With the global financial system expected to remain under stress for much of 2009, there is little consensus for clients who are looking to invest in emerging markets.
Some money managers believe that clients who invest in non-Asian emerging markets should adopt a defensive stance in their asset allocation to preserve capital, while others recommend realigning asset mixes to benefit from the growth of equities in the event of a market recovery.
Erik Nilsson, a senior economist withBank of Nova Scotia<\/b>\u2019s international research group in Toronto, says it all depends on whether \u201cyou\u2019re an optimist or a pessimist.\u201d
Non-Asian emerging markets are expected to continue to grow, albeit at an average pace that\u2019s only about half of last year\u2019s. But the slowdown is compounded by the fallout from the global credit crisis, which has turned out to be far more severe than originally believed \u2014 with expectations of more bad news to come.
\u201cA lot of nasty surprises lie ahead,\u201d says Mark Grammer, vice president of investments with Mackenzie Financial Corp. <\/b> in Toronto and lead manager of Mackenzie Universal Global Future Fund. That said, he expects all the bad news to come to an end by mid-year.
The downbeat sentiment is echoed by various banks and investment houses. Britain-based Barclays Bank PLC<\/b>, for instance, says in its 2009 outlook, issued this past December, that the first quarter \u201cis set to be considerably worse than anything in the current cycle thus far.\u201d
Leading institutions, such as the International Monetary Fund<\/b> and the International Institute of Finance<\/b>, have caused alarm bells to ring even louder by making downward revisions to their 2009 forecasts in the fourth quarter of 2008.
None of this is good for emerging markets\u2019 equities. \u201cWhen the world is off-kilter, investors revert to risk aversion and stay with safe assets,\u201d says Charles Bastyr, a portfolio manager with Toronto-based Meadowbank Asset Management Inc. <\/b>As a result: \u201cNon-Asian emerging markets will be orphaned until confidence returns to the developed markets.\u201d
Non-Asian emerging markets have been sold off more than their developed counterparts on the back of substantial deleveraging by institutional investors \u2014 especially hedge funds, Grammer says.
In addition, flows from banks in mature economies to emerging economies, as well as portfolio equity and debt flows to emerging markets, have fallen sharply, reflecting a pronounced adjustment of investors\u2019 earnings expectations, according to the IIF.
The drying up of interbank flows and foreign currency funding pressures have caused corporate spreads in emerging markets to reach near-distressed levels, reflecting increasing default risk that is largely due to refinancing constraints. This past December, Ecuador defaulted on its debt (see story on page 32), and other countries in Latin America could follow suit.
That said, the IIF said in December: \u201cAnecdotal evidence seems to suggest that foreign currency funding pressure in emerging markets has eased somewhat from the stress level in October, even if tension persists and funding costs remain elevated.\u201d
Countries in the Middle East, Latin America and Africa that are net exporters of oil, iron ore and\/or soft commodities such as food have been hurt by the price declines that have come with the global slowdown. However, Nilsson says, Eastern Europe is a beneficiary of lower commodities prices because it is a net importer of commodities.
Eastern Europe needs all the help it can get, as it is currently the least favoured region. Chuk Wong, vice president and portfolio manager with Goodman & Co. Investment Counsel Ltd. <\/b>in Toronto, describes Eastern Europe as the \u201cnext Asian crisis waiting to happen.\u201d
He says that an economic contraction in developed Europe \u2014 upon which Eastern Europe is dependent for exports \u2014 and a substantial \u201cmismatch of foreign currency debt\u201d will hurt the eastern region.
Another factor is exchange rates. Non-Asian emerging market\u2019s currencies have depreciated significantly against the U.S. dollar since mid-2008, losing about a third of their value and making repayment of US$-denominated debt by both governments and corporations very expensive.
Some managers of emerging-markets funds believe the US$ will weaken by mid-2009. Mark Mobius, the Singapore-based manager of Templeton Emerging Markets Fund, which is sponsored by Toronto-based Franklin Templeton Investments Inc., <\/b> is among them, although he also expects significant currency volatility during the year. But others say that if this volatility happens, it will be \u2014 as Nilsson puts it \u2014 \u201crelatively short-lived.\u201d\tIE<\/b>
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