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For Emerging Markets, China’s Shift to Consumer Goods Is a Blow

(Bloomberg Businessweek) -- To hear some big-name investors talk, 2019 is set to be a great year for emerging markets. Mark Mobius, co-founder of Mobius Capital Partners and a pioneer in emerging-market investing, says he’s buying stocks in places such as Brazil, India, and Turkey, predicting a “terrific recovery” in their economies. Howard Marks, the billionaire co-founder of Oaktree Capital Group LLC, is giving “a lot of attention” to developing-nation assets, particularly in Asia. Rob Arnott, founder of Research Affiliates and co-manager of the $17 billion Pimco All Asset Fund, is so optimistic that he’s boosted the fund’s stake in emerging-market equities to 23 percent, near the highest it’s been since its inception in 2002.

If they’re right, it would be quite a turnaround. In 2018, MSCI’s gauge of emerging-market companies fell almost 17 percent. Shares were weighed down by slowing economic growth, interest-rate increases from the Federal Reserve, and the U.S.-China trade war. Two key nations, Turkey and Argentina, saw ballooning trade deficits, soaring inflation, and political chaos. The Argentine peso lost half of its value, and the country received a record $56 billion bailout from the International Monetary Fund.

For Emerging Markets, China’s Shift to Consumer Goods Is a Blow

This year, though, the MSCI benchmark has surged 6.6 percent through Jan. 29. Investors seem to be reacting in part to a change in Washington—the Fed is expected to hold off rate hikes for a while, dimming the outlook for the U.S. dollar. (A weaker dollar makes holding assets in other currencies more attractive.) They may also be noticing that with a price-earnings ratio of 12, emerging-market stocks look about 25 percent cheaper than those in rich countries. “Now is the time to be buying emerging markets,” Mobius said on Bloomberg Television on Jan. 25. “Valuations are very attractive.”

Yet cheaper assets alone may not be enough to sustain a rally. The developing world still has a China problem, according to strategists at Citigroup Inc. and UBS AG. The complications are twofold. First, China’s trade frictions with the U.S. and Beijing’s mounting corporate debt have dragged down growth in the world’s second-largest economy, which buys everything from South African iron ore to South Korean computer chips. Second, China’s government has avoided flooding the economy with a big stimulus. Instead, it’s taking a drip-feed approach, focusing on infrastructure spending, tax cuts, and making more credit available for small companies.

Such focused spending will probably have less of a positive spillover on the rest of the world, compared with the real estate spending spree three years ago that helped spur the global recovery, according to Bhanu Baweja, deputy head of global macro strategy at UBS. “The willingness of the Chinese to give you the same degree of stimulus is much lower,” he says.

Even without a significant slowdown in China, the economy’s structural shift could threaten developing markets for years, according to David Lubin, head of emerging markets economics at Citigroup in London. China used to rely on investment in manufacturing and housing for growth. But consumption accounted for three-quarters of its growth last year, double the portion in 2010. Developing countries such as Brazil and South Africa have relied heavily on the nation’s voracious appetite for their iron ore and copper. They don’t produce much of the cars, cosmetics, and other goods Chinese consumers want.

For Emerging Markets, China’s Shift to Consumer Goods Is a Blow

“The decade of prosperity for emerging markets was the longest boom in commodities since the late 1700s—and that’s China,” says Carmen Reinhart, a Harvard economist. But the share of China’s total imports that comes from developing nations slid to 33 percent in 2017 after surging to an all-time high of 36 percent in 2012, data compiled by Bloomberg show. China’s iron ore and soybean imports fell last year for the first time in almost a decade, while inbound coal shipments declined to their lowest rate in seven years.

Emerging-market pessimists are in the minority now, at least among traders. A Bloomberg survey in December showed that more than 80 percent of investors and strategists expect developing-nation assets to have positive returns this year. Brazil was the top pick for all three asset classes, while Indonesia was another standout. (Brazil’s market was briefly shaken in late January after a dam owned by mining giant Vale SA failed, with hundreds of people missing and dozens known to be dead.)

Lukewarm performance has been more of a rule than an exception in emerging markets over the past decade. Since the beginning of 2008, the countries’ stocks returned merely 14 percent, including reinvested dividends. That’s a fraction of the 139 percent gain in the S&P 500. In comparison, emerging-market equities returned 349 percent in the seven years since the beginning of 2001, when China joined the World Trade Organization, or 13 times the gain in U.S. stocks.

“In the first phase of China’s modern development, it was EM that benefited” more than rich countries, says Stephen Jen, chief executive officer of Eurizon SLJ Capital and a former economist at the IMF. “Going forward, it will be very different. It’s a good wake-up call.”

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net

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