Commentaries

The Envestnet Edge, September 2015

China, Commodities, and Crisis: What's Next for Emerging Markets?

Download the full PDF

China’s growth story fueled global markets for years, and the recent market rout raises concerns that the spigot may be tapping out. But is it really? Emerging markets, currently out of favor with investors, are showing signs of domestic economic growth driven by an expanding middle class. Could these economies, along with China, re-emerge as bright spots in the global markets?

In August, equity markets finally displayed the volatility that many had been anticipating. Other asset classes, including currencies, high-yield and emerging market bonds, and, of course, energy and commodities, had roiled throughout the year. But equities had been largely immune—until now.

The sell-off was attributed widely to accelerating worries about the tenability of China’s economic growth, and how its sharp deceleration would negatively affect global economies. For more than a decade, skeptics warned that China’s economic model, dependent on exports and state spending on infrastructure, was on the verge of a hard landing. But over the summer, those concerns began to emanate from China itself, and its domestic equity markets began to crash. Although those markets are largely unconnected to global markets, global equities began to sell off hard, as investors worldwide began to question whether China’s day of reckoning had arrived.

Other factors played a part for sure: low volumes in the normally slow summer month of August; a high level of algorithmic and program trading; the ongoing question about when the Fed will begin to raise short-term rates. But the China question looms largest, especially because as China goes, so goes global growth.

So, will China slow so much that global growth is imperiled? If the answer is ‘yes’, then, indeed, we should be very concerned about the stability of emerging markets, and the viability of international bonds and financial assets that are exposed to those trends (which is most of them). But there are strong reasons why the answer could be ‘no’.

2 billion and counting

When our children and grandchildren look back at the first 15 years of the 21st century, it is likely that the addition of billions of people to the global middle class will be a dominant theme. And that China—and its string of double—digit growth years—was the anchor. As hundreds of millions of Chinese moved from the countryside to newly constructed cities, China’s appetite for raw materials fueled a global economic boom. From Chile to Brazil to swaths of sub-Saharan Africa to Indonesia and Southeast Asia, more than a billion people in turn benefitted from China’s growth.

China also became a market for high-end finished goods: turbines, semi-conductor equipment, locomotives, airplanes, and tempered steel. China’s trading partners prospered, from Germany to Japan to South Korea to the United States. In fact, the only large country that grew almost entirely on its own internal steam was India, which, lagging China’s impressive trajectory, was powered by its domestic market.

China also reaped benefits from the globalization of supply chains, becoming the low-cost global producer for Europe and the United States. At the same time, it became a highly desirable market for U.S. and multinational companies looking to tap China’s burgeoning middle class consumers. Businesses such as Apple, Kentucky Fried Chicken, Federal Express, and Walmart all gained from China’s growth.

China’s growth resulted not only in the creation of a new Chinese middle class several hundred million strong, but also a global middle class several billion strong. That is why the prospect of a severe China slowdown is of such concern to so many.

Because so much of the world has changed so dramatically and so quickly is the very reason why this train of global growth will be so difficult to derail. It may face challenges in the year ahead, but the momentum is powerful.

Think about it. The last time there was global concern about the viability of emerging market economies was the Asian currency crisis and the meltdown of the Russian ruble in the late 1990s. Many countries, ranging from Latin America to Asia, had autocratic, inept governments with high levels of foreign debt and few reserves.

Today, much of the world has democratically elected governments that are accountable for economic growth and prosperity. Brazil, for instance, may be facing recession and scandal, but its democratically elected government knows that if it cannot enact meaningful reforms to enlarge the middle class, it will lose its mandate to govern. In addition, over the past decade, many of the countries that have advanced from China’s rise have not squandered their profits.

Instead, they have bolstered their reserves and invested in infrastructure and education—perhaps not as much as they could or should have, but incomparably more than twenty years ago. They have strengthened their foreign reserves, and many have favorable current account balances, all of which better positions them to weather storms and downturns than was the case in the late 1990s when their high debt made them vulnerable to the ebbs and flows of international credit and finance.

Today, many countries are overly reliant still on the export of raw materials and oil. That is a real weakness in light of China’s diminished appetite and the efficiency evolution sweeping the planet that translates into less demand.

