2018 decline across investment classes prompts allocation reconsideration

2018 was a tough year for emerging markets (EM) as currencies and equity investment classes struggled to keep up with developed countries’ investment options. Posing the question, should EM assets make the cut for any portfolio come 2019?

The US Dollar rally last year only exacerbated the pressure against many currencies but the relative interest rate normalisation in most developed economies should ease the pressure in 2019. For South Africa, the fiscal stimulus announced by President Ramaphosa is set to narrow the economy’s fiscal space and double the scrutiny from rating agencies.

On the political front, populism has become the new norm as right wing rhetoric is fast replacing patriotism. EM have had to adjust to the geopolitics which has progressively evolved into a trade and aid skirmish between Washington and Beijing.

“In EMs, politics drives the economy. In the developed world, the economy drives the politics. Geopolitics are always a risk for EM markets. I am optimistic that the US and China will resolve their issues, resulting in a boost to global growth. As for EM, let us hope there are no more politicians behaving impulsively,” cautions Michael Treherne, a portfolio manager at Vestact.

Meanwhile, the Argentina and Turkey financial predicaments left many questions unanswered on whether more could have been done as buffers to elude the fiscal and monetary woes. Nonetheless, could structural safeguards have prevented the Turkish Lira Crisis? “The problem in both Argentina and Turkey were the politicians. I’m not sure you can set up buffers to counter poor policies,” says Treherne.

Contagion may spread, but for now EM indices remain the cross fires of developed market policies. A worst-case scenario involving a meltdown in the Chinese economy would damage world markets, unlike the version a decade ago when the rest of Asia and commodity exporters suffered most of the consequences.

This week, the International Monetary Fund further downgraded its 2019 growth forecast to 3.5% with South Africa’s growth outlook surprisingly revised from 0.8% to 1.4%. Consequently, foreign trade and investment to major emerging markets will remain in the $US1 trillion band, according to the Institute for International Finance.

“I have seen a number of international money managers saying that they are increasingly looking at EM as a place for investment. Which is good news for us,” affirms an optimistic Treherne.

“I think the big factor in our FDI will be the outcome of our election, who is appointed to the cabinet and then what the focus for government is. Settling the land issue quickly is also vital for having long term capital flow into RSA”

Blame the easy money

Blame Ben Bernanke and quantitative easing for easy money which in turn saw a lapse in structural reform momentum in the last decade. Monetary policy independence may now be at risk in many EMs as authorities cope with the fallout of large corporate and household debt. “ I think we were lucky Ben was running the Fed in 2008.

He understood what not to do and how bad things were, probably better than most. Thanks to him, the Fed acted quickly and we only had a great recession, instead of another depression,” says Treherne who also argues that corporate and household debt might be higher now than 10-years ago, but this is directly proportionate to their net asset value.

“For most the debt levels are not out of sink when looking at the rest of their balance sheet. Added to this, interest rates are very low, and expected to stay low for years to come. In a low interest rate environment you can afford to have a bit more debt sitting on your balance sheet.”

Investment fund trackers project stock and bond inflows at less than US$40 billion in 2018, with a slight increase predicted this year but much of that is destined for China and South Korea given their large weight in the MSCI index.

2018 saw a drought on the bond side but the IMF projects that $2tn in combined local and foreign currency maturities will come due in 2019 but what is more appalling is official defaults would already be widespread in Africa without IMF programme rescues.