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Understanding the Challenges that Affect Emerging Markets

Question:

Discuss about the Stock Markets Challenges for Economic Conditions.

Stock markets are faced with big issues as indicated by market outlooks. This are the challenges that determines whether new investors enter the market or rather avoid it. This paper will be important to such potential investors as it will help them understand the potential challenges that they may face and thus may lead them to entering the market with different improved strategies. Piper (2017) noted that first time investors have challenges in that they are not aware of the major factors influencing decisions on stock markets. The equities market were predicted to rise by the end of 2016 but this was upended by geopolitical surprises (Moore et al., 2017). However, the bonds were predicted to remain relatively low. The first time traders use the strategists’ forecast to determine the changes on the stock markets. There are many questions therefore that pre-occupy investors and will be answered in this paper. The average retail investor receive exposure to emerging markets from mutual funds investing in a collection of countries or exchange-traded (Shmuel, 2017). This was in 2015, but he posed an argument that broad market funds performance in 2016 was very poor that it created a need to rethink the approach. The various challenges that will be covered in this paper will help in determining who wins and who loses depending on how they are able to overcome them.

The index of MSCI Emerging Markets has fallen for three consecutive years. This has resulted in investors withdrawing a sum of US$500 billion from equity funds on the emerging markets. This has been noted as the biggest outflow of funds from the emerging markets for decades. The presence of outliers poses a rationale for the investors who are seeking engagement with the emerging market to be more selective (Shmuel, 2017). However there exist the challenge of screening who are the losers and who are the winners. According to Gale (2017), the stock markets purchased stocks through using bank loans, the banks noted greater profit margins made by this firms and also started the trading on such securities. This distorted the market and the prices are falling and the investors are still required to repay their loans.

This is what Shmuel referred to as a more hawkish Fed. He noted that there was a calm reaction by the emerging markets when the Federal Reserve of U.S. raised its interest rates in December 2016. This was noted to come as a surprise for decades. This creates a test on how emerging markets will use its assets to handle further hikes in the interest rate. The calm response has enabled the economy to impose further rate hikes with projections that U.S dollar will become stronger as this is a tightening monetary policy. The implications from this of struggling economies whose lots of debts are held in U.S dollars is very big. The result from increment in interest rate is an increase in the costs of borrowing; this has subsequently resulted in such economies experiencing huge financial losses. At extreme case, some of them have fallen into outright recessions (An example is Brazil and Russia). A senior markets economist David Rees stated that further losses will be incurred by issuing countries with fragile balance of payments such as South African Rand or the Turkish lira. The West has had a loose monetary policy that has resulted in a borrowing spree and consequently an explosion in the emerging markets.

Fluctuations in the Equity and Bond Markets

The note of the International Monetary Fund concerning the emerging market was that corporate debt of non-financial firms exploded from U.S $4 trillion in 2004 to over US$18 trillion as at 2016. The dangers of further risks is created by the fact that most of these corporate debts are held in U.S. dollars where the maturity date is on the coming years. The International Settlements Bank noted that the stock of dollar-denominated debt held outside U.S. by non-financial entities is almost $10 trillion where about 40% is held in emerging markets. This statement was said by National Bank Financial Market’s senior economist Krishen Rangasamy in his note “the historic USD surge has now made it harder to service that debt”. According to the IMF, there is a need for the emerging-market governments to prepare for a potential corporate failures swell. This is because many of the borrowing firms won’t be able to service the money they had borrowed and may put little effort towards the same. This is because the tightening of the monetary policy is also associated with low prices of commodities.

The bond yields have been slumbering and thus growth has been argued to be induced through fiscal stimulus and a reduction on the regulations that imposed on various businesses. Since there is a leap of faith by the investors for this lacklustre growth, money has started flowing to equities and leaving the bonds market. The stocks of S&P 500, Nasdaq Composite, Dow Jones Industrial Average and Russell 2000 have hit highs levels since November 8, 2016.

There has been a deflation where the commodities price have remained low; this is especially the case for oil prices. The oil prices have not yet recovered and these prices are expected to be lower for a longer time. The emerging world has been divided by the commodity price crash. The oil price has been too low for a couple of years now. Many economies that are major oil producers has greatly lost for selling at the low prices while importing economies have had much gains. The low oil prices have been accused of bringing down the returns from stocks. Many emerging market economies and commodity producers has been bedeviled by pressures of low commodity prices. Marc Chandler, Brown Brothers Harriman global markets strategy’s head noted that the turn of the calendar is anticipated that it wouldn’t result in the alleviation of this pressure. This means that even with an improvement in the sales on the exporting economies, the investors are still not being provided with a significant bargain.

