Investors shouldn’t rush to buy emerging markets at the moment, according to NN Investment Partners' Maarten-Jan Bakkum, who argues that just two countries are presently worth investing in.
The senior emerging markets strategist says there are three main headwinds in the market globally that investors should be keeping a close eye on, especially when thinking about emerging markets.
The most significant issue at the moment, he says, is the month-long tumble in Chinese stocks, which has continued despite numerous emergency measures deployed by the Chinese government in an attempt to avoid the market crashing.
Performance of index over 1month
Source: FE Analytics
These measures have included the suspension of 745 Chinese stocks, dozens of firms scrapping plans to introduce initial public offerings (IPOs) and China’s top brokerages buying billions of dollars’ worth of shares in an attempt to steady the market. 
“With the stock market coming down so quickly there, there’s a lot of attention [on China] which I think is very good - there has to be attention on the economy and the market because there’s a lot of risk,” Bakkum (pictured) said.
“The big question for China is whether they can have an orderly slowdown towards more sustainable growth levels - the economy has been slowing since 2010. We think that a 4 or 5 per cent growth rate is a growth rate that would suit China perfectly, rather than the [planned growth rate of] 7 per cent they’re on now.”
“The thing with China is that when the market comes down, people start to get worried about everything – that’s always how it works. There are question marks surrounding things that were not questioned when markets were going up, so this means that you have to focus more on China at the moment as it’s very critical what happens there.”
The emerging markets expert adds that Chinese policymakers have built up a successful track record in managing the world’s second largest economy over the last couple of decades.
However, as the situation in China is becoming increasingly desperate, people are questioning how effective they really are, especially when considering the country’s debt load, which is more than 280 per cent of its GDP, its large capital outflow in the first quarter of this year and rapidly falling house prices.
“I think that’s the big thing for China. I think they will continue to have a negative impact on the whole emerging world through low commodity prices,” Bakkum continued.
The other factor that he is keeping a close eye on is the unwinding of the US dollar, as he points out that a strong capital inflow into emerging markets has correlated with low US interest rates and quantitative easing since early 2000.
“Debt capital still has to flow out I think. With rates in the US potentially rising before the end of the year, it looks like there will be more pressure on flows into emerging markets and that puts a lot of pressure on financial systems, particularly in countries where credit growth has been sustained by strong capital inflows,” Bakkum explained.
The third factor that is reducing the appeal of emerging markets, he says, is the general slowdown in emerging market growth, which has been apparent since 2011.
Performance of index over 15 years
Source: FE Analytics
“We were on 8 or 9 per cent growth and now we’re back down to around 4 per cent. That’s not good, of course, but we also thought that over the last few quarters we would not be far away from the trough of emerging market growth. But at this point, momentum is still very negative,” Bakkum said.
“As long as emerging market growth isn’t improving, you probably shouldn’t be in a hurry to invest in emerging markets.”
“The picture that I’m painting here has not emerged recently – we’ve worried about emerging markets for years. It took a long time for a lot of investors to become worried about it, but now we’ve reached a point where a lot of people are talking about these structural issues.”
However, contrarian investors could point out that the slowdown in growth has made valuations more attractive and that now could be a good time to buy into emerging markets.
Bakkum argues that for valuations to truly work in the investor’s favour, however, there need to be apparent “triggers” on the horizon that could kick start the market in the future.
“You have to be very critical. When growth momentum is still negative, there’s a reason not to be in a hurry. But if it does improve and it does become positive, then that’s the time you buy emerging markets,” he explained.
As such, Bakkum would only recommend two emerging markets to invest in right now – India and Mexico.
Faith in India’s economy generally increased after the election of pro-business reformist prime minister Narendra Modi in May last year. However, scepticism soon began to show when people questioned how proactive Modi’s Bharatiya Janata Party has been since its landslide victory.
“If you talk about the big risks globally, you talk about the growth slowdown of emerging markets, you talk about China, you talk about policymakers not doing the right things in emerging markets throughout the world, then India really stands out as very positive,” Bakkum argued.
“India has really done a reasonable job. They had a new government elected and have had more reforms than most emerging market countries. Growth has slowed down in the last two years but in the last few quarters it looks a bit better and also recently there are some signs of fixed investment growth picking up.”
“India always was the darling of the emerging market investment world for a long time and it’s gradually becoming the darling again.”
Last year, India’s GDP growth came in at 7.4 per cent, which is 0.5 percentage points more than growth in 2013 and 2.3 percentage points more than in 2012.
Apart from India, Bakkum admits that there aren’t many emerging market countries that have both a low sensitivity to negative global factors and reasonable growth fundamentals. However, he says that Mexico could be a potential investment space for investors with a strong stomach.
“Mexico is another one but there are question marks in terms of the positioning of global investors – Mexico is the market where the ownership of foreigners is the highest, so Fed rate hikes are a concern,” the strategist warned.
“So of course Mexico has its weaknesses, but it’s also a market where growth momentum is okay. India and Mexico are the only two emerging countries where you can say that.”