Emerging Markets Equity Commentary: July, 2014

Signs of Stability in China Aid Asian Markets; Ukraine Tensions Hurt Emerging Europe

Emerging market equity prices continued to outperform the developed markets in July and ended the month with moderate gains. Markets in Asia significantly outperformed during the month, helped by signs of stabilizing economic growth in major markets such as China. Countries such as Indonesia, South Africa, and Turkey, where improved political stability is likely to lead to policies that are business friendly, also saw healthy gains during the month of July. On the other hand, most emerging markets in Europe declined as the continuing geopolitical tensions over Ukraine and weaker expansion in the Euro-zone have clouded their growth outlook. In response to the wider economic sanctions by the developed countries, Russia has retaliated with restrictions on imports into the country. These measures are likely to dent economic growth on both sides in the coming quarters.

Second quarter GDP growth data available so far for the major emerging countries has been mostly positive, and has led to modest upgrades in their economic growth forecasts. The Chinese economy expanded at a healthy 7.5% annualized, while growth in Taiwan accelerated. Though the pace of growth declined in Indonesia, the economy continues to expand at over 5%. Korea also expanded at a slower pace during the second quarter and has announced a modest fiscal stimulus program to support growth. Export trends from Asian countries remained largely positive in July and manufacturing output growth also expanded further in most countries.

Near-Term Outlook

The outlook for emerging market economies continues to see modest improvements, and has encouraged investors to consider emerging market assets more favorably in recent months. The better than expected U.S. economic growth has offset the renewed concerns about further weakness in the Euro-zone, lifting the export outlook for most countries in Asia and Latin America. Gains in exports are already visible in monthly data from China, India, Taiwan, and Korea. Though domestic consumption growth remains restricted, select governments in Asia and Latin America have tried to support demand through stimulus measures. The relatively healthy second quarter growth in China was partly the result of improved domestic consumption after the government’s mini-stimulus measures announced earlier. While relatively high inflation risks continue to limit the flexibility to cut interest rates in several emerging countries, fiscal measures that support growth remain an option, though at a modest scale. In addition, industrial investment inflows to the major emerging economies remain healthy and should support capacity additions and technology upgrades.

Renewed concerns about an earlier than expected interest rate hike by the U.S. Federal Reserve and a potential debt default by Argentina have not caused excessive volatility in emerging market assets. Unlike in 2013 and also during the first few months of this year, when similar apprehensions led to sharp sell-offs in emerging market assets, the economic outlook for most of these economies has improved. The political environment in most countries has also improved, adding to investor confidence. In addition, countries that were facing large current account deficits a year ago have managed to narrow the gap through policy measures. As well, the improved export competitiveness that followed the substantial fall in currency values has helped improve the current account deficits.

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