While many are worried about the domestic economy and whether the US is headed for a recession, those invested in emerging markets should perhaps be even more concerned. One of the fears specialists in the area have is that there is probably about $200 bn of unreported Chinese loans on the books of emerging market borrowers. China is not obligated to report these loans anywhere, so no one is quite sure of the size of the exposure. The risk is that as the economy sours, and these credits debts become distressed, China could impose some severe conditions on borrowers, which could cause emerging markets to seize up.
FINSUM: We could see this becoming an issue, especially because China will be feeling distress itself, which means it is likely to use a heavy hand. Even if nothing comes of this, it will likely weigh on EM asset prices in the near-term because of the uncertainty.
For many years, emerging markets were a must-have in every investors’ portfolio. The idea was that a large swath of the world was on an inevitable path towards economic parity with the west, and that there was a great deal of money to be made by investing in that growth. For several years, that view held. However, changes over the last decade mean that such a thesis is increasingly in doubt as many of the factors that drove EMs have fallen away. In the words of the Financial Times, “high commodity prices are a fading memory. Trade is stuttering and global supply chains are being disrupted. Far from catching up with the developed world, many supposedly emerging markets are growing more slowly”.
FINSUM: It is not just economic either. Governments have not cleaned up as fast as many had hoped, which means the law and governance aspect of EMs has hardly improved.
There have been a lot of stories, admittedly in this publication too, that have diminished the threat of the current trade war with China for the US economy. In a very direct sense, that may be true, but there is a lot of misunderstanding about the Chinese economy. Most people think that China is currently slowing because of the trade war with the US, but that is not really the case. The much bigger issue is that the country’s credit boom has run its course and the government is running out of options to boost growth. The credit boom was caused by the government needing to stimulate consumer spending in an effort to spur a domestic consumption economy, but credit has more or less reached it limits, and therefore, so has the economy.
FINSUM: If China has a big contraction/meltdown, it will ripple across all the countries who are part of its ecosystem, including all the EMs in the region, Africa, and then ultimately the big developed economies with which it is now inextricably linked.
How does a big global housing meltdown sound? Crappy. Well, that is exactly one of the things that the IMF is currently warning investors about. Americans will already be well aware of the several month downturn in real estate, but what is likely much less well understood is that many markets around the world, including emerging markets, look at risk of a major housing bust. One of the big worries of the IMF is that a real estate downturn will spark a banking crisis in overseas markets that could then bubble over to the rest of the world.
FINSUM: We don’t tend to think of real estate as a particularly globally-correlated asset class. However, the banking industry that underpins it certainly is, so the risk is definitely there.
American investors generally don’t pay enough attention to merging markets. We have such a big economy and markets that investing abroad often feels foreign and unnecessary. However, the diversification benefits of doing so can be huge, and right now may be an excellent time, says Morgan Stanley. The bank’s lead emerging markets strategist, Ruchir Sharma, is changing tune. For the last decade he said US shares, and particularly tech, would outperform. Now the pendulum is swinging back, with EM likely to take the lead.
FINSUM: EMs have obviously been beat up over the last decade, so there is certainly value to be had. The big worry for us is about global trade policy and how that constrains EM growth.