Return of emerging markets: Relief

Suddenly, everything is forgotten. The fact that in the past ten years emerging markets have only been able to grow fast thanks to excessive credit growth, dependence on foreign capital has only increased and government involvement in the economy has increased significantly across the board.

None of this matters anymore if the Americans decide not to raise interest rates for the time being and if the Chinese keep the credit tap running. So emerging markets are on the rise again, and they are going up fast. Since the end of January, emerging market equities have outperformed developed markets by about ten percentage points.

This is merely how financial markets work. Fundamental issues lose their relevance as key short-term factors suddenly improve significantly. From January 21, the US dollar has started to weaken.

This was the result of emerging recession fears in the US, and the associated conclusion that US interest rates will not be increased in the coming quarters. As a consequence, capital outflows from the emerging world started to decline, simply because the US had become a less attractive alternative. At least for now.

Investors started to look for higher returns outside the US again. Commodity prices were back on the rise, largely due to the weaker US dollar, which made it easier for investors to give emerging markets the benefit of the doubt.

Meanwhile, China started to show some initial signs of economic recovery. In January, credit growth was much stronger than expected and the housing market in the largest cities was highly dynamic.

It is still hard to believe that the Chinese authorities have really decided to turn the credit tap back on. The overall credit growth is now three times higher than the economic growth and China’s debt-to-GDP ratio is rapidly approaching the 300% mark. This kind of numbers makes it difficult to avoid a credit crunch.

But then nobody knows when China’s bad-loan problems will become unmanageable and the system will collapse under the weight of too much debt. Most investors will choose to take advantage of a new credit-driven economic recovery, rather than being gloomy about a crisis that might not materialise for years.

So here we have the explanation for the upswing in emerging markets in recent months: a delay in interest rate hikes in the US and a new acceleration of China’s credit growth.

These are not factors that will solve the fundamental problems in the emerging world. But they do provide relief to the economies burdened by capital outflows and declining Chinese demand for commodities. Let’s hope that the US Federal Reserve does not have to change its ways any time soon and that the bad loans in China will remain manageable.

Maarten-Jan Bakkum, senior strategist, Emerging Markets

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