Chidem Kurdas
It used to be said that emerging markets caught pneumonia whenever developed markets sneezed. By the late 20th century this notion had become conventional wisdom.
The impression of magnified knock-on effects may have been self-fulfilling. Emerging markets lost more in crises at least in part because investors perceived them as at risk for such effects. They therefore herded away at the first sign of financial or economic trouble—even when the trouble was elsewhere. Massive outflows of capital caused securities prices to sink.
Does that pattern still hold? There is a reasonable argument that certain emerging economies now march to a different beat. But then there are reasonable counter-arguments.
For investing purposes, this is a key question. If Asian markets no longer move in lock-step with Western economies, Asia is a potential safe haven in the event American high-yield bonds or European credit seizes up.
Even if there is no major tremor, developed markets may yield low returns for a long time. Many institutional investors look to Asia as the solution to the low-yield problem.
Some emerging markets, though still pigeon-holed under that moniker, are far removed from what they were 30 years ago. But by certain measures they are even more closely linked to the U.S., EU and Japanese economies than they used to be. That suggests they’re tightly correlated and will not be immune to a crisis or stagnation in the developed world.
India is where you get routed to when you want guidance on how to deal with problems in your computer network or sometimes even brokerage account. Surely the Indian service providers – and with them Indian stocks – will suffer in tandem with American IT and financials. On the other hand, many Indian companies cater to domestic consumers or other developing economies.
In China, the share of domestic demand has been growing, though exports still loom large. China – the world’s second larger economy and growing at 7.5% — is more resistant to external shock waves the less the share of exports in national output.
Currently Asian stocks (ex-Japan) have almost zero correlation to U.S. equities, according to Lyxor. Funds that focus on Asia outperformed other funds on the Lyxor platform—July’s top performer was Lighthorse China, up 5.7% for the month.
Asian credit, like Asian stocks, made for profitable investing. The Chinese property market may slide some more, but so far the correction of the bubble has not been catastrophic. Compared to Europe, Asian credit looks robust.
This is a factor that would act as protection in a global financial upheaval or recession. Another favorable element is that Chinese stocks appear to be under-valued—especially compared to the relatively expensive S&P 500.
As for geopolitical risks, China is less involved than the U.S. and Europe in the Middle East and Ukraine conflicts. There is the tension with Japan, but that is unlikely to escalate into a hot war any time soon.
A major downside of investing in China is the weakness – indeed in some areas absence – of the rule of law. The Chinese may point to recent investigations of corrupt officials as evidence that the law is applied. But the move to root out corruption was political, coming from the top leadership. There is no sign the courts are independent.
Businesses and hence investors are subject to political arbitrariness. Investors have to factor in that big minus against the pluses.
