15th December 2015
Nick Price manager of the Fidelity Emerging Markets fund, provides his outlook for 2016…
The slowing of the Chinese economy and excessive supply for certain commodities resulted in significant pressures on the materials and energy sectors this year. This had a negative impact on some of the more commodity-dependent economies of the world’s emerging markets. Once again this proves that, in today’s world, the achievement of attractive performance within emerging markets relies as much on avoiding weakness as it does on identifying strength.
The emerging world in 2016 looks set to continue exhibiting the economic divergences of recent years, with those countries prepared to reform their economies looking best placed to achieve success.
All eyes still on the Fed
Developed world monetary policy continues to cast a shadow over emerging market (EM) assets. However, these concerns are now mostly priced in. There is a belief amongst some that a Fed rate rise would be a positive for emerging markets as some of the uncertainty will be removed from the market.
This will be even more likely if any move looks likely to be limited in both magnitude, and extended in duration. With a household sector that is very sensitive to rising mortgage rates and a manufacturing/export sector already struggling with the effects of a strong dollar, it will be interesting to see how willing the US government is to raise rates by a material degree.
Currency weakness a tailwind for EM exporters
2015 has already exhibited a high degree of currency depreciation of most EM currencies versus the US dollar – along with most other developed market currencies such as the Yen and the Euro, which have also weakened significantly on the back of quantitative easing
To this end, weaker EM currencies actually provide a tailwind for EM exporters. They make products and services derived from emerging economies more cost competitive, making them more attractive in the face of hopefully improving demand as the global economy continues to recover.
On this topic, one of the key potential drivers for a potential improvement in global demand could be a continuation of depressed energy prices. Now that driving season in the US is out of the way, people are waking up to the fact that inventories are once again expanding. Should this continue, we may well see the threat of storage limitations present itself once again early next year if the world continues to pump oil at a faster rate than it is able to consume.
Whilst a subdued oil price would not be helpful for oil-producing economies suffering from elevated current account deficits such as Colombia and certain Middle Eastern states, it may well help to stimulate global activity more broadly, and this could be beneficial to EM manufacturers and exporters.
India shows the importance of reform
Falls in commodity prices have not been bad for everyone. Take India, for example. As a net commodity importer, both the economy and the household have benefited from the impact of lower price inflation as the prices of fuel and food have fallen. In particular, this has allowed India’s central bank to move interest rates lower at exactly the point where the ongoing reform agenda is raising both consumer and business confidence – and with it the appetite for business investment and loan demand. This environment provides a tailwind for the better run independent banks that do not suffer from problematic legacy loan books built in the past.
As we said this time last year, appetite to reform the weaker developing economies is going to be important in determining their future destinies.
China continues its shift towards consumption
China continues to deliver on its gradual transition from being an economy driven by one-off capital spending to one built on more sustainable domestic consumption and higher value manufacturing. This may well weigh on the absolute level of economic growth delivered by the Chinese economy, but it is better to see a lower rate of sustainable growth than an elevated, stimulus-fuelled growth rate reliant on a continued increase in leverage.
A key area that provides scope for limiting further extension of debt as a percentage of GDP is in the Chinese industrial sector. With much of the Chinese steel sector having lost competitiveness to countries like Russia – who have benefitted as the rouble has nearly halved in the last eighteen months – it will be interesting to see how the Chinese respond. Will they accept making continued losses on every non-economic tonne of steel that they produce, or will they act to purge the system of excess capacity that depresses prices for all?