To what extent are emerging markets now the ‘New Defensives’?

Russ Koesterich, managing director and chief investment strategist at iShares, ponders to what extent EMs are supplanting developed markets as safe harbours.

For much of the past 30 years, financial shocks mostly originated in emerging markets. However, the epicenter for the worst economic crisis in generations was clearly in the developed world.

And as the global economy struggles to stabilize, Europe, Japan, and arguably the United States continue to be major sources of systemic risk.

EMs are not without their share of macroeconomic problems – inflation, corporate governance, and potential credit bubbles to name but a few.

But many of these countries have made tremendous strides over the past decade and for the most part, appear more stable and suffer from fewer imbalances than ten years ago. In fact, not only do most emerging markets compare favorably with their own histories, today they also do so with more established, developed markets.

The improvement in macro stability is beginning to be mirrored in a shift in volatility. While emerging markets suffered in September, over the past several years the difference between emerging market and developed market volatility has shrunk. This decline in relative volatility appears justified in light of improving macroeconomic stability and better growth prospects, and we would expect it to continue.

In light of these changes, we believe that investors should adopt a more nuanced view of emerging markets. Rather than treating them as just a high-beta, levered play on risky assets, investors should focus on the ability of certain EMs to provide a defensive play in the event of a recession in the developed world – with the caveat that the impact of another global recession would be ubiquitous, as it was in 2008.

 

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