Mark Zuckerberg was $7-billion poorer in 24 hours on 4 October when Facebook crashed. This has, clearly, been a difficult month to be in equities most exposed to “growth”.
Developed world investors are wary of naggingly persistent inflation and slowing growth. With central banks having little option but to start to edge towards rising rates and tapering stimulus, combined with high valuations, investors are rightly skittish.
But this perhaps obscures where the most risk in global markets lies. There is a strong argument to be made that those investors who are most exposed are in emerging markets, not developed. While stagflation in the developed world would be unfortunate, if it were to happen in the emerging world, it would be economically calamitous.
Not all emerging markets are created equal, but they have certain things in common. They tend to be more vulnerable to currency weakening and inflation as they are broadly net importers of food and energy.
Emerging market central banks have needed to be more proactively hawkish than central bankers who deal in hard currencies; investor “flights to safety” of the US dollar can be ruinous for those in the Global South.
Many emerging market economies have also historically borrowed heavily in hard currencies, leaving them vulnerable to debt spirals – as their currencies weaken, so their debt-service costs rise and their credit becomes less investable, resulting in further selling and higher interest rates.
For emerging markets such as Nigeria and Russia that are energy exporters, the current spike in energy prices could be seen as something of an opportunity, but for those that are energy importers (such as Turkey, India, China and SA), this will be an additional burden.
Many emerging market central banks are already reacting to this impending inflation and are tightening: Russia has pushed rates from 4.25% to 6.75% this year; Brazil from 2% right up to 6.25%; and Mexico has hiked from 4% to 4.75%. Others, such as South Africa, have held back, with Lesetja Kganyago at the SA Reserve Bank holding rates steady at an all-time low of 3.5%, citing weak aggregate demand outweighing any inflationary pressures.
He may start to rue this reticence. Already, compared with South Africa’s peers, the rand has been crushed, down 5% over the last month against the dollar, which compares poorly against the Turkish lira, Brazilian real and Russian rouble, which have all held broadly steady. Investors are rewarding the central banks that are treating inflation with due caution. This combination of sticky inflation with slowing growth and weakening currencies could be something of a perfect storm for emerging markets. For those foreigners who are exposed to such markets, growth is key, as well as low hard-currency interest rates.
Should growth expectations slow and US rates start to rise, there will be very little reason for developed world investors to have exposure to markets like South Africa.
Luckily, the vast majority of South African sovereign debt is rand denominated, and foreign ownership of the country’s bonds is relatively low at just over 30%. Although this makes South Africa less prone to a debt spiral, it does not make it impervious.
As the currency has sold off, South African government bonds have moved correspondingly, with the 10-year bond almost one percentage point higher over the past month to trade just below 10%, and the SA 10-year break-even inflation rate this week touching a 17-month high. Should there not be noises of impending hikes from the SA Reserve Bank soon, this could risk turning into a rout.
In equities South Africa has held up comparatively better, with the JSE Top 40 having outperformed the S&P500 over the past month, which would imply that investors are rather more complacent than they should be.
This comparative resilience in South African equities may be a reflection of the hard currency exposure of the stock market. A large proportion of the South African stock market is, of course, in rand hedges such as Naspers, Sasol and AB InBev. DM168
This story first appeared in our weekly Daily Maverick 168 newspaper which is available for R25 at Pick n Pay, Exclusive Books and airport bookstores. For your nearest stockist, please click here.