Insight and analysis by Vanguard leaders on the economic and market outlook for emerging markets

What is the economic and market outlook for the emerging market sector? Jonathan Lemco of Vanguard Investment Strategy Group and Vanguard Chief European Economist Peter Westaway offer their insight and analysis.


Jonathan Lemco: Yes, Peter makes a good point because when talking about average, looking at emerging markets alone, for example, you find reasonable rapid growth. Again, 5, 6% growth in some countries of Asia and the large majority are at least reasonably positive. Eastern and Central Europe 2, 3% in some cases. A little bit negative in a few. But overall, 2% or so. It’s not great, of course, but at least it’s positive. And, finally, Latin America, which is entirely bifurcated, if you will, or expectations of Brazil, the largest country in the region according to the IMF are negative GDP growth for next year. Argentina also probably negative or zero as best we could tell so far. But, by contrast, very well managed politically and economically polities and economies like Chile and Mexico and Columbia and Peru are doing better. And better means 3, 4 or so. Not what it was before, but still adequate and providing, from an investor point of view, some opportunities as well. So we’ve got to be very careful not to generalize.

Rebecca Katz: Yes, but let me go back to the investor question because hasn’t some of our research shown that you can have strong growth in a country, you could have 10% growth in China or 5% growth in China. It doesn’t necessarily mean the stock market will go up 5% or 10%, correct?

Jonathan Lemco: And that’s absolutely right. And, again, what is the stock market? It’s a reflection of companies in a particular country too. And, again, when we evaluate the relative strength and weakness of a particular country, growth is just one important but not the sole characteristic we look at. If you’re a fixed income or a bond investor, you’re paying very careful attention to how much debt and deficit that country has. What is its fiscal performance? What is its foreign country reserve capability and so on? Is it politically stable? All of these are characteristics that go into the mix. And one thing that I would just stress at this time and, again, particularly with regard to emerging markets, is we’re seeing relative to the last 10 years, 20 years, 30 years, and so on, reasonably solid performance with regard to all of those indicators.

Rebecca Katz: I think you actually have shared a chart, or we might have it on hand, about debt.

Jonathan Lemco: I’d like to bring that up. So if we can call up the reserve slide, that’d be really great, the gist of which is this. If you look at the foreign currency reserves held by some of the largest emerging market countries, you see that they’re vast. Now China alone has somewhere over $3 trillion U.S. or Treasuries or other securities just in their storehouse, if you will, just in their central bank and elsewhere which is used for a rainy day. So if you lend China money in the sense that we are buying their bonds, in turn they have the ability to repay you with interest because they have amazing reserves. But it’s not just China. It’s also countries like Korea and Mexico and Peru and many others around the world that have a tremendous storehouse of reserves.

Peter Westaway: And that contrasts with the earlier emerging market crisis, the Asian crisis in the ’90s—

Jonathan Lemco: Absolutely.

Peter Westaway: —the Latin American crisis in the ’80s where they didn’t have those reserves. And so this is really critical for the stability of those regions really.

Jonathan Lemco: Exactly right. In fact, policymakers in many of these countries, first in Asia but subsequently in Latin America, learned the lesson of the 1997/’98 financial crisis, which had many aspects to it. But, again, one of it was not building up reserves and they decided never again. We are going to build up our foreign currency reserve capability. Second thing we’re going to do is we’re going to manage our fiscal, our debt performance better than we have in the past. And if you can call up the debt slides, first one you’re going to see is on developed markets where you’ll see that it’s just adequate how well developed economies manage their debt. But then contrast this with the next slide on developing economies and you see many of them have relatively low debt-to-GDP ratios. And the credit rating agencies, Moody’s and Standard & Poor’s and Fitch, who look at debt more than anything else and assign a rating to these countries say, “You know what, they’re managing their fiscal performance well, they have decent reserves, their growth is adequate. We see some measure of political stability.” And a lot of these countries which in 1998 were junk, were double B and B rated and they had to offer a very high yield for investors to be interested, well, have now been elevated to investment-grade, which means the risk of their default is modest, very modest. It’s unusual such that when it happens, it really makes news like in Argentina or in Ecuador. And as a consequence, many of these countries’ bonds have found a way into mutual funds offered by Vanguard, for example, and elsewhere too. And the credit risk associated with them is much less than it was. The point I want to stress, particularly in regard to emerging markets in general, is how they’ve improved their performance in the last 20, 30 years in a way that is underreported in the press. When it comes to macroeconomic or political issues, the large majority of the countries that are now investing have provided really attractive returns now over time. And although in many cases yields have gone down a bit, they still provide, from a bond perspective especially, a nice alternative to stocks Don’t ignore the fact that the Koreas and the Malaysias and the Indonesias and the Perus and the Colombias and so on have consistently improved in a way that we just didn’t see coming. But it’s been tremendous. And now many of these countries’ bonds are a part of many of Vanguard’s broader mutual funds.

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