CHALLENGING THE EMERGING MARKET CONSENSUS / THE WALL STREET JOURNAL

Heard on the Street

Challenging the Emerging-Markets Consensus

The usual response to financial turmoil is to sell emerging markets, but that looks like outdated thinking

By Richard Barley

Updated June 24, 2015 10:10 a.m. ET

 Moscow skyscrapers sit on the skyline beyond the Kremlin building, right. Russia has managed to withstand a sudden and almost total loss of access to international financial markets—something that in the past could have had a far bigger impact.


U.S. interest rates rising? Sell emerging markets. Eurozone standoff with Greece? Sell emerging markets. Problem in a couple of emerging-market countries? Really sell emerging markets.

The received wisdom is that emerging markets are risky and volatile—and therefore are first in the firing line when risk aversion rises. The latest jitters over U.S. interest rates and Greece have proved no different. Investors’ exposure to emerging markets stood at a 15-month low in June, with a big reduction since May, Bank of America Merrill Lynch’s global fund manager survey showed.

That looks increasingly like outdated thinking, however. The story since the global financial crisis broke out has been one of belated realization that risks in developed markets have been underpriced. Vast swaths of apparently low risk or “risk-free” instruments, from U.S. mortgage-backed securities to eurozone government bonds, turned out to be anything but.

Developed-market investors have had to cope with concepts such as sovereign credit risk that are bread and butter for their emerging-market counterparts. The latest manifestation of this is the lower liquidity and higher volatility being seen in advanced markets, traits normally more associated with emerging markets.


The temptation with emerging markets always seems to be to take the glass half-empty view.

Take the latest worries about lower growth—some of which, at least, is due to reforms that could make growth more sustainable. Emerging countries are still growing faster in aggregate than their developed peers. They will account for more than 70% of global growth this year, the International Monetary Fund thinks, and already account for more than half of world gross domestic product on a purchasing-power-parity basis. The bigger puzzle surely is the lackluster growth in developed economies given the sheer scale of stimulus thrown at them since the crisis.

Meanwhile, emerging-market crises have been loudly proclaimed as imminent several times in the past few years but have failed to live up to that billing. The buffers of cleaner government balance sheets, more flexible exchange-rate regimes and high reserves are proving powerful.

Russia, while undoubtedly suffering as an economy, has managed to withstand a sudden and almost total loss of access to international financial markets—something that in the past could have had a far bigger impact.

Indeed, with the power of extraordinary monetary policy potentially waning, the fact that emerging markets have been largely unloved may be to their advantage. Developed-market valuations for both bonds and stocks look rich; yields look to have troughed. Emerging-market stocks and bonds look much more attractive in terms of future returns given their starting point. Pictet Asset Management strategists forecast double-digit annualized returns for shares over the remainder of this decade. Emerging markets are risky—but at least investors get paid for taking that risk.

A rise in U.S. interest rates is likely to prove testing for all markets, after so many years of loose policy. And knee-jerk selling of emerging stock and bonds at the first sign of trouble may still be hard-wired into market behavior. But it is time for investors to question more carefully its validity.