If the U.S. Treasury market’s 2013 Taper Tantrum revealed the fragility of emerging markets, political turmoil this year is highlighting their resilience.
UBS AG, Goldman Sachs Group Inc. and a host of other naysayers have cautioned against excessive optimism as investors have piled into stocks, bonds and currencies in developing nations. They say traders are ignoring the risks of political turmoil, trade protectionism and subdued prices for the commodity exports the countries depend on.
But for all the talk of doom and gloom, the rally continues unabated. Equities and currencies in the developing world are heading for the best annual start in 11 years and their dollar-denominated bonds have jumped to a record. The appetite for higher-yielding assets has increased rather than diminished with the end of ultra-low borrowing costs and the rise of populism, and there are some very good reasons why.
Here we take a look at the common arguments against emerging markets, and provide the bullish counterpoint.
1) Political Risks From Venezuela to Turkey to North Korea
THE CONCERN: Investors will dump emerging-market assets because of political instability, including the riots stemming from food shortages in Venezuela, the turn toward more autocratic rule in Turkey and a bellicose North Korean regime. That’s not to mention trade losses arising from Donald Trump’s protectionist crackdown and the U.K.’s bid to leave the European Union.
THE REALITY: All those things are worrisome, but some of the biggest gains this year are coming from countries going through political upheavals that investors bet will be net positives in the long term. South Korea’s Kospi Index has risen to a six-year high after its first female president was ousted, Istanbul stocks are giving the second-highest return in emerging Europe after Turks voted to abolish their parliament, and South Africa’s rand is heading for the continent’s best performance amid a row surrounding President Jacob Zuma. At the same time, developed nations are looking unstable themselves these days, with a hard-to-predict U.S. president, the ascendance of an anti-globalization party in France and the U.K.’s Brexit negotiations.
“Geopolitical risk is not just an emerging-market phenomenon at the moment,” said Simon Quijano-Evans, a strategist at Legal & General Investments Management Ltd. in London.
WHAT’S NEXT: Investors seem most concerned about specific countries that have the most to lose from global tensions. The widespread optimism about Russian stocks that followed Trump’s election has all but evaporated as expectations for a quick easing of U.S. sanctions fade.
2) Valuations Are Getting Too Rich