Are The Emerging Markets Still Emerging?

By John Schroder - January 24, 2016 

Some of the latest financial news headlines seem to want to tell us that the markets in China are cooked to a crisp like a Peking duck.  Brazil, land of carnival and samba, has lost it's rhythm and is not dancing so well economically speaking.  Russian markets and it's currency certainly are starting to truly resemble it's national mascot, the bear.  And of course we have Venezuela, finally coming to grips with years of left wing socialism that has not exactly produced the modern day democratic version of the so-called proletarian paradise (insipid central planning kind of government economic policies will tend to do that).  Images of armed military guards in Caracas supermarkets guarding a few precious rolls of toilet paper pretty much sums it all up.  So, are the emerging markets not a “thing” anymore?

The mainstream media place the blame mainly on falling commodity prices of which the income prospects of many developing or emerging markets rely (petroleum being the largest factor).  China of course is the other leading scapegoat as the mantra is now: So goes China, so goes everyone else (at least as it pertains to the downside).  And of course we also have the very truthful notion that the world is certainly more interconnected in general (financially, electronically and perhaps in a number of other ways we cannot even think of) to the extent that the proverbial burp in one part of the world leads to indigestion in another part of the world, all the way on the other side of the globe.  However, that degree or level of indigestion will vary from country to country in the longer term all depending upon the fundamentals.  Which is to ask the question:  What has changed over the past 8 years in terms of exports, job growth (or lack thereof), government and private balance sheets, demographics, new business and start-ups (or lack thereof) and financial or fiscal policy in each individual nation?  Have the fundamentals honestly improved internally in each country or have they gotten worse?  These are the questions you really should be asking on a case by case or nation by nation basis.


I am not crazy about reality, but it still is the only place to

get a decent meal – Groucho Marx.

Emerging Market Statistics & Demographics

We prefer to continue to look at long term trends to get an idea what the future may hold both politically and economically (the first usually follows the later).  And with that said, part of the problem today in the modern developed countries is that responsible long term investing, both by politicians and captains of industry alike, has been replaced by a short term trading mentality.  Company executives focus on the short term stock price as many have their bonus compensation linked accordingly.  The banking and financial industry focus on the short term deal rather always doing what is correct in their previous role of customer fiduciary.  Politicians manage national problems and crises with short term band aid solutions lasting long enough until the next election cycle rather than crafting a lasting resolution even though it may be politically unfashionable at the moment (QE is NOT a lasting solution to a problem rooted in a debt crisis of dubious credit quality).  So, what then are the long term trends that set apart some of the emerging markets from their so-called developed world counterparts?

1. Demographics, Demographics, Demographics.

The populations of the developed word is aging and that older population represents a significant portion of the overall populations in many of the so-called modern industrialized nations (the term industrialized probably is a misnomer today considering much of the manufacturing has gone to China, Malaysia, etcetera).  Unfortunately, these government managed pension and social welfare schemes were set up under the premise of an ever increasing young population paying taxes into the coffers in order to support the theoretical few taking out benefits.  But guess what?  People in Western Europe, the US and even Japan either reduced the number of children they were having or decided to have none at all.  The obvious result is a much smaller population of young people expected to carry the financial weight and tax burden of supporting the aging old folks (I hope you were good to your kids because now it is payback time, literally).

In contrast, the emerging markets still have a very large cohort of young people in comparison to the number of retired or soon to be retired.  In fact, one can say that in some cases, some of these developing markets are baby factories with the largest export being people.  But, in terms of managing a pay as you go social welfare paradigm inside such developing markets, these nations should be golden for the next 30 years or so at least.  That is assuming there are jobs for all these young people and that they can thus have the ability to pay taxes into the state welfare benefits coffers.  This really is the main challenge for such emerging market nations, generating jobs and employment (which brings us to new trends regarding migration to emerging markets in another article shortly).   

2. Are They Banks Or Are They Casinos?

What has been the business growth plan for the banking sector in the US and Europe over the past 20 years or so?  Derivatives (basically gambling bets on interest rates and company or government defaults with banks and even insurance firms acting as bookies, and the real fear is that no one is sure the bookies can pay off when the time comes), Securitization (Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations, or other non-debt assets which generate receivables, and selling their related cash flows to third party investors as securities) and generally gaming the financial markets not dissimilar to a casino operation (again, remember the trading paradigm as opposed to investing paradigm).  In addition, this policy of zero (or close to zero) interest rate policies coupled with so-called quantitative easing has not been the magic elixir it was sold as.

