Emerging markets have been on a bit of a roll lately. The commonly traded iShares MSCI Emerging Markets ETF (EEM) has gained 11% since July 1, when the first wave of global Fed taper panic began to subside. That outstrips a 9% rise in the S&P 500 (^INX) over that period. The wise men and women of the financial chatterati are suggesting it might be time to buy a little EM again.
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But news flow over the past week suggests a dead-cat bounce rather than a sustained rally for developing-world economies and stocks. Two marquee global corporations that depend on emerging markets for growth, Unilever (UL) and Heineken (HEINY), reported underwhelming results thanks to slowing demand for their soap powder, mayonnaise, and beer. Unilever's sales growth in emerging markets contracted to 5.9% in the third quarter from 10.3% in Q2, and chief executive Paul Polman sees no reacceleration any time soon. "The reality is that the global economy is not in as good shape as some would like to make out," he pronounced on the post-earnings conference call.
Heineken CEO Jean-Francois van Boxmeer issued an official warning that full-year 2013 profits would fall short thanks to disappointing sales in markets from Russia to Mexico. "Heinekin now expects full year net profit (BEIA) to decrease in the low single-digits, on an organic basis," a company statement read. Whatever that means exactly, investors did not like it. Shares dropped by 5% following the Oct. 22 announcement, and have languished there.
Even China has started complaining about the slowdown in emerging markets. The No. 2 economy's exports actually shrank slightly (by 0.3%) in September from August, and a commerce ministry spokesman was quick to blame customers elsewhere in the developing world. "Many risks, such as capital outflows, currency depreciation, and rising inflation pressures exacerbate the economic slowdown in emerging countries," the Beijing functionary said.
But the most forward-looking and comprehensive recent bear indicator for emerging markets is a quarterly bankers' poll published by the Institute of International Finance (IIF) in Washington. The Q3 edition of the Emerging Markets Bank Lending Conditions Survey shows developing world lenders in a distinctly crabby mood, tightening lending standards and finding liquidity tougher to come by themselves.
Like many confidence surveys, the IIF's works on a 100-point scale, with values under 50 indicating a worsening outlook. The overall score compiled from 134 different emerging markets banks was 48.3 this time, down from 49.5 in the second quarter. In other words, finance on the ground has been getting tighter for six months now, after a bit of an uptick in the previous two quarters.
By sub-sector, emerging markets bankers are hitting the brakes hardest on consumer lending. Fully 25% of all respondents said they were tightening standards for retail loans, against 15% who are loosening. That will inevitably cramp the historic expansion of the developing world middle class, at least for the moment.
Geographically the hardest-hit region is all-important Asia, whose IIF index number has sunk below 45. "Bank lending conditions in emerging Asia deteriorated further, led by a sharp tightening in funding conditions, particularly local funding," the report concludes. Bankers in Latin America, the other key region for emerging market investors, are also feeling few animal spirits, though their index is closer to the global average of 48.
Financiers are feeling more cheerful in the Middle East and Africa, but these regions offer relatively few instruments for international punters. The most telling contrast in the IIF report is between emerging markets and the US, where credit standards for both corporate and consumer loans have been loosening strongly and continuously since 2010. Both these indices are cruising comfortably above 55. American bankers have been considerably more cautious with mortgage lending, though, moving into a moderate loosening mode only over the past year.
Capitalism is called capitalism because its heart is the deployment of capital. This vital function is largely performed by banks, particularly in developing countries where securities markets are shallower. If the banks are retrenching, the heart will beat more weakly and a new growth spurt will remain on hold.
It is important to remember that all these signs of gloom are relative. Quarterly sales growth of 5.9%, as Unilever achieved in its emerging markets business, is hardly a mark of crisis. China, for all the talk of its export story being over, recorded a current account surplus of $214 billion last year. Its sales to the rest of the world will certainly grow again after an unaccustomed month of stagnation. Emerging markets are still the future, just maybe not so much the immediate future.