Developed markets are decelerating, despite years of central banks trying to boost these economies through quantitative easing and monetary policy.
But emerging markets have been growing–even though president-elect Donald Trump’s victory has rattled them over the last week.
“Developed market growth is slowing down; not dramatically, but [that growth] continues to be weak,” says Michael Reynal, a portfolio manager at Sophus Capital. Sophus Capital sub-advises the Renaissance Emerging Markets Fund.
In contrast, he’s been “looking for emerging market growth to be roughly 4.5% to 5% in 2017, and that’s coming off of roughly 4% in 2016,” he notes. “We are seeing growth and we are seeing it accelerate.”
Reynal has partially credited this upsurge to the improving commodities environment. “This turn has not been as strong as one would normally see historically, where you have a six-to-10 year down cycle and then a six-to-10 year up cycle in commodities.” But an up cycle is occurring, he says, just in a more muted space.
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In particular, this year’s upturn has been benefiting commodities like oil, pulp and paper and copper – and Reynal says that’s been positive for emerging markets.
However, commodity importers haven’t been gaining as much. Says Reynal, “For every Brazil or Chile that’s a commodity exporter, we do have an India or a Korea [that’s] a commodity importer. Further, the largest player, China, is absolutely a net commodity importer.”
Reynal explains, “When we talk about commodities being a big driver of emerging market returns, and [about commodities] being a part of the geopolitical framework, we must bear in mind that emerging markets are not [always] beneficiaries of that reinflation in commodities.”
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But in many regions, Reynal’s been seeing a “celebration of profitability in the emerging market space, partly thanks to inflation which is starting to creep back in.”
Here’s a breakdown of the political environments of several emerging markets.
With the price of oil sitting in the $40 range, the Russian economy is thriving–the country’s budget was developed with that price point in mind, says Reynal.
He traveled to Russia in October, and met with President Putin and other senior officials, and says, “The interesting thing about Russia today is that the domestic environment is much more stable, notwithstanding all the noise about Ukraine and Syria. I would argue we’re seeing some very significant improvements domestically.”
Specifically, the Russian government is taking steps to reduce its reliance on state-owned enterprises, due to the history of corruption and inefficiency of those enterprises, he adds.
There have also been discussions about reforming the judiciary. “[Many] believe the Kremlin has been using the judiciary to further its own ends,” says Reynal. “A reform of the law system would, at the margin, be negative for the Kremlin, but positive for the economy and the system overall.”
Reynal says such decisions indicate that “Putin is worried about his legacy and is starting to become more worried about domestic policies. On the Ukraine, he’s very pragmatic; the reality is Russia is in the Ukraine, and the Ukraine was going through massive turmoil.”
The Middle East
Putin isn’t likely to back out of the Ukraine, says Reynal, but he will likely end up renegotiating his activities in Syria. “I think we will see Putin come back to the negotiating table because he has a lot to lose. Again, the reality is this has been very hard to handle for the U.S. during an electoral cycle. And, the rest of the world is really falling behind the U.S. in terms of how to manage the Syrian conflict.”
Reynal adds, “I do worry about the Middle East and, in particular, the Shia-Sunni conflicts which continue to develop. I don’t think that will be freed up any time soon.”
Reynal’s concerned about the pressure on South Africa from both global markets and political opposition. He explains, “The Zuma presidency has been a disaster from a political perspective. The African National Congress, the party in the lead, is struggling with corruption issues, decision-making and, ultimately, popularity.”
The biggest concern for China is the potential for tension in the Politburo Standing Committee between Premier Li Keqiang and President Xi Jinping, which could result in political instability and impact the trajectory of economic policy, says Reynal.
“Having said that, the Chinese system is stable inherently; Xi Jinping is broadly positive for the economy and [he’s] put through a very strong anti-corruption campaign. I am fairly comfortable with the direction of the economy and the [state-owned enterprise] space.”
Overall, the news in Latin America is good, due to several positive political reforms, says Reynal. For instance, “in Brazil, Dilma Rousseff was effectively asked to leave and was replaced with President Temer, who’s significantly more market-friendly.”
As well, in Argentina, “We saw President [Mauricio] Macri come in at the end of last year, 2015, and he’s putting in place some very positive developments for the Argentine economy—and more importantly, for Argentina’s relationships within Latin America.”
In Mexico, president Enrique Peña Nieto has two years left on his term and he’s worked to clean up corruption, says Reynal.
Reynal adds, “Similarly, in Peru, we’ve seen an election in the first half of this year, where the winner [Pedro Pablo Kuczynski] is firmly free market and open to driving economic returns for the country. I would say [change is also likely] for Colombia and […] Chile, where you’ve had a fairly unfriendly government under [president Michelle] Bachelet, that is likely to turn in the next electoral cycle.”
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