Emerging Markets: New Affluence and Influence

Growth Trends and Regional Divergence:

• Emerging markets accounted for approximately 80% of global economic growth since the financial crisis, yet the panel observes cyclical divergence within the BRIC+ group.
• Brazil is transitioning out of a cyclical downswing; Russia is entering a cyclical downswing requiring structural reforms; India is currently on an upswing aided by lower oil prices; and China is projected to continue growing at 7%.
• Jay Pieloski argues the post-1990s export-led growth model is broken, evidenced by the Asia ex-Japan current account surplus falling from a 7.5% GDP peak in 2008 to less than 2% today.
• A structural shift is occurring where emerging markets require strong currencies to foster domestic demand-led growth, contrasting with the previous 15-year era of weak currencies for exports.
• The real effective exchange rate of Asia-Japan economies has appreciated 15% since 2007, while the U.S. dollar has depreciated 10% in real terms.
• Pieloski warns of a potential stagflationary environment for emerging markets, though currency appreciation may eventually dampen inflation and allow domestic interest rates to fall.
• John Coombe identifies regional trade blocks (intra-Asia, intra-Americas, intra-Europe) as the primary growth engine for the next decade, noting BHP and Rio Tinto wasted approximately $20 billion each in infrastructure projects with zero returns.
• Thomas Flohr of VistaJet reports that 75% of the company's 10,000 international flights in 2012 did not touch North America or Western Europe, indicating robust direct trade between emerging economies (e.g., Angola-Mozambique-Kazakhstan).
• Chris Hung confirms a "Chinese Wallet Strategy," noting double-digit growth in outbound tourism from China to Hong Kong, Macau, Australia, London, and Japan despite government restrictions limiting travel to a 300 million-person subset of the population.
• China's domestic demand is highlighted by a Shanghai property launch selling all 500 units in six weeks despite strict austerity measures requiring marriage, residency, and single-home ownership.
• China faces a "credit bubble" risk; while current leverage is low due to cash-only purchases, non-performing loans are rising, and the banking system remains exposed to local government and property sectors.

Specific Country Opportunities and Risks:

• Sarah Service excludes South Africa from the BRIC group due to political volatility but maintains it as an overweight in local bonds due to high yields and a credible central bank.
• Mexico is identified as a top opportunity due to unprecedented cross-party agreement on major economic reforms, potentially boosting growth from 2% to 3%.
• John Coombe expresses skepticism regarding India's growth prospects, citing structural failures in power infrastructure and the lack of a manufacturing base despite a young demographic.
• Thomas Flohr identifies a reversal in human capital flight, with skilled workers educated in the West returning to emerging markets to create local entrepreneurship.
• Indonesia is highlighted as an emerging market with a young, educated population and improved government stability, though infrastructure deficits remain a constraint.
• Brazil presents investment opportunities in equity and property linked to the World Cup and Olympics, though property markets are heavy with regulation.
• The "next tier" of emerging markets is shifting to East Africa, specifically Tanzania, Kenya, Mozambique, and Uganda, as West African distressed bond opportunities have largely passed.
• Rwanda issued a bond that was "hugely oversubscribed," demonstrating the appetite for high-yield opportunities in frontier markets.

Investment Vehicles and Currency Dynamics:

• Chris Hung utilized the offshore "Dim Sum" bond market to raise 1.85 billion RMB, achieving a lower cost of funding than the domestic market for private enterprises due to arbitrage opportunities.
• Jay Pieloski identifies local currency debt, particularly Dim Sum bonds, as the most attractive asset class, offering a 3-4% base return plus currency appreciation potential.
• The emergence of public investment vehicles is accelerating, including a new Nigerian ETF and African ETFs, though liquidity remains a constraint for large sovereign funds.
• Currency wars are currently active due to quantitative easing in developed nations; Brazil and others are attempting to restrict capital inflows to prevent currency overvaluation.
• Emerging markets are increasingly hedging against currency risk, with countries like Mexico cutting interest rates to stimulate domestic demand amidst a strong currency.
• Sarah Service notes that the "door" for capital flows is small, creating a risk of sudden outflows similar to the 1994 Asian crisis if quantitative easing is withdrawn too abruptly.
• Pieloski predicts a four-polar world by 2025 (Asia, Americas, Europe, and Africa), driven by regionalization and the rise of direct trade between non-Western nations.
• Institutional participation has shifted from speculative developed-market money to "real money" like sovereign wealth funds (e.g., Norway's fund) with dedicated long-term allocations to emerging market debt.

Panel Final Outlooks:

• Most Optimistic:
  • John Coombe: The Chinese equity market, anticipating a reversal after a period of commodity squeezes and margin pressure.
  • Thomas Flohr: The long-term mega-trend of direct trade between non-Western nations ending the dominance of Western trade routes.
  • Chris Hung: The consumer sector targeting the emerging market middle class.
  • Sarah Service: Emerging market corporate yields (high yield and high grade), specifically Russian and Brazilian corporates.
  • Jay Pieloski: Local currency emerging market debt over the next two years.
• Most Pessimistic/Risk Areas:
  • John Coombe: The Middle East, due to significant geopolitical instability.
  • Chris Hung: Europe, due to structural economic issues.
  • Sarah Service: Argentina, citing a lack of risk-adjusted returns.
  • Jay Pieloski: The execution risk of the transition from export-led to domestic demand-led growth, which historically has been difficult and could lead to subpar returns.