Why you should care

Emerging markets account for 50 percent of global GDP and two-thirds of growth.

It probably (and hopefully) wasn’t big news on your radar, but last week was a nerve-wracking time for investors trying to figure if there’s still money to be made in so-called emerging markets. In rather spectacular fashion, or at least for some insiders, portfolio managers yanked nearly $8 billion out of Asian stock markets, the biggest such outflow in roughly 15 years. That was a larger sum than fled Asia during the financial crisis — which, we trust, was on your radar.

That could be a sign of trouble for a sector that already has been slogging through the mire for two years running. Or it could be a glitch, which of course might mean it’s still a good time to push more of your investments into funds focusing on places like Brazil, Russia, India, China — the famous BRIC countries — or deeper into Latin America or Eastern Europe, where the next emerging kings may be.

We grabbed Ankur Patel, co-founder and chief investment officer at R-Squared Macro, a notable firm in Alabama that manages endowments for foundations and universities, for a quick walk-through of last week’s drama and what lessons may have come from it. In this case, there was something of a flux involved — it turns out a team of Wall Street analysts rendered an arcane decision about Chinese stocks that didn’t end well. But in remarks edited below, Patel says it could be a warning to anyone who’s been sinking a lot of their retirement funds in this sector. Time to call your broker?

OZY: What exactly happened last week?

Ankur Patel: The big story was that MSCI [a Wall Street firm that provides stock indices] was considering including China in its emerging markets index. [That would have compelled money managers around the world to load up on Chinese stocks.] But China was not included in the index partly because it’s a closed-off economy and money would be locked into the country. Investors that put money into Chinese stocks expecting China would be included bailed out.

Portrait of Ankur Patel

Ankur Patel

Source R-Squared Macro

OZY: So it’s just a one-time thing? Or does it have the potential to become a bigger trend?

A.P.: Even though this was a more technical move, it could spur people to panic and leave emerging markets altogether. It could make investors think that the money pulled out of emerging markets signaled that something is wrong. … It’s hard to say whether that will actually happen because it’s based on human emotion.

OZY: Do you think that pulling out of emerging markets is the wrong choice in the long term?

A.P.: If you look at the global economy as a whole, it’s tough to lump emerging markets into one bucket. China was the biggest mover, and emerging markets generally followed China. But not anymore. Now there are some major winners and losers. Investors should simply reposition in more attractive destinations. India comes to mind — they import a ton of oil and oil prices are collapsing. On the other side, Latin America, which is so dependent on commodity exports for destinations like China, they are going to be major losers.

But Mexico is one of the markets that will benefit tremendously over the next few years. Its proximity to the U.S. is a big reason, especially if there are more trade agreements. Hitch your wagon to the U.S. economy and you’re going to be in a good position. China was the low-cost producer in the world for the last 10 years, but wages are rising so that Mexico is becoming once again competitive with China. It will change trade around the world.

OZY: What does this mean for your everyday Mexican or Chinese worker?

A.P.: Every year, businesses decide where to open up new factories and new plants. Major multinationals have to make decisions on where to expand. That may not immediately hit workers, but it does over the course of a few years. [Eventually] Mexican workers will have more jobs and higher wages than Chinese.

OZY: What’s really happening on the ground in China?

A.P.: There was a run-up in Chinese equities, driven primarily by retail investors. But there is no avenue for them to [take profits] — they can’t invest in real estate or banking because they’re run by the government, and they can’t move money outside of the country. It’s just parked in equities, which is a disaster waiting to happen. When Chinese equities take a tumble, there’s a massive confidence hit globally. The confidence shock could then surpass borders and hit other emerging markets. It could then flow into developed markets as well.

OZY: What’s the worse-case scenario?

A.P.: It starts with the eurozone. The European Central Bank has to coordinate policy among 19 nations. There’s a real possibility that mid next year they’re going to stop quantitative easing [the central bank’s effort to inject cash into the economy with huge purchases of government bonds] altogether. It’s very likely that they prematurely exit the program because of a lack of consensus.

If the ECB stops printing euros, the currency’s value stabilizes and potentially rises, and then European manufacturers would lose their competitive edge. Without domestic demand, the economy would stagnate. At the same time, China is slowing down quite a bit, and the U.S. might be cooling off as well if the Federal Reserve is raising interest rates. That means the entire world cools off at the same time, and [governments have no options for kick-starting growth]. Everyone’s back would be against the wall, which could cause the next recession.

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