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16-3-2017
Time to look at developed markets through emerging market lens - Adviser - Schroders
MARKETS
An emerging market toolkit is
essential for investors in the West
Economic nationalism has led to a boom in political risk analysis.
15 Mar 2017
Huw van Steenis
Global Head of Strategy
30 Minutes
Unstructured
Learning Time
During the financial crisis I found that mugging up on economic history, particularly from
emerging markets, was often more helpful than talking to conventional policymakers hooked on
their fair-weather economic models.
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Time to look at developed markets through emerging market lens - Adviser - Schroders
The rise of economic nationalism and the threat to globalisation means I find myself using
emerging market parallels again. I cannot help wondering if investing in Western markets may
become more like investing in emerging markets.
Investing in emerging markets requires an intense focus on country risks and political economy.
Investors in the West have long been able to ignore political risk and focus on the sectors’ or
individual companies’ prospects. But the prospect of a new independence referendum in
Scotland is only the latest in a series of shocks to the institutional fabric of Western countries.
Careful monitoring of the strength of political institutions and corporate governance issues are
central to successful emerging market investing and can have a profound impact on valuations
and long-term growth expectations. Our analysis suggests country risk can account for as much
as half of investors’ returns. Little wonder the market for political risk analysis is booming.
Since the crisis some domestic sectors have already been severely affected by this – the
epicentre being banks. US banks are up 51% in the last 12 months, whilst British banks have
fallen 21% for international investors.
Emerging markets also teach us that economic nationalism is often inflationary. In the West,
after an excessive reliance on monetary policy, a reflationary regime-change in trade, fiscal and
regulatory policies is welcome. But emerging markets’ experience suggests we should watch
carefully how this plays out. In the early stages of programmes, the reactivation of the economy
is often positive as employment increases. But emerging markets diverge later on. Some
succeed strongly. For others, weak investment and poor productivity often follow, and the
interaction of a rise in inflation and inequality can feed the politics of anger, particularly in those
markets where income levels are lower.
Currency volatility is also higher under economic nationalists. For investors this type of volatility
in Western markets could be a fundamental change in the way we think about risks across
portfolios. However, I suspect that the reserve currency status of the Western economies taken
by economic nationalism should be a drag anchor to avoid the excessive currency volatility and
spikes in the cost of financing, absent a eurozone breakup.
Emerging markets also show us populism is infectious. Across Europe, populist parties could
have a material impact on the elections in Holland, France and Italy. The feedback loop from the
US and UK elections upon the narrative of European elections is also strong.
Populists typically have also put far more political pressure on their institutional fabric. Although
we have seen growing challenges, not least to central banks’ independence, we assume the
strength of Western institutions will win out. But this pathway doesn’t need to be negative. The
threat of protectionism may prompt a stronger policy response to boost domestic growth – which
Europe sorely needs.
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Time to look at developed markets through emerging market lens - Adviser - Schroders
Economic nationalism is also about an inflection in regulatory policies as the benefits of
globalisation continue to be reappraised. The Balkanisation of banking markets will grow as
countries put up financial walls and the consensus around Basel banking rules breaks down.
The US is likely to have an economic boost from the filing down of the rough edges of banking
rules to enable credit to flow more easily. Whilst a more compartmentalised banking system can
help seal off shocks, it is likely to be negative for growth unless global markets can fill the gap,
as we also find in emerging markets. The negative tone towards capital markets from some
European nations as the UK leaves the EU concerns me and could be a brake on their
economic growth.
But historical parallels can only take us so far. Underlying shifts in technology, impacting work,
culture and politics sits in the middle of a Venn diagram and intersects with economic
nationalism, political nativism and the fragmentation of globalisation. Since this technological
change is here to stay and accelerating rapidly, the impact will keep growing. A fundamental destabilisation of markets and economies is the consequence of these changes.
A different distribution of economic and financial returns is the result.
A guiding principle for investors over the last 30 years has been convergence - whether it be
emerging markets catching up with developed, or eastern and southern European economies
converging on western Europe. Quantitative easing has helped suppress divergence, but can no
longer be taken for granted. If we are investing in a more divergent world, then the emerging
market toolkit, alongside a deep understanding of how technology is impacting societies,
business and markets, will be critical.
Johanna Kyrklund, Global Head of Multi-Asset Investments and Nicholas Field, Global
Emerging Market Equity Strategist, also contributed to this article
This is a slightly expanded version of an article which first appeared in the Financial Times on
Wednesday 15 March 2017. For professional advisers only. This site is not suitable for retail clients.
Issued by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England.
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