But that reliance is offset by the surge in consumer demand within those countries. In fact, the growth of domestic consumer economies is perhaps the strongest reason to suspect that even a significant China slowdown does not portend a general financial and economic crisis. India is the most compelling example of a vast non-Western economy that is surging because of its own internal middle class market, rather than reliance on exports or commodities. It is not alone: countries such as Nigeria and the Philippines, and to a large extent Indonesia, which have a combined population approaching half a billion people, are exhibiting similar dynamics (despite Nigeria’s former dependence on oil exports and Indonesia’s extensive commodity boom and bust).

Although the commodity bust and China’s shifting economic mix have been and will continue to be unsettling, and at times painful, these are positive adjustments for the world. They move the next stage of global evolution away from selling stuff and digging stuff and towards billions of people using stuff. They move the world away from selling to the highest bidder or to the one with the largest appetite for metals and oil and towards a world ever-more grounded on billions of people striving to create a better life for themselves and their families.

To believe that we are on the brink of a significant global crisis, therefore, is to believe that several billion people in the world formerly known as ‘developing’ cannot make the transition that a billion people in the developed world already have. It is to believe that they are both incapable of good governance, and unable to craft a formula for their own wellbeing. That may, of course, be true, but if it is, our worries will be more substantial than what asset classes to invest in and how much.

Advisor Take-Away:

In recent history, industrialization and globalization spawned a Chinese middle class of millions that in turn created a global middle class more than a billion strong. With democratically governed countries having bolstered their reserves and invested in infrastructure and education to enlarge their middle class, they are well positioned to withstand the challenges they could face from China’s shifting economic mix. The next phase of global evolution will be towards consumption, as several billion people strive to create a better life for themselves and their families. All of this should have positive ramifications for financial markets.

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this commentary is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results. Indices are unmanaged and their returns assume reinvestment of dividends and do not reflect any fees or expenses. It is not possible to invest directly in an index.

Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet | PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

Neither Envestnet, Envestnet | PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.

© 2015 Envestnet, Inc. All rights reserved.

Featuring

Zachary Karabell
Head of Global Strategies, Envestnet, Inc., Consultant to Investment Committee*

