Price dislocations lead to a rise in contrarian views
The hot summer in emerging markets (EM) has been a key investor theme in the third quarter of this year. While the ongoing US/China trade tensions continue to weigh on investor sentiment, the sequence of country-specific stories (Turkey, Argentina and South Africa) contributed to the almost indiscriminate repricing of EM assets, starting with plummeting EM currencies. The causes of the collapse seen in the currencies’ values in these countries are different (need to apply for IMF aid for Argentina; balance of payment crisis in Turkey, accelerated by the perceived lack of independence of the central bank; the start of an economic recession in South Africa, with additional concerns regarding the land reform plan).
However, what all these countries had in common are some areas of vulnerability, starting with government deficits and dependence on foreign funding, often denominated in USD, which resulted in a higher exposure to multiple headwinds that are surfacing in this late phase of the cycle. On the opposite side, strong economic momentum in the US (with 4.1% GDP growth in Q2 2018, the highest level since Q2 2014), shrinking global liquidity, higher US rates, and a strengthening US dollar are all forces driving outflows from EM and making US assets more attractive. Yet, in a late cycle phase, a small size problem (Turkey+Argentina+South Africa make up only around 3% of the global economy*) can turn into a catalyst for a risk-off mode in the EM area.However, we do not expect to see a broader market capitulation or systemic risk.The trigger for either of these issues would be a marked slowdown in China, which is not our main scenario. In fact, credit growth in China, certainly a higher risk for global economy, is showing further signs of stabilisation, with Chinese policymakers acting to keep the monetary stance on the easing side and shifting the fiscal stance to be more supportive.