In May, the bellwether investment bank Goldman Sachs decided to slash its exposure to Emerging Markets. Rising trade tensions between the US and China were blamed for the move.
“We have scaled back overweight exposure to EM (emerging market) currencies and EM debt until we gain clarity on the direction of travel for both US-China trade relations and global growth, with the two being interconnected,” Goldman Sachs Asset Management said in a note.
The challenges are legion. Flows into emerging markets can be dependent on cheap capital from the Federal Reserve and are very sensitive to a change in monetary policy in the U.S. Add to that domestic factors such as high current account deficits, weak currencies and a dependence on commodities, these markets can make for a risky investment, the bank’s analysts added.
It was a shocking about-face for the bank that had proselytised Emerging Markets, convincing investors around the world to take them seriously. Goldman Sachs analyst Jim O’Neill in 2001 invented the term ‘BRICs’ (Brazil, Russia, India, China) and created the idea of Emerging Markets as a concept.
O’Neill was certain that there would be growth across Emerging Markets for many years, and spurred a flood of investment to EMs seeking better returns than were available in the West, with its low interest rates. Yet, as early as 2013, he admitted that the results were disappointing.
It’s clear that the growth he forecast never materialised. From October 2015 through the end of September 2018, the S&P 500 produced a 61.4 per cent total return, including reinvested dividends. The MSCI World Index ex-USA, on the other hand, has produced a 30.6 per cent return, less than half the cumulative return of domestic stocks.
Social development also fails
And the social development that was to come from this wave of investment in EMs also never materialised.
The middle class was supposed to be growing rapidly, creating new markets for conspicuous consumption, all across Emerging Markets – across the world. The theory was that investment in EMs would drive the creation of a large middle class, which would establish a consumer economy and drive out corruption.
It happened, somewhat, in China. But nowhere else. “While people often look around the emerging markets for a repeat performance of China’s economic boom, in reality the overarching theme of a broad, rising EM middle class scarcely exists,” writes commentator Justin Leverenz of Invesco.
“Rather, optimism about this theme was largely conjured up by investors and multinational corporations that observed the nascent expansion of discretionary income in EM and extrapolated it into the next big opportunity across the entire asset class.
Slow growth for South Africa
South Africa should have been the poster child for Emerging Market growth; instead it is a basket case.
With its vast mineral resources, South Africa should be thriving, with investment pouring into social programmes – just like O’Neill promised us.
Instead, the country entered a recession earlier this month—the first since 2009. Weak growth is expected next year. Joblessness is over 37 per cent. Vast numbers have simply given up on looking for work. The murder rate is also rising. The country’s sovereign debt has been downgraded to junk by all of the big credit-rating agencies. The rand has fallen nearly 20 per cent this year.
India is struggling with unemployment
For a while, India seemed to be among the most successful of EMs, as internal consumption rose on the back of a new middle class.
But it became clear earlier this month, that it wasn’t sustainable. Official government figures revealed that the economy had been slowing for three quarters. After months of denial, the government also admitted that unemployment is higher than it has been for four decades. Now, Arvind Subramanian, a well-regarded economist who was till last year one of Modi’s most senior advisers, has argued in a Harvard working paper that India’s official figures overestimate growth by several percentage points.
It’s ironical, but it’s about politics
And Turkey, Mexico, Russia and Brazil are all weak and struggling. The Russian economy is still entirely based on oil sales. Turkish companies are overburdened with foreign currency debt, and a political regime that has disconnected with the country’s businesses and people. Mexico is mired in slow growth.
Behind all this is political failure – obvious in Turkey and Brazil, but also visible in Russia, India and South Africa.
When the investor money was flowing in, not enough investment was made in productive growth. Similarly, not enough reforms were undertaken to underpin the middle class. The transition from emerging to emerged just didn’t happen.
Now that the money is gone, these countries are paying the price. Let’s hope political change will keep it from being a too-high price.