The very articulate and intelligent Ms. Nomi Prins has opined recently, the banks in the US still maintain a healthy interest rate spread on loans they originate (car loans, mortgages, personal loans) even though the banks are getting money from the US Federal Reserve for zero or close to zero interest.  Yes, it is true that mortgage interest rates and car loan rates have come down in the US, but the banks still maintain a spread ranging from 3 to 5 percent in terms of interest charged and their own cost of funds.  Credit card interest is another story altogether and the most disturbing problem right now are pay day loans.  Bobbi Rebell writing for Reuters on January 6, 2016 reports that:  28% of college-educated Millennials have gotten short-term financing from pawn shops and payday lenders in the last 5 years (remember, this is the younger generation aged between 23 and 35 that is expected to cough up higher taxes to support all of the older retired folks).  In New York payday loan interest is capped at 4 percent per month (PER MONTH) but in Alabama such lenders can charge up to 456% as an annual percentage rate by law.  Think about this for a moment.  Almost one third of university educated young people in the US are basically borrowing via loan shark like interest rates (because they have no money saved or other choice?).  Couple that with student loans they might owe and the fact that many cannot find jobs, and you do not have a very positive economic paradigm at play for these young people.  This is the next up and coming American generation and I feel for them.  Ironically, it was recently reported that 5 million Mexican migrants in the US have returned to Mexico because they feel the economic situation is now better there than in the US (maybe the Mexicans know something the young Americans do not).

What is the banking situation in the emerging markets?  Again, you need to look at each country individually.  But, generally speaking, many of the banks in these developing markets have not gotten involved with the US mortgage backed securities affair nor have they gotten involved with derivatives.  Instead they have maintained their business model locally and more importantly many of the banks keep the loans they make on their own books (which is what US banks used to do and why the credit lending process in many of the emerging market nations is still conducted with prudence and due diligence towards the borrower).  When banks know that whatever loans they originate will stay on their books, they usually are going to be very careful about who they lend to and under what conditions.  In addition, in many of the smaller emerging market countries there is less gaming with the overall interest rates by the central bank in such a respective country.  It is not necessarily the case they do not want to or are smarter or more dedicated to free and fair markets, but rather they do not have the same capacity or tools to do so as the central banks in the other countries (which is a good thing). 

3. The Central Bank Market Puts

One major problem we see that has become the norm rather than the exception in the so-called developed markets of Europe and the US is this idea that the central bank (and other government agencies) should step in any time there is a market correction in equities or fixed income instruments.  This paradigm of course came out of the 2008 financial crisis and has been a continuing policy even since.  The problem with all this is, it is nothing more than smoke and mirrors.  Properly functioning financial markets in a free and capitalistic system will always experience periods of exuberance, correction and return to the mean.  Such a process allows for bad investments to be purged and thus better allocation of funds towards healthy or viable investments in the markets as a result.  When central banks interrupt this process and step in to flood the markets with newly created fiat money in order to halt correcting markets, they are not allowing the free market system to do it's job.  Investors of course will tend to cheer about this as it basically creates a central bank put against falling equity or bond markets.  However, this also creates what is known in economics as moral hazard.  If banks and investors know they will always be bailed out by either tax-payer funded bailouts or free money printing by the central bank, then all forms of prudence and sensible decision making goes out the window.  In addition, it permits bad investments to remain on the books which in turns chokes off capital that should be going to new, innovative and hopefully sustainable growth investments that will add jobs and increased prosperity to the economy.  Stated another way, governments and central banks have now become modern day Dr. Frankensteins, keeping zombie companies and banks alive artificially.

With China aside (as they have not recently joined in on the central bank put paradigm as well) most of the smaller emerging or developing markets still behave and are truer free markets than their so-called developed country counterparts.  What this means is, from a fundamental basis, such emerging markets have a better asset or capital allocation paradigm in place.  Which also means, in our opinion, they still have more a propensity for true and real economic growth (as opposed to fake GDP growth that in reality only exists from central bank money printing and or governmental shenanigans). 

