The global economy is in trouble, of that there can be little doubt. Its direction is almost impossible to read. The situation has become so dire that there’s little more than threadbare hope of keeping it together. Hope alone is unlikely to stave off a protracted slump or worse a second recession in two years.

It is almost inevitable that the countries of Europe will suffer worse, although the chance of the same happening in the US increases every day, and the interdependent emerging markets, which had shown signs of pulling clear of the US and Europe are proving to be as heavily dependent as always.  

Growth around the globe is torpid at best and developed nations are most at risk. Today, instead of wondering a way out of this mess it would be more pertinent to ask, how long will this economic listlessness last and what does it mean for emerging markets growth in the short to midterm?

There are many nightmarish charts doing the rounds but the simplest one for emerging markets investors is straight off the MSCI EM Index; September 2011 MSCI EM Index -14.8%.

The two weeks at the beginning of October proved just how contrarian the market had become. Prior to the start of October, the precipitous fall in equities had begun to reflect the true parlous state of the economies of developed nations. The S&P500 was 1350 at the beginning of July, close to its three year high, at opening on 4 October it was at 1078, a 22 month low.

On 4 October, in the last 30 minutes of trading, the S&P500 spiked upwards 270 points, more than 2.5%, off the back of comments made by members of the Eurozone, little more than a rumour of collective support for troubled banks in the Eurozone.

Since that time the Bank of England has pumped £75bn ($117bn) into its economy and the European Central Bank has consolidated the European Economic Financial Stability Fund, which now has €440bn in its coffers (as of writing rumours are the fund could be bolstered to top €1trn). In truth not a lot has changed.  The finance ministers of Europe will want to minimise the damage, which has effectively been factored in by the markets, although that is unlikely to diminish the hysteria.

In this game of rumour and counter-rumour emerging markets are virtually helpless, impotently waiting for the end game to play out, knowing they’re not even at the table to make a telling move.

Impact on Latam

Latam may be losing its pitch battle with developed economies. Brazil’s open condemnation of the easing policies of the US and the subsequent ‘currency wars’ can be passed off as politicking, but it’s becoming harder to ignore the weak IBovespa and equities outflows. The IBovespa had fallen by 23% for the year to the end of September.

Just as worrying for Brazil and the rest of the region is the falling risk free rate. “In terms of warning signs, the most important one is the risk free rate decrease in Brazil, and the implication that it may be followed by other countries in Latam,” says Otávio de Magalhães Coutinho Vieira, partner, Fides Asset Management.

In its defense the real economies of Latam remain strong and the credit problems aren’t what they are in Europe and the US. Still, the region waits with trepidation on the outcome of European finance ministers meetings and the upcoming G20 meeting in Cannes, France. “Central Banks and governments are trying to be proactive as the European crisis does not seem to have a definite solution. The Eurozone is trying to postpone the inevitable Greece haircuts on its debt to a more appropriate moment and adding features to the Maastricht treaty in order to make the European Economic Community a feasible structure. If this process unfolds in a disorganised fashion, we will witness another crisis and years of low global economic growth,” says Vieira.

The uncertainty is enough to adversely affect financial markets in Latam. “The impacts for investments are numerous as investors tend to be more risk averse as their portfolios are showing weak numbers. The flow of funds is less vibrant and fixed income is the favorite option,” says Vieira.

In fact fund flows are vibrant, but only away from Latam. In the second week of October “Latam equity funds posted the biggest outflows in both dollar and percentage of assets under management terms [of all emerging markets equities],” according to EPFR Global.

And what of the ongoing currency wars, the real will continue to feel pressure and with downward pressure on interest rates volatility is a definite issue. “The currencies [of Latam] have been showing higher levels of volatility and even though there is no currency flight, volatility spikes have been caused by repatriation of resources from foreign investors,” says Vieira.

Global context

This isn’t the first time economic strife in Western markets has and will affect emerging markets. Its recurrence is so commonplace that even laics would assume a flattening of the learning curve sooner rather than later and a severing of the umbilical cord that so links emerging with developed markets. Sadly, such simple recourse is unlikely to play out, not even in the slightest, if anything the dependence has increased and the fallout could be much worse than many remember

Doom and gloom scenarios often distract investors from the lingering and intrinsic benefits of emerging markets. “Yes, events at home have prevented investors from paying more attention to this part of their portfolio. But we haven’t seen a major shift in sentiment from investors not wishing to discuss Africa,” says Larry Seruma managing principle Nile Capital Management.

The fundamental long term strengths of emerging markets remain intact, according to Gerhard Pries Sarona Asset Management: “’Invest in the big ideas.’ Good advice. The world bounces around, but the big ideas for us are: emerging markets (including developing countries) have a steadily growing middle class population that is eating more, moving around more, buying more, producing more, sleeping in better houses, etc. That is a big long term trend. And developed Markets like ours are mature, have demographic (aging) problems and are slowing down.”

By Zaki Abushal