For the past few months, reporters, commenters, bloggers and twitterers have been frequently using the aggressive terminology of war to discuss economic matters. One of the most common has been the claim that central bankers of the developed world, and/or their Treasuries, have "run our of bullets", stemming from the belief that all their ammunition has already been used in seeking stimulus, leaving nothing should there be another serious dip.
A new paper from Credit Suisse’s Asset Management Division in effect agrees with that assessment (sometimes clichés are true) but it adds an important point: that the emerging market nations (EMs) are in better shape in this respect. They do have bullets left. As one might expect, though, they are more interested in using their ammunition for the development of their own domestic markets than in using it to serve as an engine for global recovery.
The report is “The Way Forward: Measuring the Impact of Short-Term and Structural Growth Drivers on Emerging Market Investing.” It argues that the EMs have two central objectives that will dominate their policies in the near future, growing their domestic consumption on the one hand and controlling inflation on the other. Given this, the authors draw the following conclusions:
• The currencies of several EM nations will appreciate against the dollar. This is especially so in Asia ex-Japan, where almost all the exchange rates “appear very cheap relative to fair value.”
• EM assets denominated in local currencies, especially debt, will outperform their respective equity markets at least in the short term.
• A portfolio of EM bonds and currencies will offer a better hedge against global equity markets than would a portfolio of emerging equities.
The likelihood of a new recession in both the United States and Europe has increased in recent months. This has naturally made investors quite cautious, and that in turn has hit the emerging markets, as reflected, for example, in the purchasing managers’ indices (PMI), one way of measuring manufacturing activity.
The PMIs for each of the five regions involved (Asia, Central & Eastern Europe, Latin America, the Middle East and Africa) have been heading downward since the start of the year. Yet the PMI news is not uniformly gloomy. China’s PMI survey for August shows a slight increase from July. Even though it is only a one-month blip, it is especially intriguing because it was achieved despite a fall-off in the export component of the index. Thus, the PMI survey indicates that China is growing its domestic market.
“This is interesting, in our view, as we have noticed that post-crisis China PMI, unlike past patterns, now seems to lead the US and Europe, instead of trailing them,” write the authors of the white paper.
The paper also makes the point though that monetary and macroeconomic policy makers in the EM countries “have much more room to maneuver” than those in Western Europe and the U.S. One measure of this room-to-maneuver is the extent of a nation’s consolidated gross government debt as a percentage of its GDP. Indeed, the Eurozone’s sometimes-flouted “Maastricht criteria” stipulate a debt-to-GDP ratio ceiling of 60 percent. Russia, China, Poland, Hungary, etc. all have consolidated debt well below 100 percent of their GDPs. In the US, though, that number is above 100 percent; in Greece it is above 150 percent; in Japan it is above 200 percent.
Another Maastricht criterion involved the annual budget deficit, against as a percentage of GDP. EU nations and candidates for membership are expected to keep this figure at or below 3 percent. Nations that do have a budget-to-GDP ratio below 3 percent include Peru, Russia, and the Philippines. For many developed economies, the ratio is well above that. It is above 6 percent for Portugal. The US, the UK, and Greece are all above 9 percent.
In these respects, then, as the white paper summarized the point, “the EM came out of the credit crisis of 2008 in much better shape than their developed counterparts.”
Consumption growth in EM countries has increased steadily as a percentage of total global consumption since 2002. US consumer spending has been in decline since the same time, by the same metric. The two trend lines crossed in 2010.
The Credit Suisse white paper contends that the Asian economies will lead the rest of the EM in shifting their model of economic growth toward a more consumerist orientation. But over time, EM nations in other regions will follow, switching their focus, too, from pushing exports to encouraging domestic consumption, a change that will allow for a fundamental change in their policy as to foreign exchange. It will make possible greater appreciation in their nominal exchange rates.
A crucial take-away for investors is that EM interest rates “will likely be less correlated with global risk assets than EM equities, which are likely to be highly correlated to global risk appetite.”
The authors of the report are: Bunt Ghosh, CSAM’s head of emerging market strategy; Anja Hochberg, head of investment strategy for its CIO office; and Adrian Zürcher, emerging market and equity strategist, CIO office.
This article was written by Christopher Faille and was originally published on the All About Alpha blog under the title: 'CSAM: The Emerging Market Nations Have Some "Bullets Left"'
Further reading on emerging market nations:
- The oligopoly that is the US financial sector. Part 1 by Anthony Harrington
Tags: alpha strategies , asset management , China economy , china future , China PMI , Credit Suisse , debt to GDP ratio , dollar deficit , domestic consumption , emerging economies , emerging market nations , emerging markets , european debt crisis , eurozone , hedge fund industry , hedge fund strategies , hedge funds , institutional investing , Maastricht criteria , PMI , Purchasing Managers Indices , The Way Forward: Measuring the Impact of Short-Term and Structural Growth Drivers on Emerging Market Investing , US economy