Emerging markets (EMs) have suffered less than developed countries during the financial crisis that has lashed the planet since the end of 2007. EM banks were not extensively exposed to high-risk credit derivatives and subprime loans, and they have suffered less damage from the shortage of financing than the major economies. This scenario has led many investors to view EMs as an opportunity for making money at a time when their portfolios were getting hit by losses.
As a result, stock markets in developing countries have registered significantly higher prices in 2009 — far above those in Western markets. The Shanghai stock index has gained 78% this year so far, according to Bloomberg. Aside from China, Latin America is the region capturing the most attention. There, the Merval Stock Market index in Buenos Aires has risen by more than 100% since January; Brazil’s Bovespa is up by more than 80%; and the Chile Stock MKT Select is up 44%.
These increases are significant compared with the gains seen in the world’s most important economies. For example, the EUROSTOXX 50, the benchmark index of the euro zone countries, has gained only around 13% so far this year; the FTSE 100 in London has risen only slightly more than 15%; the Dow Jones in New York is up 16%, and the Nikkei in Tokyo is barely up 11%.
Will emerging market stock prices continue their upward trend? Despite concerns about a potential bubble, experts who spoke with Universia Knowledge at Wharton say that these markets will continue to grow over the next year – but most likely not at the same pace.
Fear of a bubble
The high returns in many emerging markets have led some analysts to believe that a bubble is being created there. Olivier Blanchard, chief economist of the International Monetary Fund, said at the end of November in an interview with French newspaper Le Monde that some emerging economies are seeing rapid, destabilizing capital movements that could create a bubble and threaten their long-term prospects.
“Generally speaking, markets in emerging nations — and Latin American markets in particular — are experiencing very strong price increases, but I don’t know if we can talk about a bubble at this time,” says Juan Carlos Martínez Lázaro, an economics professor at the IE Business School. According to Martínez, the strong inflow of capital to some Latin American economies is justified. The region “is doing a much better job of dealing with this crisis than on [past] occasions,” and his own “expectations for growth are very high.” Since 2003, he notes, Latin American markets “have experienced a very positive and stable economic cycle in which they reduced imbalances, applied realistic fiscal policies, and created jobs and sustainable growth.”
However, Vitoria Saddi, professor of economists at Insper (Institute of Education and Research) in São Paulo, Brazil, believes that there is reason to be concerned. “The bubble in the emerging markets is a reality, since the developed countries have reduced their interest rates to almost zero. While this produced a low rate of return in the United States and Britain … it boosted returns in those countries that are considered ‘emerging,’ including Brazil, Turkey and Chile. All you have to do is look at the change in the Bovespa index, [which was] driven above all by the fall in the dollar in world markets.” Saddi adds, “Nevertheless, the bubble only reflects the capital flows; that is to say, capital goes where there [are high returns]. The problem is that the bubble can explode; the dollar can recover and the impact of this explosion can be devastating for some countries.”
This is not the case in Brazil, he adds, where the gains have “not just been caused by the global economic crisis; you’re dealing with a structured economic policy.” In fact, according to Robert Tornabell, professor of financial controls and management at the ESADE Business School, the situation in Brazil underscores that what is happening in emerging markets “is not a bubble” but a reflection of “the great influence that the incoming capital is having in these countries…. The rise in indices such as the Bovespa is not extraordinary, since Brazil can be considered the economic miracle of this year.” In the wake of the global financial crisis, Brazil was the first country in Latin America to stage a recovery — in the second quarter of this year — and the country is expected to grow by between 5% and 5.5% in 2010, according to several sources.
Key factors for 2010
With this year coming to an end, investors are beginning to plan their strategies for next year. One of the questions they are asking is if Latin American markets can maintain their current pace of rising share prices.
One short-term factor that has provoked serious doubts about the future of emerging markets is the recent financial problems in Dubai, the United Arab Emirate whose real estate holding company, Dubai World, caused a commotion in markets when it asked for a moratorium on its debt, which has reached some US$60 billion. This week, a default was averted when neighboring emirate Abu Dhabi extended a US$10 billion bailout to Dubai.
According to Martínez, failure by Dubai to repay its debt could have influenced the rest of the emerging markets, as was the case during the Asian financial crisis of 1997, which began in Thailand. “But this time around, you have to separate what happened in the Emirate with the rest of the emerging markets, since the financial crisis has affected the richer economies while the emerging markets have not been affected as much.”
For his part, Saddi believes that the impact of a debt default by Dubai would have been limited. “Any talk that investors will abandon all emerging markets because of a single market does not seem feasible to me,” he says.
The second factor that will have an impact on the future of Latin American markets will be movements in the value of the dollar and the value of their own currencies, and the cost of raw materials. According to Saddi, “The fall of the dollar reveals a loss in confidence among investors. The increase in American debt is already unsustainable. The fiscal situation is more than sufficient for the risk agencies to lower their country rating [for the U.S.]”
Martínez notes that “raw material prices are on an upward swing thanks to the global industrial recovery, and you have to consider that there is a great deal of speculation in those markets where the great investment funds continuously take positions ….” He adds, however, that there is a negative side to the fall of the dollar against the currencies of Latin American countries. “It restrains their exports to the United States, their main trading partner.” Currencies such as the Brazilian Real “continue to appreciate against the greenback because of the arrival of foreign capital flows in the region.” However, he believes that it will be “difficult” for these currencies to keep appreciating at the same pace as they have in recent years.
Lower Profits and Greater Stability
In this context, Tornabell anticipates that in coming months the main Latin American stock markets will suffer a small correction before moving forward again. “They will continue to grow but not at the current pace, since they have been going so quickly.” He is especially positive about the prospects for Brazil. However, he notes that he is worried about Mexico “because of its social problems, and because it is exhausting its oil wealth. I tend toward Brazil, not Mexico.” In fact, on December 14, Standard & Poor’s, the rating agency, downgraded Mexico, citing “the country’s falling oil output and anemic growth prospects,” according to the Financial Times. As for Chile, Tornabell notes that its stock market “is more stable and less explosive than the country led by Felipe Calderon [Mexico], but also safer.”
Martínez adds that “stock markets will tend to stabilize, but you have to remember that indices such as the Bovespa are still below the highs they reached in 2008, although I don’t believe they will increase as the same pace [in 2010] as [they did] this year.” Still, he expects that interest in Latin America will continue to be strong in 2010. “In Brazil, there is a lot of euphoria among investors about what they have to achieve for the 2016 Olympic Games, and about how local companies can take advantage [of the opportunities].” Beyond such factors, he believes that some countries in the region, such as Brazil and Chile “have gained the respect and recognition of international investors because of their serious and reliable economic policies.”
Saddi believes that “interest in some economies tends to be long term,” as in the case of Brazil, “whose attractiveness began [long] before the crisis.” Since 2006, when President Luiz Inacio “Lula” da Silva was reelected – or even before that, when the country repaid its US$15.57 billion debt to the IMF at the end of 2005 – “the country has been recognized as secure for investors, [not just] because of the stability of its market and its policies, but mainly because of its sustainable macroeconomic conditions. In addition, it has a strong financial system, comparable even with that of China. The situation in Brazil is not just a temporary one.”
As for movements in the stock markets of the region, Saddi believes that if the European and U.S. central banks commit themselves to maintaining clear stability in interest rates for at least until the third quarter of 2010, Latin American markets will remain stable. “I am not betting on an increase, but on stability. If rates were to go up against our expectations, there could be an orderly outflow of capital and it could stop any further inflow of capital in emerging markets,” he says.