Conditions appear benign for emerging markets going into 2020.

The US economy is expected to grow at a comfortable pace, neither so quickly as to suck risk appetite out of emerging-market assets, nor so slowly as to erode confidence in the global economy. The Federal Reserve is expected to leave interest rates unchanged, while many EM central banks continue their easing cycles. China can be relied on to provide enough stimulus to keep its own economy buoyant, providing support for the rest of the emerging world.

The prospects should be bright. But investors face two difficulties. One is how to make the most of these conditions while dodging trouble in individual countries. The other is that the benign outlook itself may be an illusion.

Among those focused on the former difficulty is Matt Murphy, institutional fixed income portfolio manager at Eaton Vance.

“The macro environment is really not bad for EM risk,” he said. “But there are serious concerns in the large emerging markets because of a deterioration in fundamentals. In the big names, nothing good has happened.”

He points to political and economic difficulties in markets with big index weights such as Mexico, Brazil, South Africa, Poland and Russia, and to immediate problems of keeping up debt repayments in Argentina, Ecuador and Lebanon as well as the smaller frontier markets of Suriname, Cameroon and Papua New Guinea. His approach is to ignore the benchmark indices and look for returns in the likes of Serbia, Egypt and Ukraine.

Dodging trouble in big and small markets has become harder in recent months. Previously, crises in places such as Argentina and Turkey were well contained. But investors were blindsided in October when protests erupted on the streets of Chile — formerly an oasis of stability — and spread to other countries in Latin America including Colombia, another economy previously seen as a rare bright spot. Some investors began to worry that reform momentum in Brazil, which had been gathering pace with the passage of a landmark pension reform, would stall.

So far, contagion has not spread beyond Latin America. But growth has disappointed in sub-Saharan Africa, in emerging Europe and even in Asia. India, previously tipped by some to take up the slack as Chinese growth inevitably slows, has fallen short of expectations.

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So the health of the US economy will be especially significant for EMs next year. Many investors are banking on strong employment and consumer demand to keep the pace of growth not far below this year’s.

But several analysts disagree. Stephanie Pomboy of MacroMavens — who has long questioned the strength of the US economy — notes that despite record low unemployment, record high net worth and record low debt service among consumers, US inventory levels have been persistently high and US companies have been unable to pass on the costs of raised import tariffs to retail prices. Demand has failed to pick up, she argues, because the US consumer, rather than consuming, has been saving ever more aggressively since the housing crisis of 2008-09. She does not expect that to change next year.

Erik Norland, senior economist at the CME Group, argues that the US economy has been held back by an overly-aggressive Federal Reserve that raised interest rates by more than it should have, leaving US monetary policy tight even after recent rate cuts, with negative consequences for global growth and for EMs in particular.

“It was Fed tightening in the 1990s that led to the Mexican, Asian and Russian crises,” he said. “A tight Fed is not good for emerging markets.”

He expects slowing growth in China to be a drag on emerging markets next year, as global growth slows from its pace in 2019.

Piotr Matys, an analyst at Rabobank, is gloomier still, expecting the US to go into a mild recession.

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“Once the Fed realises that the risk of recession is much higher and starts cutting interest rates aggressively, starting in April, it will be too late,” he said. “This is one reason why it is hard to have a constructive view on emerging markets, apart from a short-term relief rally on the back of the phase-one trade deal [between the US and China].”

Rather than a recovery, he expects EM assets to continue their recent pattern of sharp moves in both directions — a continuation of the inflows and outflows that have mirrored the baffling US-China trade talks.

With the short-term issue of a phase one deal out of the way, he argues, investors’ horizons will be dominated by long-term issues such as intellectual property rights, access to China’s market and Chinese state support, none of which is likely to be resolved quickly.

Even if the dollar does remain supportive for emerging markets next year, the sector will face a lot of headwinds.

jonathan.wheatley@ft.com



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