Emerging markets and the many pitfalls to avoid in 2020

Dubai — A jump of almost $3-trillion in stock-market valuation in 2019, currency volatility at a five-year low and bond spreads at their narrowest level in almost three years.

On the surface, emerging markets (EM) are ending 2019 with a spring in their step.

Look under the hood, though, and many pitfalls await investors, from the US election to an upsurge of popular unrest across Latin America and the lingering worries over trade wars. Never mind country-specific issues such as rising defaults in the Chinese domestic bond market, slowing growth in India, and the deepening crisis at SA’s state-owned utility, Eskom.

The competing narratives in a sector that accounts for 60% of the global economy are well-illustrated by the divergence in outlooks. UBS says riskier assets will produce only moderate returns in 2020. But Goldman Sachs Group and JPMorgan Chase are bullish on developing-nation stocks, while Morgan Stanley is betting that bonds are poised to rally.

The US-China trade dispute and Brexit “dominated and drove markets” in 2019, according to David Woo, the Bank of America strategist who a year ago said he wouldn’t touch EMs with a “10-foot pole”.

“2020 will be about the dissipation of these policy uncertainties, and this should provide a boost to global growth by releasing pent-up demand as companies rebuild inventory and resume capital expenditures,” said Woo, who heads the bank’s rates, currencies and EM, fixed-income strategy from New York.

For HSBC Holdings, which was optimistic about EM assets earlier in 2019, tougher times loom. “Heading into 2020, the conditions are not seen coming together for EM currencies to stage a broad-based recovery,” said analysts, including Hong Kong-based Paul Mackel and Ju Wang. “It will be another frustrating year.”

Trade wars

As in 2019, EM investors will watch how the US and China’s relationship develops. There are many who doubt the recent phase-one agreement will lead to much progress over deeper problems such as Washington’s displeasure over Beijing’s vast web of industrial subsidies.

Any signal that tension between the two sides is worsening will hit developing-nation assets hard, not least China’s yuan.

“The outcome of the US-China trade war is crucial to the outlook for EMs in 2020,” said Bank of America.

The Fed and the dollar

US Federal Reserve chair Jerome Powell buoyed EM assets last week when he suggested the central bank would hold off from raising interest rates until at least 2021. If that happens, it should keep the dollar in check and ensure plenty of capital still flows to EMs.

However, if an unexpected acceleration in US inflation prompts the Fed to change plan, or other major central banks suddenly turn hawkish, that could push up core rates and squeeze the spreads on developing-nation bonds. The extra yield investors get when buying sovereign dollar bonds in EMs rather than US treasuries is already at the lowest since April 2018, with the gap falling below 300 basis points this month, according to JPMorgan Chase.

Slowing growth

The International Monetary Fund (IMF) reckons EM economies will expand 4.6% in 2020, almost three times as fast as developed nations. Still, growth in China and India is slowing, which will hurt emerging economies as a whole, according to Citigroup.

“EM potential growth rates are falling,” said analysts, including David Lubin in London and Dirk Willer in New York. This “raises questions about asset prices, and particularly foreign exchange”.