Volatility increasing in emerging markets

The emerging market space has been the main source of global volatility this year, says Benjamin Tal, deputy chief economist at CIBC Capital Markets.

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As such, “People have woken up to the realization that emerging markets can actually slow down,” he notes. “The reality is that emerging markets have been slowing for more than five years,” and the main driver of this trend is China’s lagging performance.

The bad news is emerging markets will continue to suffer, given the outlook for China is even bleaker than most perceive. “The real [growth] number is about 4%, not 7%, which is the official number. If you look at indicators like electricity usage and freight activity, these all suggest China is slowing down more rapidly than official numbers suggest.”

Read: Can you trust China’s economic pronouncements?

Up to this point, markets have been reluctant to accept China’s further deceleration, says Tal. This is because “the market was under the impression that the Chinese authorities have the monetary might, the fiscal might, and the political ability to deal with whatever happens.”

However, when the Chinese stock market dipped, “the government made the mistake of putting its credibility on the line and trying to save the stock market. At that point, the global market [started to] realize that maybe the Chinese government isn’t as powerful as believed.”

Read: Who wins when China’s volatile?

Still, some emerging markets have strong fundamentals. The key, says Tal, is to “distinguish between countries like Brazil and Russia, which continue to suffer from a fundamental perspective, and others such as Mexico, India and Indonesia.” The latter three have good fundamentals, and effective monetary and fiscal policies.

And, volatility may present opportunities. “In the short term, emerging markets [have been] oversold and, in fact, could surprise on the upside over the next six months.”

Read: Investors should look beyond North America

This is because there’s so much stimulus in the global economy, Tal adds, and Chinese authorities are trying to stabilize the country’s market as well as reverse its crisis of credibility.

Read: Global weakness masking emerging market strengths

But, says Tal, the real test for emerging markets will come when “the unemployment rate in China starts rising. Then, we’ll see how committed [authorities] are to economic reforms,” and how this trend affects countries outside of China.

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