The US 10-year Treasury yield has jumped up from 1.32 % in July 2016 to 2.5 % as at 2017. This is because of the contemplation of faster economic growth by the bond investors coupled with the fact that future interest rate is going to be higher. The fiscal stimulus of tax cuts and lowering of business regulations have been argued to be offset by the increase in the strength of the U.S. dollar over multinational US companies (Moore et al., 2017). A country is able to provide reliable investments if it’s stronger and has stable finances (Perry, 2017). The level of economic growth for emerging markets is extremely high owing to the rapid industrialization. The returns from strong economic growth on emerging markets may at times exceed that of developed markets (Paganetto, 2012). However, investment on stocks is safer in the developed markets and riskier on the emerging markets (Naqvi, 2013). The risks result from the presence of many political uncertainties and the proneness of the economies to booms and bursts (Mobius, 2012). According to Hasson (2016), the strong growth of the economy coupled with credit quality has contributed to the decline of emerging market stocks.

Volatility Associated with Interest Rates

The world is in a situation of ongoing conflicts that are affecting the emerging markets (Saut, 2017). The ongoing Western intervention in the Middle East against ISIS militants have continued to negatively impact the production of oil and gas in the region. There has been a tensions between Turkey and Russia; the fester on the two important regional economies continues after the downing of a Russian jet fighter jet by Turkey in November. There are many sources of geopolitical unrest and the terrorism group is one of them (Naqvi, 2013). The geopolitical risk market perception according to Citigroup analysts is at 25-year high. I addition to the Middle East tensions, South China Sea is on an undergoing military escalation. Unrest in Europe could therefore result from the alarming number of refugees from Syria; and also a potential for more terrorism attacks. Whenever there is a flare up on geopolitical risk, a negative impact results on the emerging-market assets. A JPMorgan Asset Management analyst noted some certain emerging market countries stock market depends on international flow of investment, and thus their performance tend to be worse even with the existence of a selloff. The analyst identified five countries so-called fragile five to be at a higher risk of experiencing huge declines even in the presence of an emerging market selloff — Colombia, Mexico, Indonesia, Turkey and South Africa. This is because of their cripplingly dependence on foreign money; this money has a habit of being more skittish. The Brexit referendum resulted in the U.S. equity market losing over $1 Trillion (Hasson, 2016). This political issue has been argued to have had a great impact on the stock markets.

Conclusion

The policies of the government can be concluded to have been a very important factor in the variation of stock prices. Investors agree that, optimism on the emerging markets is caused by the prospect of stronger economic growth in the presence of higher interest rates; the policy gears is also projected to shift from monetary measures to fiscal measures by 2018. Restrictive monetary policy makes the dollar stronger. It therefore can be concluded that a in the presence of a fast economic growth and a restrictive monetary policy, a weak dollar cannot be sustained. The world is a global economy and thus the economic changes of the biggest economies are easily transferred to other economies. The above are the most important challenges that first investors in the stock markets face.

Gale (2017). Corporate Disasters: Speculative Mania and Bubble Bursts. Gale, Cengage Learning.

Hasson, J. (2016). These three investing legends are warning of another crash. [Online] Canadian Business. Available at: https://www.canadianbusiness.com/investing/these-three-investing-legends-are-warning-of-another-market-crash/ [Accessed 7 May 2017].

Kachru, U. (2005). Strategic Management: Concepts and Cases. New Delhi, Excel Books.

Mobius, M. (2012). The little book of emerging markets: how to make money in the world's fastest growing markets. Singapore, John Wiley & Sons Singapore Pte. Ltd.

Moore, E., McCrum, D., Blitz, R., Bullock, N. and Raval, A. (2017). Markets outlook: the big issues facing investors in 2017. [Online] Ft.com. Available at: https://www.ft.com/content/416e65ba-c82f-11e6-8f29-9445cac8966f [Accessed 5 May 2017].

Naqvi, N. (2013). What’s up with the Pakistan Stock Market? [Online] Karachi Stock Exchange. Available at: https://file:///C:/Users/Richard/AppData/Local/Temp/MD_article_PakistanStockMarket.pdf [Accessed 7 May 2017].

Paganetto, L. (2012). The political economy of the European Constitution. Aldershot, England, Ashgate.

Perry, B. (2017). Evaluating Country Risk for International Investing. [Online] Investopedia. Available at: https://www.investopedia.com/articles/stocks/08/country-risk-for-international-investing.asp [Accessed 7 May 2017].

Piper, M. (2017). What's the Biggest Mistake First-Time Investors Make? [Online] WSJ. Available at: https://www.wsj.com/articles/what8217s-the-biggest-mistake-firsttime-investors-make-1389369155 [Accessed 6 May 2017].

Saut, J. (2017). We are for ‘flation! [Online] Raymondjames.com. Available at: https://www.raymondjames.com/wealth-management/market-commentary-and-insights/investment-strategy [Accessed 7 May 2017].

Shmuel, J. (2017). Four challenges facing emerging market investors. [Online] Financial Post. Available at: https://business.financialpost.com/investing/outlook-2016/four-challenges-facing-emerging-market-investors [Accessed 7 May 2017].

Smelser, J. and Swedberg, R. (2010). The handbook of economic sociology. Princeton, N.J., Princeton University Press.

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