bernstein point out that the benchmark MSCI index of high-dividend emerging market stocks yields 5.6 percent annually and trades at nine times annual earnings. The equivalent developed market index has a yield of just 3.9 percent and trades at nearly 18 times annual earnings.
If we believe that U.S. and European stocks have gotten expensive due to low interest rates, then emerging markets may be next in line for the same somewhat artificial inflation.
None of this implies all will be easy for emerging market economies. Western demand for manufactured goods which allowed China, for example, to grow, will not be as strong, making the development of consumer-based domestic economies all the more important.
Still, if we have to face up to a low-growth, low-inflation future, emerging market assets will enjoy at least the first part of the journey.
(Editing by James Dalgleish)
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