Last year markets focused on developed market politics, which provided plenty of surprises and uncertainty. As a result Emerging Markets seemed much more pedestrian, and even mature in comparison. Overall positive indicators such as elections in Argentina led investors to believe that Emerging Markets had turned a page on populism, while a series of tests demonstrated the robustness of institutions and the rule of law in countries such as Brazil.
Two developments last week served as a reminder that geopolitical risk is never far from the surface in Emerging Markets.
First, Venezuela was officially declared “in default” of its debt – in this case a $60 bn sovereign bond issue. If it defaults on all of its debt ($150 bn in total) it would be second to only Greece (which defaulted on $200 bn of its debt) in terms of being the largest sovereign default in history. This country has become increasingly isolated diplomatically and the default is unlikely to have much contagion to other Emerging Markets, but it will be interesting to see how it is handled and how Russia may be employed as a stopgap lender to avoid further default. The seizure of power by the army in Zimbabwe seemed on its face to be a very “gentlemanly” military coup. The supposed premise – to save the economy from further ruin and hyperinflation as well as an increasingly disconnected ruling party, would suggest that it will ultimately stabilize the beleaguered country. But the potential for it to be a flashpoint remains, and, again, it bears watching carefully. South Africa, a neighboring country, has experienced meaningful political upheaval and currency volatility over the past year, and Zimbabwe’s woes may render it untouchable.
These two, unconnected, developments have occurred against a backdrop of stabilizing growth forecasts and a truly stellar year for Emerging Markets (+30% in USD terms). This has been a largely narrow recovery (mostly driven by Asian technology stocks), but managers seem more inclined to revise estimates upwards rather than downwards.
Then, just when Europe seemed to be slipping in to a year-end slumber, Angela Merkel failed to form a coalition government after one month of talks, and declared that she would rather hold new elections than continue discussions. This uncertainty led the Euro to fall and to the growth of fears of a weaker Europe. It is poor timing, as the economy just seemed to be “out of the woods” in terms of meaningful growth and investor “buy-in”.
In the US, tax reform is all but priced in, particularly in the small-cap arena, where stocks would benefit hugely from a tax cut, given their mostly domestic focus. With the outcome of tax reform now in the hands of the senate and by no means certain, there is increasing room for disappointment if it fails to pass in its current form.