By Angelika Millendorfer
For the emerging markets (EM), May was once again dominated by falling prices, as the MSCI EM stock index declined by around 3%. The return of worries about Chinese economic growth weighed on prices, along with speculation that the US central bank may make an early move to reduce its purchases of bonds.
Prices began to fall even in countries such as Thailand and the Philippines, where stock prices had previously been nonchalantly climbing to new record highs, as international investors started to pull capital out these markets. As in the preceding months, commodities and commodity exporters continued to feel some strong pressure. Nevertheless, some of the Eastern European equity markets (in particular Poland and Hungary) were able to buck the trend, and Chinese mainland stocks also ended May with handsome gains.
From a global perspective though, EM equity markets were once again weaker than the developed markets in May. Along with the declines in commodity prices, the leading indicators in many countries and the development of world trade, this ongoing trend points to a renewed threat of deflationary pressures for the global economy. This may also be exacerbated by April’s extremely sharp change in the monetary policy pursued by the Japanese central bank (BoJ). Because the measures announced by the BoJ may result in Japan exporting the deflation it has been struggling with for many years to the broader global economy in the quarters ahead, and there is no doubt that this is an “export” that no one is going to enjoy.
The comments by central bankers in the US were probably mainly used to test sentiment and find out how the financial markets might react to this kind of shift in the Fed’s policy. The Fed was probably not too heartened by the reaction, as the response showed that the equity and bond markets in the US (and increasingly at the global level as well) are now practically dependent on more and more injections of liquidity.
As the US central bank more or less views rising or at least stable equity prices as an objective of its monetary policy, another expansion of its already unprecedented expansionary monetary policy currently appears to be equally as likely as a gradual reduction of its bond purchases. In any case, an end to the extremely loose monetary policy is still probably far off in the future.
Consequently, the sub-average relative performance of the emerging markets compared to the developed markets may continue for the time being. In the event of a strong, sustained recovery in global economic activity, however, this trend could turn around quite quickly and lead to the EM countries producing significantly stronger performance again. So far, there are still no clear-cut signs of such an upswing in economic activity, even though many analysts are predicting a recovery for the USA, China and Europe in the second half of 2013 and the first half of 2014.
There are more and more warning signs for EM bonds and during the months ahead at least the downside risks may outweigh the upside ones, in particular for local currency (LCY) bonds. Some EM currencies may be facing significant corrections versus the US dollar and the euro in the period ahead.
Angelika Millendorfer is head of emerging markets equities, Raiffeisen Capital Management
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