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Despite China, some opportunities ahead for emerging markets in 2016

Lawrence Lewitinn
Lawrence Lewitinn

It’s only one trading day old, but so far 2016 is starting off the way we spent much of 2015. That is, investors are worried about emerging markets. But some parts of those markets may also offer buying opportunities.

Bad economic data in China and tensions between Iran and Saudi Arabia helped to drive global shares sharply lower on the first trading day of the year. Though there was some stability the following day, Monday's volatility added to the rough few months many investors in emerging markets have had. The iShares MSCI Emerging Markets ETF (EEM) dropped nearly 20% in 2015. China comprises 26% of that ETF.

“A 7% drop is really kind of extraordinary,” said Peter Marber, head of emerging markets at Loomis Sayles, on Monday's sell-off in China. “I don't think we should assume that it's going to continue to collapse, but it is a key market in emerging markets ... In fact, it's almost one quarter of the emerging market equity index, so many emerging market equity funds will be hurt by China's performance.”

But if emerging markets are showing familiar patterns, it’s perhaps because they are in the midst of their third “megacycle,” said Marber, who is also on the faculty of both Harvard and Columbia universities.

According to Marber, the first megacycle lasted from the late 1980s until the global financial crises of the late 1990s. “That's the period where many countries transitioned from a statist to market economy,” he explained. “Most countries used dollar pegs, and the result over time was they had to get rid of the pegs.”

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The calm following the 1990s currency meltdowns in places like Thailand, Mexico, and Russia, marked the beginning of the second megacycle. “That's when the global supply chains were built out,” said Marber. “China had a massive economic boom, sucking down commodities all around the world. And most emerging markets flourished during this period of time. We had lots of record trade surpluses, credit upgrades, and investors got great returns for that period.”

However, the 2013 “taper tantrum” was the final nail for the second emerging market megacycle as U.S. interest rates began to climb, pulling money out of riskier emerging market assets.

“Since then, we're in this emerging markets 3.0 where we're going to be in a new period of transition, with a lot of reforms in these countries and a lot of uncertainty,” Marber said.

A key feature over the last couple of years has been the strong U.S. dollar. Countries like Brazil, Colombia, and South Africa saw their currencies fall 20% or more versus the greenback. The more powerful dollar also meant a fall in commodities prices, hurting economies and markets such as Kazakhstan (^BKGKZ) and Zambia.

“The dollar strength is going to continue,” predicted Marber. “You probably want to stay away from commodity producers, whether it's in the metals or the oil (CL=F) space.”

Yet he sees some bright spots, particularly with Indian equities. Though the S&P BSE Sensex index (^BSESN), which tracks stocks on the Bombay Stock Exchange, fell 6% in 2015, Marber is optimistic.

India … has been immune from a lot of the malaise that has plagued some of the key emerging markets in the last couple of years,” he said. “Last year the rupee was one of the only EM currencies that was actually up against the dollar.

Marber also sees opportunities in emerging market bonds. “Last year, emerging market debt returned about 1% or 2%, depending on what fund you might have been in,” he said. “That was a pretty good return considering that U.S. aggregate bonds on average fell 2%. So this is not a bad place for investors who want to have emerging market exposure but don't really want to go into the foreign exchange space or the equity space where there's going to be a lot of volatility.”

 

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