Boons and barriers for emerging markets

Four drivers that continue to influence emerging markets are worldwide demographics, financial intermediation, globalization and closer global links, says portfolio manager Michael Reynal.

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Demographics remains a factor as the baby boomer generation, in developed markets in particular, continues to age and drive labour and demand trends, he said during a mid-September interview.

But he’s keeping a closer eye on the growing impact of financial intermediation. Related to emerging markets, “I’m talking about the expansion of banking systems, improved access to credit and the nature of global flows in and out of these markets,” said Reynal, chief investment officer and portfolio manager at Sophus Capital in Des Moines, Iowa. His firm subadvises the Renaissance Emerging Markets Fund.

Globalization is also key for emerging markets, since it leads to greater flow of trade, capital, people and information, said Reynal. Currently, geopolitical tensions are hampering businesses and organizations that aim to develop global influence.

“With more protectionist policies in Europe, and with a number of countries reacting to protectionist, isolationist policies—largely driven by the United States—we are indeed seeing the flow of trade either being halted or questioned,” Reynal added.

“Linked to that, we are seeing the flow of capital at the margin being impacted,” he explained. “People are less willing to make investments across borders; people are not doing as much secure borrowing across borders and lending across borders.”

Early last week, the MSCI Emerging Markets Index was down approximately 17% for 2018, the Financial Times reported (requires subscription), citing issues such as Brexit and Italy’s disagreement with the EU over its budget. The index has steadily slipped since late January, from nearly US$1,300 to approximately US$940.

While most of the growth drivers listed “remain intact,” Reynal said, “I worry about productivity both in developed and emerging markets.” The global flow of capital and people was helping drive productivity, which benefited everyone, he added.

Migration issues

As the flow of people becomes a politicized issue in both the EU and U.S., there will be repercussions, said Reynal, including “slowing overall growth.”

One reason could be “a number of those countries where migration comes from are feeling sore or put upon by some of the developed countries,” he said. The overall effect could be changing migration patterns altering “productivity expectations, cost bases and, again, some of the trade flow that we mentioned earlier.”

Last week, Germany and the Czech Republic said the EU should have an agreement with Africa to slow down the number of migrants and refugees, the New York Times reported. German chancellor Angela Merkel spoke in favour of creating a plan like the one where the EU pays Turkey to take Syrian refugees, saying it’s working well. But, at that time, the Czech Republic, Hungary, Poland and Slovakia had refused to accept a plan by the EU to accept an assigned number of migrants.

Meanwhile, the Mexican peso fell in recent weeks when President Trump threatened to close the southern U.S. border and cut off aid if migrants from Central America to the U.S. weren’t stopped by their governments, Reuters reported.

Commodities

From a regional perspective, a number of cyclical sectors have done well in the last couple of years, Reynal said, pointing to the price of oil rising and the price of copper almost doubling.

“We’ve seen a number of these commodities do well,” he added. “That has boosted [the economies] of Latin America, [and] large chunks of emerging Europe and the Middle East.” In Asia, the producers and users of cyclical commodities have also performed well.

Further, “Asia’s a large partner with the rest of world as well as internally,” and is one region that’s benefited from the rising consumer consumption of discretionary goods, including big-ticket items like classic cars.

“We have not seen a dramatic slowdown in 2017 or in the first half of 2018 in consumption, in particular of discretionary goods,” Reynal said.

Broadly speaking, internal trade in Asia and in other markets is positive for emerging economies, he added, since it could “be an offset to that isolationism that we’ve seen developing in the United States.”

For more on emerging market trends, read: Where to find growth in emerging markets

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