MASSIVE MARCH OP-ED
Emerging market outflows mask a positive picture for commodity-rich countries
Huge outflows from China in March contrasted with significant inflows into emerging markets ex-China, a dynamic interpreted as unprecedented and suggestive of a market rotation out of China into commodity-rich emerging markets such as Asia, Latin America and South Africa.
An almost $10-billion outflow from emerging markets in March will undoubtedly fuel the usual pessimism around the prospects for developing economies in the year ahead – particularly against a backdrop of the ongoing Russia-Ukraine war and anti-inflation moves by hawkish central banks.
But these Institute of International Finance (IIF) headline statistics in its March Capital Flows Tracker belie a structural improvement in the macro-economic and financial circumstances of a large part of the emerging markets universe outside China.
Most of the outflows were a result of foreign disinvestment from Chinese assets in what the IIF interpreted as an “unprecedented dynamic that suggests a market rotation”.
More than $11-billion flowed out of China’s bond market and $6.3-billion from the country’s equity market. In contrast, other emerging markets experienced debt market inflows of $8.2-billion and marginal equity outflows of $0.4-billion.
The shift out of Chinese assets is significant because the world’s second-largest economy, and largest emerging market, has consistently attracted money, even during tricky times over the past few years, for instance during the protracted US-China trade war which saw the US impose tariffs on Chinese goods and China retaliate – and the turn in the tide of sentiment against China in the early stages of the pandemic.
Opinion is still typically divided on the outlook for emerging markets, with HSBC’s 7th Emerging Market Sentiment Survey, titled “Caution Reigns”, reflecting emerging market investors that collectively manage more than half a billion dollars indicating in March that they are bearish (40% of respondents) compared with November (27%).
Those with bullish expectations declined from almost a third to a fifth of respondents. That still leaves 43% who were neutral on emerging market prospects.
HSBC global head of EM research Murat Ulgen points out that sentiment is the second most negative since the launch of the survey in June 2020. What also needs to be taken into consideration is that the bulk of the survey was conducted prior to Russia’s invasion of Ukraine, and thus sentiment could become even more bearish in the next survey.
Investors’ caution is primarily based on inflation posing a “persistent puzzle” for major central banks, according to the survey, with a vast majority seeing it as unlikely that market inflation will revert to pre-pandemic levels. As a result, 60% saw the US Federal Reserve’s response to higher inflation by hiking interest rates and reducing its balance sheet reduction as the biggest risks to emerging market performance this year.
The volatility and uncertainty prevalent in the first quarter prompted Ulgen to say that it was the longest quarter in his career – because there were so many moving parts.
According to him, the most surprising data point in the survey was that investors are still overweight equities even though their risk appetite fell to 5.75 out of 10 – almost a percentage point lower than the previous quarter’s 6.6% and the lowest level since the survey began almost two years ago.
Meanwhile, JPMorgan Asset Management has downgraded its emerging market growth expectations by 50 basis points this year, to 4.5% from 5% in December, with the asset manager’s expected base-case scenario shifting from its reflationary scenario that predominated last year to a soft landing this year. It views the greatest risks facing emerging markets as global economic recovery uncertainty and the ongoing Ukraine conflict.
Again, JPMorgan’s headline emerging market growth forecast and HSBC’s cautious-to-bearish emerging market sentiment survey outcome doesn’t reflect the likely economic reality of all emerging market regions, with conditions on the ground in Asia, Latin America and South Africa markedly more positive. The latter two are expected to benefit from their commodity-rich status and Asia’s relative stability is viewed as positive against a turbulent global backdrop.
JPMorgan sees commodity exporters, like South Africa and Brazil in particular, as likely to be beneficiaries of the Russia-Ukraine conflict. It’s reflected in equity market performance year to date.
Latin America has been a standout performer, with the MSCI Latin America Index up almost 30% year to date, versus a 6.6% decline in the MSCI Emerging Market Index.
On the foreign exchange front, the asset manager says: “We see Chile, Malaysia, Brazil and Indonesia potentially benefiting. For example, currencies such as the Brazilian real, Indonesian rupiah and Chilean peso all offer positive beta to commodities.
“In the more idiosyncratic space, we see South Africa as a winner, though we are more sceptical on the outlook for Colombia given the upcoming election.”
The foreign exchange movements this year already reflect these views, with the Brazilian real the best performing currency, 21% firmer year to date, Chile’s peso coming in third, up 8.9%, and the South African rand the fourth best performing emerging market currency, appreciating 8.5% this year.
Aiding in the relative attraction of those emerging markets, as they stand to benefit from a seismic and likely long-lasting shift in the global commodity landscape, is that they have also been ahead of the curve in tackling inflation and have lower debt burdens to deal with than those in the developed countries.
Together, these provide cushioning that other parts of the world won’t have during these unprecedented times. But investor sentiment towards emerging markets has always been far more volatile, no matter the state of their economies.
Investors rush for safety in response to adverse global macro-economic and geopolitical developments. Emerging markets inevitably get swept away in these risk-off tides – and, above all else, capital flows do matter in their economic and financial market lives. BM/DM