Articles By This Author

Video: Time to stock up on growth or value? The Envestnet Edge, September 2017 Video: Time To Take A (Measured) Risk? The Envestnet Edge, July/August 2017 Video: Bitcoin: Buy Or Buyer Beware? The Envestnet Edge, June 2017 Video: FANG, FAAMG: Too Big a Bite of the Market? The Envestnet Edge, May 2017 Video: Invest "As If" The Envestnet Edge, April 2017 Video: What To Do In Quiet Markets The Envestnet Edge, March 2017 Video: Bull Or Bear: Should Investors Still Care? PMC Weekly Review - March 10, 2017 The Envestnet Edge, February 2017 Video: Separating markets from politics, is it really a "Trump rally"? The Envestnet Edge, January 2017 Video: Investing in Trump’s Economy? Proceed With Caution The Envestnet Edge, December 2016 Video: Have We Only Just Begun? The Envestnet Edge, November 2016 Video: Rotations, Reversals, Rising Rates: A Time to Reposition Post-Election, Will Markets and Portfolios Emerge Winners or Losers? Webinar Replay: Post-Election Winners and Losers The Envestnet Edge, October 2016 Video: In a 2-2-2 world, look for modest economic growth and expansion PMC Weekly Review - September 16, 2016 The Envestnet Edge, September 2016 Video: Diversification is working in 2016 (so far) The Envestnet Edge, July/August 2016 Video: Valuations: it's all relative Brexit: Plunging into the Unknown? The Envestnet Edge, June 2016 Video: Equity valuations and bond yields: reach no further PMC Weekly Review - June 17, 2016 The Envestnet Edge, May 2016 Video: Hitting singles: a measured approach for this investing season The Envestnet Edge, April 2016 Video: Investing with impact: increasingly a matter-of-fact Video: In this election cycle, will investors be winners or losers? The Envestnet Edge, March 2016 PMC Weekly Review - March 11, 2016 Video: In a low-growth world, less could be more The Envestnet Edge, February 2016 The Envestnet Edge, January 2016 Video: Markets are a mess, but don't jump to conclusions yet A Most Challenging Year Video: Interest Rates and Energy: The Highs and Lows of Year-End The Envestnet Edge, December 2015 The Envestnet Edge, November 2015 Video: We'll always have Paris The Envestnet Edge, October 2015 Video: Politics and the markets: déjà vu all over again? Video: China, Commodities, and Crisis: What's Next for Emerging Markets? The Envestnet Edge, September 2015 PMC Weekly Review - September 11, 2015 Is This The Big One (Financially Speaking)? Probably Not. The Envestnet Edge, August 2015 Video: In a "meh" market, look again at U.S. stocks The Envestnet Edge, July 2015 Video: Is this the Big One? What to do in a financial crisis Don't Worry About China Don’t Believe the Hype About Greece The Greek Catastrophe Is Finally Here (Unless It Isn’t) The Envestnet Edge, May/June 2015 Video: When Following the Herd is Risky, Where is the Safety? The Envestnet Edge, April 2015 Video: The End of Short-Termism is Long Overdue PMC Weekly Review - April 24, 2015 The Envestnet Edge, March 2015 Video: Keep Your Friends Close and Your Robo-Advisor Closer The Envestnet Edge, February 2015 Video: The Return of the Comeback: Is 2015 the Year for International Stocks? PMC Weekly Review - February 13, 2015 Why the Jobs Report Means Diddly Don’t Turn America Into Europe PMC Weekly Review - January 23, 2015 Video: Active and Passive: The Yin and Yang of Investing The Envestnet Edge, January 2015 PMC Weekly Review - January 9, 2015 Will Politics in 2015 Catch Up with the Economy? Video: Our Perspective on 2015: Maintain Yours The Envestnet Edge, December 2014 PMC Market Commentary: December 12, 2014 No, This Is NOT the '90s Economy Again PMC Market Commentary: November 14, 2014 Video: 2014 U.S. Midterms: A Win for Stocks? The Envestnet Edge, November 2014 Whose Economy Will It Be in 2016? PMC Market Commentary: October 17, 2014 Video: Special Video Commentary: Market Volatility and Fundamentals The Envestnet Edge, October 2014 Don’t Panic! Video: You Know What’s Not Sustainable? Ignoring the Opportunity in Impact Investing PMC Market Commentary: October 10, 2014 Greenberg’s Folly Naomi Klein Is Wrong PMC Market Commentary: September 26, 2014 Subprime Loans Are Back! Video: When it Comes to Interest Rates, Who Says What Comes Down Must Go Up? The Envestnet Edge, September 2014 PMC Market Commentary: September 12, 2014 Why Indie Bookstores Are on the Rise Again The Fed Is Not As Powerful As We Think PMC Market Commentary: August 22, 2014 Americans' Sour Mood on the Economy Doesn't Square with the Fact The Envestnet Edge, August 2014 Video: The World is in Crisis... the Markets are not PMC Market Commentary: August 8, 2014 PMC Market Commentary: July 25, 2014 Punitive Damages Video: Market Valuations and The Theory of Relativity The Envestnet Edge, July 2014 Don’t Kill the Export-Import Bank. Clone It. How India’s Economic Rise Could Bolster America’s Economy Video: Separating Risk from Reality PMC Market Commentary: June 27, 2014 No Sex Please, We're French PMC Market Commentary: June 13, 2014 The Envestnet Edge, June 2014 PMC Weekly Market Review, May 23, 2014 The Envestnet Edge, May 2014 Don't Bet on Rising Wages PMC Market Commentary: May 9, 2014 The Sharing Economy: Why Are So Many So Afraid? PMC Market Commentary: April 25, 2014 The Obsession with CEO Pay Won't Help the Middle Class PMC Market Commentary: April 11, 2014 Time to Face Reality: Our Unemployment Problems Are Structural PMC Market Commentary: March 28, 2014 In Defense of Relentless Optimism The "Made in China" Fallacy Forget GDP - Use Big Data