Latest Emerging Markets (Core) economic and market outlook.
Job growth at 200,000 per month and moderate inflation suggest that the US economy is fundamentally in good shape. However, with the trade war escalating and the boost from fiscal stimulus coming to an end, a nascent slowdown is likely to intensify, despite the Fed’s recent rate cut. This is reflected in the inversion of the yield curve. Our analysis of previous instances of yield curve inversion suggests that equity markets typically soften after about a year. Thus, while we are cognisant that risks are rising, it seems too early to adopt an overly defensive position. We will continue to monitor the situation, looking for concrete signals such as a deteriorating labour market that will cause us to turn more defensive.
The Chinese economy expanded at the weakest pace in nearly three decades in Q2 as the trade war with the US continued to undermine the external sector and investment. To counter these effects, the government has stimulated the economy with infrastructure investment and tax cuts. These measures have largely been geared towards Chinese consumers. Consequently, the domestic side of the economy is holding up reasonably well, with retail sales up 9.8% in June and the services sector growing 7% in the first half of the year. We expect further stabilisation in the second half of the year as the stimulus measures gain more traction. However, we do not expect the government to unleash a significantly larger stimulus package. Beijing has said many times that it will avoid doing so, and even if it wanted to, its hands would be tied to some extent. Indeed, the augmented government deficit is already running at high single digits, the debt-to-GDP burden is high, and the current account surplus is much lower than in previous crises.
Indian growth has been slower than expected, with weak auto sales and subdued construction activity due to changes brought about by the Real Estate Regulation Act. However, we still prefer India to China and North Asia. We view many issues in India as short term drags that will ultimately benefit the economy. For example, the Real Estate Regulation Act is consolidating the property sector, meaning that fewer developers are launching new developments. While this weighs on growth in the short term, a less fragmented property sector should be a positive, particularly for some of the companies we own. By contrast, issues in countries such as China appear to be more structural.
We remain constructive on Russia. Trump has recently signed off on some new sanctions, but they appear reasonably lenient. One sanction bans US entities from being involved in the purchase of Russian sovereign debt. However, it only refers to dollar debt as opposed to Ruble debt. Moreover, it only relates to future issuance, not existing debt. Another sanction states that Russia is not allowed to borrow from the IMF. In reality this sanction is toothless as Russia is a net contributor to the IMF. Finally, Russia is not allowed to buy sensitive military technology from the US. Again this is unlikely to have a significant impact in practice because Russia does not do this anyway. A more serious risk to the Russian market is the potential for a fall in the oil price, particularly with global growth slowing and US shale production ramping up. We will be watching this closely.
In South Africa economic momentum is subdued and the distinct lack of reformist newsflow is concerning. Consequently, we continue to have limited exposure here.
September should see vital pension reforms being approved by the Senate in Brazil. This, combined with the nascent economic recovery, could catalyse further outperformance of the Brazilian market.
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