Emerging market investors try to navigate new normal of slow trade
Emerging equities and bonds are among this year’s top performers, having attracted hundreds of billions of dollars in recent months from investors faced with negative yields across most of the developed world.
But despite encouraging recent data from developing nations, concerns about the recovery’s resilience remain, and double-digit returns will be tough to sustain without a growth uptick.
However, for emerging markets, growth in the past was linked to trade, whether in manufactured goods or commodities, and the prospects here are bleak.
The Center for Economic and Policy Research found world trade momentum fell 0.8% in July and has been negative since April, with emerging markets suffering more than their advanced peers.
September’s surprise 10% fall in Chinese exports cast doubt on signs the world’s second-largest economy was steadying.
Growing public sentiment against trade and globalization has added to the woes: from Britain’s vote to leave the European Union to the US election campaign, which saw both candidates pledge to review major trade deals such as the North American Free Trade Agreement and raised doubts over the ratification of the 12-country Trans-Pacific Partnership. The Transatlantic Trade and Investment Partnership, a free trade deal being negotiated by the United States and the European Union, is widely seen as doomed.
“Especially emerging market investors should recognize we are in an environment where a lot of countries are looking inward. It is a move away from freer markets, and a lot of emerging markets are small, open economies and part of their lifeblood is trade,” said Mike Cirami, co-director for global fixed income at fund manager Eaton Vance.
“It’s a concern, though one that is hard to fully price… but the trend is clear and we are taking it into account and thinking about where to make investments and at what price.”
For two decades before the 2008 financial crisis, the global economy expanded at roughly twice the rate of global trade. Trade was credited with fueling stellar growth rates across emerging markets. China took center stage and the economies of the former Soviet bloc opened up.
According to UBS, the ratio of global trade growth in volume terms versus economic output in emerging economies averaged 2.2 in the 1990s and 1.6 in the mid-2000s. Thanks to slower Chinese and Western demand, it now stands at 1.07.
Trade volumes in emerging markets rebounded strongly from a sharp drop amid the 2008-2009 financial crisis, according to UBS. But this changed swiftly in 2011.
“Over the last 18 months the slide has accelerated with export volumes growing less EM real GDP and production,” UBS analysts wrote in a research paper.
Last month, the World Trade Organization (WTO) slashed its forecast for global trade growth by more than a third to 1.7%. Trade deceleration was due in part to the inward reorientation of the United States and China, due to the shale energy boom and a planned shift to consumption from exports respectively. For the first time in 15 years, the WTO said, international commerce was expected to lag world economic growth.
Investors and analysts alike are trying to pin down reasons for the changing relationship and the changing nature of trade, hoping to predict what lies ahead.
UBS estimates that as much as 40% of the slowdown cannot be explained by growth alone.
There are a host of possible reasons, including a shrinking of global value chains, resurgence of protectionist measures and an increase of services.
Trade barriers, whether in retaliatory duties or anti-dumping measures, have been on the rise in recent years. The WTO’s Global Trade Alert found protectionist measures stood at an all-time high in 2015 and outnumbered steps for trade liberalization by three-to-one.
The International Monetary Fund (IMF) warned that waning trade liberalization and an uptick in protectionist policies fostered the slowdown in global trade, in turn weighing on global growth.
“Many emerging market and developing economies maintain or face trade barriers that inhibit their entry into global markets and participation in global production chains,” the IMF found.
Services now make up a larger share of trade and the shift from “stuff to fluff” boosts domestic rather than international trade without necessarily harming growth.
Yet, while the share of services exports from emerging nations has risen to 34% in March last year from a decade earlier, that trend overall remained somewhat of a “DM gig,” said UBS.
“Other than large industrial economies of Asia, it is really only India that shows up with a meaningful global market share in service exports,” UBS found.
Emerging economies have become better at moving up the value chain, manufacturing higher value goods rather than just exporting raw materials.
“Bigger countries have an advantage here because they have more resources, are more diversified and have a bigger market, the smaller countries still will rely on trade,” said Patrick Mange, head of APAC & EM strategy at BNP Paribas Investment Partners.
Geographic location and trading partners are also crucial. Mexico — one of the US largest trading partners — has seen the peso tumble some 8% against the dollar since January, with each survey showing Republican contender Donald Trump closing in on his Democratic rival Hillary Clinton weighing heavily.
Many Asian economies such as the Philippines benefited from being sizeable economies while having a more diversified array of regional trade partners. Some like Vietnam specialised in specific sectors, such as the Internet and data base services, which were booming, said BNP’s Mange.
Some smaller emerging European countries have also caught investors’ eyes.
“(In) central and eastern Europe, we have small open economies that are performing quite well. A lot of that has been on the back of domestic demand — these economies have come out of a crisis,” said Eaton Vance’s Mr. Cirami.
Yet reading the signs of change is difficult. Data about the changing nature of trade or economic change within an economy is often hard to come by, especially on measures like productivity or changes to the value chain.
“You don’t have much data to prove it. Often we only have stories to listen to,” said Mr. Mange. — Reuters