4.  Debt Is A Four Letter Word

With The 2008 financial crisis that started inside the US and migrated over to Europe was in fact a very typical credit crisis or boom and bust as described in Austrian Economic theory.  There was an opportunity that was sorely missed in that all of that bad investment and poor credit quality loans that were (and still are) created could have been purged from the system allowing for healthy growth to once again continue as a result.  Instead, and once again starting in the US and later adopted by the nations in Europe, governments decided it was a good idea to buy up those bad debts from the banks and other institutions, which they accomplished by increasing the national indebtedness of the public government balance sheet.  In other words, the liabilities were shifted from private hands into public hands.  Central banks also joined the fray and considering they own the printing presses, have in essence created money out of thin air to take these dubious assets onto their own balance sheets as well.  In the case of the US Federal Reserve, their own holdings of various kinds of debt securities went from roughly US$800 Billion to well over US$4 Trillion in a short period of time.  Speculation is that they have been acting as the buyer of last resort in more recent years, monetizing recent additional US Government Bond issues due to a lack of buyers in the market.  In short, formal stated national government debt levels have been on the rise exponentially around the globe in these so-called developed market countries (and unfunded liabilities, which are not expressed in such formal debt levels, is another proverbial 800 pound gorilla in the room as well) and now exceed 100 percent of annual GDP in a number of countries such as the US (in Japan it is well over 200 percent).

In terms of the emerging markets, it is true that many of these countries have been also increasing their own government debt levels, possibly in part to take advantage of near zero interest rates for US Dollar and Euros and possibly in part to make up for revenue shortfalls (due to falling commodity prices or whatever else) .  However, while debt has gone up in the developed world as a banking and financial market subsidy, if you look at the statistics for the emerging markets you will find other uses for such debt increases (funding for infrastructure improvements, etc.). According to a 2015 study by Mr. Neil Shearing, chief emerging markets economist at Capital Economics, the find was that: most emerging economies haven’t added enough debt, relative to the size of their economies, to justify the most bearish warnings.  Many developing economies are much better prepared for external shocks as well. In many key emerging markets, most of the new debt is denominated in local, not foreign currency; that makes them less vulnerable to weakening currencies and capital outflows (Emerging Markets Aren't in Crisis by Michael Shuman, January 19, 2016, Bloomberg).     
5. Socio-Economic Mobility (Both Up and Down)

Mr. Gerard Celente of the Trends Forecast Service has repeatedly said:  When people loose everything, they tend to lose it.  What he meant by that was when the middle class find themselves knocked down to another socio-economic level, they do not usually take it very well emotionally or psychologically.  After all, it is much more enjoyable to go from a have not to a somewhat have something than to go from a have plenty to living under a bridge in a card board box (under the worst circumstances).

The downside to many of the emerging markets is they have a very large percentage of poor people.  The benefit of many of  the emerging markets is they have a very large percentage of poor people.  Allow me to explain.  In terms of changing their socio-economic situation, poorer people have no where to go but up (which is always preferable).  The worst case scenario for these people is that they were poor yesterday, are poor today and will be poor tomorrow (although we would hope not).  In short, their own personal economic situation has not changed.  However, contrast that with a former middle class individual that lost his (or her) house, their car, maybe their job and who knows whatever else.  Such a person is going to be angry to say the least and that is what some people are worried about in terms of social or civil unrest.

Are The Emerging Markets Still A "Thing"?

In terms of sorting out all the noise, news articles and information out there I cannot help but be reminded of an old Memorex audio tape advertisement (I am showing my age now) that asked the question:  It is live, or is it Memorex?  In terms of economic reporting, editorials, news articles, blogs and all the other plethora of media that exists it truly can be difficult for investors to decide what is in fact the reality.  It would seem half of such journalists and commentators what to tell you that the world is going to heck in a hand basket, and the rest think the future is so bright you need to wear shades.  So, what is the truth?

It is very difficult today to ascertain what is really going on with such market distortions and speeches by central bank plus political talking heads that take the term bending the truth to new heights.  In the US for example, they conveniently decide to stop counting people that have been unemployed after a certain amount of time and viola, the officially reported unemployment rate goes down.  In terms of inflation calculations, they have decided not to include food, gasoline, energy costs, education, clothing and whatever else.  Of course if it were true that no one ate, walked around naked, used a car or sent their kids to university then maybe those reported numbers would reflect reality.  But there are a number of well kept privately reported statistics out there and they are truthful because real money is riding on the analysis.  Business decisions have to made and such decisions cannot be accomplished using Alice in Wonderland accounting or Mad Hatter statistics.  And we know there is a difference in what is being reported versus what businesses are doing because the reality is in conflict with the propaganda.  Government statistics and politicians want to tell you everything in the US is fine and then the next minute we read that a US discount retailer such as Walmart is closing a 269 stores globally and 154 in the US alone, claiming these stores are no longer profitable.  However, both Walmart and Amazon are expanding in India, with Walmart claiming to open 70 new stores in India (which represents an almost 400 percent increase over it's current presence in India).  So, once again we repeat our previous rhetorical question: Are The Emerging Markets Still a “Thing”?  The answer of course is YES, and private business actions are louder (and more truthful) than government rhetoric.