Global equities, especially developed market ones, had an unusually poor start to 2014.
Experts agree that the initial sell-off was caused by worries over the tapering of QE along with slowing growth, currency weakness and current account deficits in a number of emerging markets.
Performance of indices in 2014
Source: FE Analytics
Markets have since rebounded, with the FTSE standing at 6,724 at the time of writing.
However, some commentators, such as Becket, warn that the deterioration in the economic outlook for emerging markets could well turn into a more global issue and have a serious impact on the developed world.“Clearly, developed markets have performed well,” Becket said.
“However, because most of that growth has been driven by re-ratings instead of underlying earnings growth, then I expect returns to be harder to come by in 2014.”
“One of the major reasons for that is because the traditional engine of their growth has been from emerging markets.”
According to FE Analytics, the S&P 500 and the FTSE All Share have both made steady gains over the last three years, while the MSCI Emerging Markets index has lost more than 10 per cent.
Performance of indices over 3yrs
Source: FE Analytics
“If there is more of an emerging markets crisis, then it would be worse for developed market equities, because with emerging market equities, at least valuations are on your side,” Becket explained.
“That is because a potential emerging markets crisis, or slower economic growth, is already in the price.”
“Our thoughts are that now is a good time to take profits from developed market equities and build up cash positions, and, in time, build up our emerging markets position from neutral to overweight,” he added.
David Jane (pictured), manager of the TM Darwin Multi Asset fund, disagrees with Becket, however.
While he admits that wobbles in the developing world could cause further volatility in global financial markets, he doesn’t expect any long-term impact on the recovery in the likes of the UK, US, Europe and Japan.“When you look at the history of emerging market upsets, they do tend to have a contagious feature about them,” Jane said.
“Investors do tend to bucket them all together and fund managers will allocate to the emerging markets, not Argentina, for instance.”
“It is a fair assumption, given their history, that things will get worse before they get better.”
“However, to what extent will it have a knock-on effect on developed world financial markets? My basic thesis is that it will just be another thing to worry about while we wait for earnings growth to come through,” he added.
Jane told FE Trustnet last year that he expected earnings growth to pick up substantially in 2014 as the effects of the improving economy fed through to corporate profitability.
He still says this will be the case, though markets could be very stop-start while investors have to wait for that news.
Nevertheless, he expects developed market, domestically focused stocks, to perform well over the medium-term and is therefore maintaining decent exposure to European countries such as Spain and Italy as well as more traditional exposure to the UK.
On the other hand, Rob Jukes, global strategist at Canaccord Genuity, says investors should not become complacent with UK and US equities as he is concerned that a slowdown in emerging market growth could well spill out through the global economy as a whole.
As a result, and despite the fact that the FTSE has since rebounded, Jukes says this isn’t going to be a short-term trend.
“I think the shape of global economic growth is likely to be different from here on in,” Jukes said.
“It will be less dependent on infrastructure spend and emerging market economies will have to be driven by more domestically generated growth than the export model they have relied upon in the past.They can’t rely on it anymore simply because the developed world isn’t growing enough.”
“It is something more fundamental than a short blip in sentiment, I think it is something we will be grappling with for some time to come,” he added.
Jane has no exposure to emerging markets in his fund.
He says that there are a number of countries in Latin America and south east Asia that are dependent on external spending.
However, he says these economies are not big enough to de-rail economic growth.
He doesn’t have any exposure to China either. While he admits that – given it is the world’s second largest economy – it does have the power to disrupt the global economy, it is “self-sustaining and in charge of its own destiny”.
Jane says that for as long as he can remember, China’s banking system has appeared a mess because “they don’t follow our rules”.
However, he says it is a dangerous assumption to make that the growing Chinese shadow banking sector has the power to push the country into a crisis, because the authorities can just tell the state-owned banks to lend more.
He also points to the fact that he has seen plenty of emerging markets crises in the past, none of which have had a large-scale impact on developed markets.
“Yes there is a financial issue: too much money was pumped into those markets and it is now coming back out – which is healthy I suppose – because people were far too exposed to emerging markets,” Jane said.
“How many times, however, have we seen an emerging markets crisis of one kind or another over the last 30 years? Yes these economies are larger than they have been in the past, but they are still not that big.”
“They have never had a massive impact on the global economy as a whole, but they could cause volatility in financial markets.”
The last major emerging markets crisis was in 1997 and that was also caused by falling external investment.
While there was volatility that year, the S&P 500, FTSE All Share and MSCI Europe ex UK indices all returned more than 20 per cent.
Performance of indices in 1997
Source: FE Analytics
Jane is confident that the current wobble in emerging markets will have little impact on the developed world.
Among the major reasons for this, he says, are that commodities – which are a leading indicator of global growth – have started the year strongly and equity markets have already recovered.
“That’s my basic top-down view,” he said.
“I am not concerned until there is more evidence to suggest that I should to be concerned.”
