Fidelity’s investment commentator Gareth Nicholson explains why history is not about to repeat itself in emerging markets, and Matthew Sutherland talks about Syria, below:
For the casual observer of stock markets, the newspaper headlines surrounding the recent swings in emerging market equities and currencies must be reminiscent of the Asian financial crisis of 1997/98. Back then regional markets were roiled and some economies almost destroyed as hot money inflows suddenly reversed, sparking a crisis of confidence in South East Asia’s financial markets.
The tremors were first felt in Thailand, where excessive real estate speculation and rapid credit expansion pushed asset prices to unsustainable levels. When this bubble eventually burst, the resulting loan defaults created a credit crunch, which spiralled into a wider regional crisis as foreign investors fled for the exits.
Large piles of external debt were magnified by free-falling currencies and the problem was exacerbated by a lack of adequate foreign currency reserves. The crisis ended up pulling in Hong Kong, Malaysia, South Korea and the Philippines – and even the Japanese Yen came under pressure.
Fast-forward 15 years and South East Asia’s financial markets are once again being hit by an outflow of foreign capital. Then, as now, we have seen regional equities and currencies fall as a flood of foreign capital is repatriated. Then, as now, those countries with large current account deficits, rising inflation and a buildup of household debt are facing the most pressure. Then, as now, we have central banks caught between a rock and a hard place on monetary policy – lifting interest rates to retain confidence and combat inflation at the expense of economic growth and corporate profits or taking no action and risking more capital flight.
Then, as now, we are moving into an environment in which the US economy is recovering, the US dollar is strengthening and potentially where US interest rates will rise. That, however, is broadly where the similarities end and investors would be wise to heed some of the differences. Although regional markets and currencies have come off recent highs, they are not in free-fall, and many commentators would argue the recent correction has been a necessary one to restore some balance to valuations.
Indonesia and Thailand in particular, have turned in stellar equity market performances since the 2009 global financial crisis. Although inflation pressures are rising in some parts of Asia, they are being fanned mainly by a spike in oil prices, which is hitting the biggest importers, such as India and Indonesia (food inflation is potentially a longer-term problem amid growing populations, rising affluence and supply bottlenecks – but this is not an acute issue for the time being).
Critically though, Asia’s economies are not as exposed to foreign debt as they were in the late 90s – they have developed local currency debt markets and accumulated vast foreign exchange reserves, precisely because they’ve learnt the lessons of 97/98. Today, Asia has accumulated over US$4 trillion of foreign exchange reserves – more than half of the world's total. Emerging Asian economies have also improved their credit ratings and market liquidity. Today, Asian economies conduct considerably more intra-regional trade, and are not as dependent on Western export markets. Although China’s economic growth is slowing amid a new focus on domestic-led consumption in place of export dependence, it is still the fastest growing major economy in the world and a much bigger ballast for the region than it was in 97/98.
More fundamentally, many emerging Asian economies are being supported by growing affluence and a rising middle class – which is expected to drive domestic consumption for decades. And it shouldn’t come as too much of a surprise to anybody that capital has flown from emerging Asian markets after the Fed signalled earlier this year that it may begin to taper its unprecedented program of quantitative easing. Global emerging market stocks have slumped by about US$1 trillion since May, according to a recent Bloomberg report. However, the Fed’s preferred gauge of inflation showed prices rising 1.3% in the 12 months ended June, well below the central bank’s 2% target – so the taper, when it comes, is going to be gradual and interest rates are unlikely to rise swiftly anytime soon.
On this basis, investors should beware of reading too much into recent swings in market sentiment.
However, investors need to be selective and pay attention to domestic policy decisions and what this may mean in terms of market outcomes. Policy paralysis is a key concern in India and Indonesia ahead of political elections in 2014. Emerging Asia markets must continue to turn away from export-led economic models, resist the temptation to engage in protectionism, and embrace structural reform. Progress on these issues will likely ensure that the current sell-off remains a correction and not a rout.
Matthew Sutherland, Fidelity’s senior equities investment director, also shares some insights into how the crisis in Syria is effecting markets:
“Events in Syria have sparked concerns across global markets over the past week amid signs that the UK and US are preparing to launch a punitive strike against Syrian President Bashar al-Assad’s forces, following an alleged chemical attack by them against the rebels. This has coincided with a general emerging market sell-off driven by talk of tapering QE in the US and worsening fundamentals in some developing economies.
“At the moment, the sell-off is broad and indiscriminate. At such times the best stocks often get sold first, being biggest, most liquid and most widely-owned by foreign investors. The good news is that this creates opportunities for active managers, as in reality the impact of events is not equal across all countries, sectors, and stocks. Our portfolio managers and extensive team of over 50 analysts in the region are continually focused on assessing the specific fundamental impact of all events, including currency and commodity price movements, on the companies in which we invest. This enables us to pick the best investments for any set of circumstances at any time.”