While emerging markets bounced back in 2019 there are still a number of unresolved geopolitical headwinds facing them this year, warns M&G Investment’s Charles de Quinsonas.
De Quinsonas, deputy manager of the $921.3m M&G Emerging Markets Bond fund, said excluding the challenges of Brexit there are nine key issues that investors in emerging market should keep in mind.
Persian Gulf tensions
Tensions in the Persian Gulf have been raised once again following the US killing of Iranian commander Qasem Soleimani, however, it was the drone attack on Saudi oil facilities last September that had the biggest impact on oil prices, the M&G manager said.
A few “unsophisticated drones” managed to suspend 5 per cent of the world’s oil production and cause a spike in prices.
Price performance of Bloomberg Brent Crude Sub over 1yr
Source: FE Analytics
Elections in Iran could also have the potential to escalate tensions in the region and have a significant impact on asset classes, while popular unrest in Iraq could also lead to elections, said de Quinsonas.
US-China trade war
Whilst this is undoubtedly a well-known risk, the impact of the US-China trade war on emerging markets cannot be overstated.
De Quinsonas said contagion could come from weaker Chinese economic growth and lower demand for commodities, while some Asian economies have seen falling supply-chain related sales due to a decline in Chinese exports to the US.
But despite the many downsides of the trade war “some developing countries have emerged as winners, he said, as the US has found other countries to meet its demand for goods.
“There also is hope for a sustainable deal between China and the US which would revive global growth in 2020 and beyond,” the M&G manager added. “Rather truce than a deal though. The trade war is likely here to stay.
US election
However, progress on a potential trade deal may hinge on the US presidential election taking place late next year.
As “the most unpredictable US president in recent decades and in particular when it comes to foreign policy”, de Quinsonas said, Donald Trump has upset a number of multilateral agreements, such as the North American Free Trade Association and the Paris Agreement.
“Under a different US personality, emerging economies might not face the same unpredictability of one of the largest trade partners in the world and perhaps not constantly worry about the US dollar being used as a foreign-policy weapon,” said the manager.
“On the economic front, most investors expect equity markets to reprice in the case of a Democratic victory. This would result in the Fed easing and a weakening of the US dollar.
“Whilst supportive of emerging market FX in theory, a weaker US dollar may also reflect a weaker US economy which would both impact US demand for commodities and affect risk assets across the world. In this scenario, emerging market debt as a whole may not perform well.”
Russia/Ukraine
One of the big beneficiaries of Trump’s shift in foreign policy has been Russia, which has benefited from a cooler relationship with its Cold War adversary.
Nevertheless, Vladimir Putin remains embroiled in Ukrainian conflict, backing secessionists in the country’s east.
However, a ceasefire and a new gas transit deal between Russian firm Gazprom and state-owned Ukrainian company Naftogaz have signalled a more stable period. Along with an International Monetary Fund programme of support and a reform-minded president, Ukraine’s credit rating is starting to benefit.
“Clearly the market is Putin a blind eye on any downside risk from geopolitics in Ukraine, rightly or wrongly,” said de Quinsonas.
Turkey – US sanction risk
While some relationships have improved under Trump, others have deteriorated. And ally Turkey has been an example of this.
The purchase of Russian arms by president Erdogan threaten the risk of US sanctions, said the M&G manager, which would have a significant impact on the Turkish economy.
Turkish GDP growth forecast
Source: IMF
“It remains unclear whether the US are willing to also implement broader financial sanctions on the banking sector as a whole, similar to what they did with Russia after the annexation of Crimea,” said de Quinsonas.
“Given Turkey’s banking sector’s huge need for short-term external funding, the latter option would bring material disruption to the Turkish economy and as a result is less likely because an implosion of Turkey would not be good news for either the EU (Syrian refugees agreement with Erdogan) or the US (Russia would likely increase its influence in the region).”
India/Pakistan
Tension between India and Pakistan has once again risen following the passing of a new law in India facilitating eligibility for citizenship for most religious minorities for refugees from Afghanistan, Pakistan and Bangladesh.
However, it has been the subject of mass protests in majority-Muslim state Kashmir, said de Quinsonas, a flashpoint for the two countries.
With Pakistan already under economic pressure, any escalation with India would not be welcome, said the manager.
Water stress
Coming to the “the biggest crisis no one is talking about”, de Quinsonas said that water stress is a real impediment to social and economic growth and has worsened in recent years.
“Unlike the emotionally-driven climate activism from Greta Thunberg, global research organisation World Resource Institute published in August 2019 a research-backed Aqueduct Water Risk Atlas, which found that 17 countries accounting for a quarter of the world’s population were facing extremely high water stress with consequences ‘in the form of food insecurity, conflict and migration, and financial instability’,” said the manager.
“There are other ESG [environmental, social & governance] factors that matter for growth but investors tend to focus on the geopolitics of oil, climate risk in general or deforestation,” he explained.
“Too few investors are really looking at water stress as a structural risk of economic, political and social issues.”
Social unrest across the globe
Finally, the increasing occurrence since the global financial crisis of social unrest is another issue that emerging market investors should be aware of , particularly after some of the mass protests and political changes witnessed last year.
“The trend had started since the global financial crisis but clearly accelerated in 2019 and whilst each protest has its own dynamics, to a certain degree they all shared the same claim for fundamental changes in the system they lived in,” he said.
Performance of fund vs sector & benchmark over 5yrs
Source: FE Analytics
De Quinsonas manages the M&G Emerging Markets Bond fund alongside FE fundinfo Alpha Manager Claudia Calich. Over the past five years the fund has made a total return of 58 per cent, outperforming the IA Global Emerging Markets Bond index (31.74 per cent).
The five FE fundinfo Crown-rated fund has a yield of 5.39 per cent and has an ongoing charges figure (OCF) of 0.75 per cent.