Emerging markets were on the cusp of something very big at the beginning of the year. People around the world were continuing to join the ranks of the middle class, helping build consumption economies. China was licking its wounds after a trade war and seemed poised for rebound after a trade deal was signed with U.S. President Donald Trump. The MSCI Emerging Markets Index had risen 18.4% in 2019. The International Monetary Fund predicted a 4.4% growth in emerging economies this year. To some minds, the fact that most of the world GDP growth has come from these economies—and the fact that they make up a fraction of the big indexes and market cap—showed a huge disconnect that smart investors could take advantage of.
Then came Covid-19. In just a few days, the pandemic made the world markets sick, forced people to stop gathering in restaurants, stop flying, stop going to movies, stop construction. Millions of migrant workers were stuck in cities far away from home in India. As global poverty estimates have risen, people who had just entered the middle class were likely suddenly wondering about having to re-enter the middle class.
According to the Institute of International Finance, $83 billion in funds flowed out of emerging markets just in March—a combination of Covid-19’s chilling of the economy and the shock in oil prices. An April 9 report said, “Since January 21, our high-frequency daily tracker shows portfolio equity outflows of $72 billion and debt outflows of $25 billion.”
Portfolio managers’ disquiet over the King Midas in reverse story admit it’s been an excruciating year so far.
Rishikesh Patel, portfolio manager of the BMO LGM Emerging Markets Equity Fund, says all the tailwinds that have spurred emerging markets’ long-term growth opportunities have now become serious liabilities—the poor infrastructure, underdeveloped health-care facilities that can get overwhelmed, a low penetration of goods and services. India, for instance, has seen a shortage of ventilators and hospital beds, according to a Brookings India report.
These markets “are going to be hit, there’s no way to sugarcoat this,” Patel says. “And if you add the oil price correction, then some of these oil exporting countries are going to get significantly impacted.”
Even in emerging market countries, however, there’s a division of haves and have-nots. Asset management firm GMO said in a recent white paper that emerging market countries were divided into two camps—those with better bearings to handle the crisis and those without.
“About 60% of the MSCI EM index comprises countries that rest in what we define as a ‘safe cluster,’” said the GMO mid-April white paper, penned by Amit Bhartia, Tiger Tong, and Uday Tharar. South Korea, China, Thailand and Taiwan get good marks for their strong health-care systems; their response to the pandemic, including massive testing and early lockdowns; and for their ability to respond economically with stronger government finances and central bank balance sheets. (South Korea has about 12 hospital beds per 1,000 people, India only 0.55, says the World Health Organization.) Turkey, Mexico, Brazil, Indonesia and Malaysia also greatly suffer by GMO’s comparison. Though Russia has the albatross of oil around its neck, it’s won high marks from these analysts for its virus response.
Bart Grenning, manager of the TIAA-CREF Emerging Markets Equity Fund (at Nuveen), says many of these countries don’t have the fiscal flexibility to offer large handouts to their populations the way developed markets do. A lot of them are burdened with high fiscal and current account deficits and rely on foreign capital to fund them. When the money tide washes out, as it does in cases like a pandemic, it crimps these countries’ future policy alternatives. And the debt problems could last longer than the virus itself. The currencies of South Africa, Brazil, Turkey and Mexico have all taken headers, exacerbated by a flight to dollars and oil’s collapse. This will hurt emerging markets’ abilities to pay off external lenders, especially in a foreign capital squeeze. Brookings put the emerging markets’ external debt at $11 trillion in mid-April, auguring a coming debt crisis. This puts capital-thirsty veterans of the old “Fragile Five,” now mainly South Africa, Brazil and Turkey, on even more dangerous ground.
Louis Lau, who oversees $4.5 billion in emerging markets assets at Brandes Investment Partners, says, “So a pecking order has developed with China being at the top, which is kind of ironic because that’s where the virus started.” China’s ability to respond meant that by April, most of the country had gone back to work, he says. “The expectation is that by the third quarter, consumption could return close to normal,” Lau says.