Submerging Markets

My thoughts around today’s topic is still forming, so this is going to sound more like a brainstorming note.

The title of today’s post is not a warning about US markets…

Although the US markets have rebounded far more aggressively than economic fundamentals would warrant, the US Federal Reserve and Treasury is also acting far more aggressively than it has ever acted in the last 100 years including the Great Depression and World War I and II.

No one has ever seen economic disruption of this magnitude. But no one has ever seen stimulus of this magnitude, either.

So whether the US market is up too much or not enough is…not for us in the present to know.

The title is not referring to the US…The title is actually referring to the emerging markets.

Having spent the last few months thinking deeply about COVID19 and the things that we (the US) would have to do as a society to get to the other side has made me quite skeptical about the emerging markets.

Many emerging markets have very weak finances. Their governments and central banks generally do not have the ability to provide stimulus like that of the US (or Eurozone or Japan) because their currencies are not reserve currencies.

Their medical infrastructure is weak. Many of these countries may be struggling with limited hospital capacity. Many of these countries may not have enough doctors. Many of these countries also have many citizens that have not yet adopted modern hygiene standards or understand the need for modern hygiene.

Their balance sheets are also fragile. Many of these countries have many citizens that cannot afford to observe social distancing because they do not have social safety nets to rely on. Many of these countries have many citizens that not only have limited savings, but are indebted with incomes that already tend to be quite unpredictable.

All of these things and more make it difficult to tackle an already very difficult problem to tackle.

We have all of these problems in the US, too, to some extent but not to the extent that the emerging markets do.

And for that reason, I worry.

I worry that the emerging markets will struggle to get past COVID19 and then will struggle to get back to square one.

I worry that the emerging markets will become unstable because the emerging markets has already been struggling for the last 10 years.

For example, the MSCI EM index has been flat for more than 10 years. The index represents the largest and most robust firms in the emerging markets…imagine what small businesses and individual business owners have experienced in the last 10 years if the most robust firms have stagnated for 10 years.

Source: Bloomberg

Historically, the emerging markets has been the place that developed market investors go to for faster growth. The emerging markets is supposed to be the place where you look to for faster population growth, faster economic growth, and faster capital markets growth.

But the emerging markets has already been struggling to meet those expectations, and now they look even harder.

Here’s a 10 year chart of GDP growth in some of the largest emerging markets vs the US (the largest and theoretically most mature economy in the world). Half of them have been growing slower than the US. Brazil, Russia, and South Africa are growing slower than the US.

Source: Bloomberg

China, India, and Indonesia continue to grow faster than the US, but even then they are slowing down. China is slowing understandably because it is now a very large economy that is on the verge of exceeding the US within the next few years, but India and Indonesia are slowing earlier than many would expect.

Increasingly, fast growing emerging markets like China, India, and Indonesia look a bit like outliers (one reason may be because these countries have high savings and probably sound balance sheets).

Why then would an investor invest in the emerging markets in general if the emerging markets as a whole does not deliver better growth and has higher risk?

I worry about the emerging markets because many emerging markets depend on foreign capital for development. What would happen if investors increasingly realize that emerging markets is not actually what they expect it to be?

As mentioned above, I worry about the emerging markets because I think it may become increasingly unstable. We already saw this 10 years ago with Arab Spring. Revolutions across a number of countries because young people are frustrated and could not get jobs. Except now, these people are not coming off a few years of hardship but rather a decade of hardship. Twice in a decade. I worry that it won’t just be a Middle East phenomenon this time, but wider. For example, Latin America’s political situations look increasingly volatile. Various parts of Eastern Europe, Africa, and some parts of Asia look similar.

I don’t know the future, but it certainly makes sense to be prepared.

The more and more I think about it, the more and more I think the concept of emerging markets actually ceased to exist more than two decades ago. Many years ago, many undeveloped markets started to emerge largely because of US capital investments designed to fight the tide of Communism around the world after World War II. For example, the US Marshall Plan led to significant development across many countries. The US helped many of these countries emerge through infrastructure investments under the assumption that by lifting people out of poverty, the appeal of Communism would fall away.

But after the fall of the Berlin Wall / collapse of the USSR (as well as the reinitiation of bilateral relations with China), I think, with hindsight, the US largely gave up on their quest to help developing markets emerge. Because Communism had been discredited.

With hindsight, the emerging markets still continued to grow mainly because of debt as well as China’s commodity super cycle. China’s strong need for commodities helped extend the economic development of other emerging markets for another two decades (90s to mid-2010s).

But China’s commodity super cycle ended 5 years ago.

And now the emerging markets is likely starting to realize what they should have realized two decades ago…The conditions for them to emerge no longer exist. The US is not lifting them. China is not lifting them.

Maybe I am too pessimistic, but will emerging markets get to the other side? I fear there are no emerging markets. Just submerging markets. The only emerging markets may just be China, India, and Indonesia. And maybe soon, China will not be an emerging market but an emerged market.

As a global citizen, I hope one (or a few or many) countries will come together to help pick up the mantle. The emerging markets are far away from here, but we are all on the same globe. Sooner or later, instability in emerging markets may come home to roost if the world collectively does not handle it well.