Storm clouds darken in emerging markets

The Shanghai World Financial Center, Jinmao Tower and Shanghai Tower. A China slowdown has a spillover impact on global growth.

Ottoman sultans across the centuries often married their Grand Viziers or military commanders to a favourite daughter, who then acquired the title of Damad Pasha. President Erdogan has appointed his son-in-law as the new Turkish finance minister, but Berak Damad Pasha's promotion has triggered another currency crisis on the Bosphorus. Erdogan has axed Mehmet Simsek, who was the most credible pro-markets statesman in Ankara and Turkey's de facto ambassador to Wall Street and the City of London. The financial markets are petrified that Erdogan will now order the central bank to slash interest rates, which he argues will lower the 12 per cent inflation rate. This is not economics but voodonomics and means the new executive president will crush the political independence of the central bank.
Turkey desperately needs to restore its credibility to international investors who finance Europe's largest current account deficit. This cannot happen as long as interest rates do not rise and Ankara embraces fiscal austerity and structural reform. Erdogan will not heed the pleas of the capital markets. The Turkish lira can fall well below five to the US dollar. Turkish inability to control inflation contrasts with Russia's success in reducing inflation. Turkey is an oil importer and Russia is an oil exporter at $77 Brent. Real rates in Russia are positive and grossly negative in Turkey. The Turkish lira is a no-brainer short against the Russian rouble at 14 for a 12 target.
The MSCI emerging market index trades at 11 times forward earnings, well below its five-year historical average. However, the macro storm clouds make me sceptical about the asset class. For instance, Shanghai A shares have tanked 27 per cent since their January peak. Dr Copper, Wall Street's economic growth lodestar, has plunged 17 per cent in the past month. The US dollar has been on a rampage against emerging markets currencies. Yet the most ominous metric of macro distress is the slump in Chinese economic growth, M2 money supply and fixed asset investment amid a Politburo sanctioned crackdown on the shadow banking system, wealth management (LOL!) products, property speculation and capital flight.
The slowest growth rate in the People's Republic since 1990 is a greater threat to emerging markets than Trump's tariffs or geopolitical crises in Ukraine, Syria, Iran, etc, since a China slowdown has a spillover impact on global growth. This is the ominous message that copper has been transmitting to the financial markets with its free-fall since early June. As the world's largest exporter, China has the most to lose from a global trade war initiated by Washington but emerging markets are its collateral damage. In any case, Chinese shares are more than one third of the MSCI emerging markets index. As the world learnt the hard way in August 2015 and January 2016, when the Middle Kingdom sneezes, emerging markets contract immediate influenza.
So it does not surprise me that global fund managers have exited emerging market equities for the tenth successive week, with an estimated $17 billion in withdrawals. The past 10 weeks coincides with a rising US dollar and a sharp rise in the yield on the two-year US Treasury note. The MSCI emerging market index has fallen 12 per cent since its peak in March. True, there are idiosyncratic factors that have impacted specific countries. Turkey's meltdown is due to Erdogan's concentration of executive power and inability to address a catastrophic lira/banking crisis. Pakistan's savage bear market is due to its political crisis and the conviction that the deep state will engineer a win for Imran Khan as the head of a weak coalition in July 25.
Brazil's economy was devastated by a truckers strike over diesel fuel subsidies and the front runners in the October Presidential elections are far right and far left populists. Venezuela has lost 99 per cent of its stock market value due to hyperinflation and a currency collapse. Yet Ukraine is the best-performing market in the world, up 21 per cent even though Kiev wages a de facto civil war in the Donbass. Saud Arabia is the fourth-best performing stock market in the world, up 17 per cent on the Tadawul in 2018. In emerging markets investing, country and sector selection is mission-critical in 2018. I try to invest based on fundamental realities and corporate value creation, not the fire and fury of Trumpian threats, tariffs and tantrums.
The writer is a global equities strategist and fund manager. He can be contacted at mateinkhalid09@gmail.com.