No one knows what form such a stagflation scenario will take, but one thing seems certain: it will include some emerging market assets.
Stocks and bonds from poorer countries have sunk this year amid Federal Reserve tightening and soaring consumer prices, and could sell further if the global economy stagnates. Yet it is in the pockets of emerging economies that the antidotes to stagflation exist: faster growth, accommodative policy and inflation-adjusted returns. This could unlock opportunities in everything from Indian stocks to Brazilian currency and Chinese bonds.
“Stagflation will force investors to seek pockets of growth around the world, and emerging markets will be first in line, especially those most insulated from weakening global demand,” Trinh said. Nguyen, senior economist at Natixis SA. “Countries that have huge, growing domestic markets that not only protect their economies from a global downturn, but also benefit from it, will do particularly well.”
The probability of a recession in the United States has climbed to 50% for only the second time since the 2008 financial crisis. Inflation in the world’s largest economy has shown signs of a peak, but is expected to remain well above the Fed’s 2% target until at least 2024. In the UK and the rest of Europe, consumer prices continue to rise as an energy crisis likely contraction .
This is uncharted territory for a generation of traders. Since 1982, the risks of growth and inflation have gone hand in hand, while recessions have revived economies with lower prices. But now consumer price indices and growth have decoupled, simultaneously worsening and calling for a whole new business paradigm.
The key themes of such a strategy, according to fund managers, will be:
National Growth Hero
While stagflation in the United States and Europe may hamper developing economies that depend on exports, it could benefit countries with strong domestic consumer demand and less dependence on Western markets. This would benefit countries with domestically oriented businesses and India stands out in this regard. The country, which derives only 12% of its gross domestic product from exports, is expected to experience the fastest growth among major economies in 2023. Its stock market is one of the few to post gains this year.
Less globalization, please
In general, countries offering some sort of relative isolation from Western economies are likely to attract investor interest. This could take the form of less vulnerability to imported inflation, less need for foreign capital or divergent monetary policies. Sue Trinh, head of macro strategy for Asia at Manulife Investment Management, cites Indonesia, Malaysia and Vietnam as examples. Investors have already started to favor dollar bonds from these countries, sending their sovereign risk premia to their lowest in seven, nine and two months, respectively.
“The economies most insulated from the negative demand shock are net food and energy exporters, those less dependent on foreign capital and those that still have room to manoeuvre,” said Sue Trinh. “The economies most able to mitigate the negative supply shock will have a relatively lower weight for food and energy in their consumer price indices and import baskets.”
The stimulus is not dead
China’s penchant for looser monetary policy, a popular theme for global investors since the start of the year, may become even more compelling. Declining factory-gate inflation, a slump in the housing sector and a fragile recovery clouded by Covid blasts are keeping policymakers determined to continue easing. That makes Chinese sovereign spreads close to 200 basis points over Treasuries – versus a historical average of 135 basis points – look like a bargain.
“It is possible that some emerging markets, but not all, will outperform if stagflation hits developed countries,” said Eugenia Victorino, head of Asia strategy at SEB AB. “China, a key driver of emerging markets, will be unique in pursuing supportive policy amid the tightening bias around the world.”
Big yield advantage
Brazil is an oasis in Latin America, a continent where the general mood is one of gloom in the face of persistent inflation and the restriction of growth caused by tightening policies. The country’s consumer price growth fell in July, responding to one of the most aggressive rising cycles in emerging markets. That leaves Brazil with a real yield of 3.68 percentage points, the highest inflation-adjusted rate among countries tracked by Bloomberg.
Given that stagflation could leave most countries with anemic real rates, Brazil’s yield is a potential decoy for carry traders. China and Vietnam may also find that their positive returns give them an edge.
But none of this means that emerging markets are immune to stagflation in advanced economies. It will actually be a blow to the entire asset class, causing portfolio outflows and sending investors to the safety of the dollar. It’s just that even in this turmoil, the only place investors can get some growth, some stimulus, and some yield is the developing world.
“A true global stagflation shock is unlikely to spare emerging markets, but to the extent that stagflation-like risks are a spectrum, emerging market opportunities can help hedge developed market risks,” he said. Vishnu Varathan, head of economics and strategy at Mizuho Bank. .
Catch all the trade news, market news, breaking events and the latest updates on Live Mint. Download the Mint News app to get daily market updates.
More less