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Emerging markets have grown up and 'deserve serious attention': Citi

Key Points
  • In Citi's latest report on global strategy, Citi's chief political analyst Tina Fordham focuses on the prospects for emerging markets.
  • "Emerging markets did well in 2017 and the backdrop continues to look favorable going into 2018," she said.
  • "Certainly, emerging markets deserve serious consideration," Fordham said.
Skyscrapers in the business district of Jakarta in Indonesia, a country seen as an "emerging market"
Didier Marti | Getty Images

Emerging markets (EM) are no longer the new kids on the investor block and are showing signs of "maturing", according to Citi's top global political analyst.

In Citi's latest report on global strategy, Tina Fordham focused on the prospects for emerging markets.

"Emerging markets did well in 2017 and the backdrop continues to look favorable going into 2018," she said.

While there were challenges for EM to overcome, and "it would be wrong to expect unhindered growth," there was nonetheless a "a growing resilience to shocks (that) suggests that EM is maturing as an asset class," Fordham said.

Emerging markets stand in contrast to advanced, established markets (usually called developed markets, or DM) such as the U.S. and Europe, although which countries are classed as emerging markets differs between financial institutions.

EM became popular with investors during the age of quantitative easing (QE) programs started in 2008 and 2009 by central banks in the U.S., U.K. and euro zone with investors searching for higher returns amid a low interest rate environment. A number of economies in Central and Eastern Europe, Middle East and Africa, Asia and Latin America tend to be classed as emerging markets.

Despite major economies now winding down their QE programs, which were a large factor behind the investor flight to EM, Fordham and her colleagues at Citi said that emerging markets were showing signs of resilience and maturity and were worthy of "serious attention."

"Emerging market outperformance has been an enduring theme for us recently and this looks set to continue into 2018. With more attractive expected returns than developed markets and a seemingly improved ability to endure shocks, there is an argument to be made that EM has 'grown up' as an asset class and merits more attention from asset allocators," their report said.

Citi called 2017 a "Goldilocks" year for EM, in which "growth accelerated but in no sense overheated; and capital inflows increased but not excessively."

Fordham said that the factors that drove inflows to EM in 2017 were still in place, including the fact that EM currencies are "not overvalued, real rates remain relatively high, current accounts remain strong and reserves are robust."

She also expected "a modestly weaker U.S. dollar in 2018 which should also help support emerging market in-flow."

The acid test

As with the economic outlook for developed markets, understandably there are challenges ahead for EM too.

Global risks mentioned by Citi ranged from the political to economic, with risks posed by less supportive financial and monetary conditions caused by major central banks winding down their expansive monetary policies, and a "maturing business cycle mean there is less of a cushion for political threats."

For EM, there were other so-called "external risks," such as a slowdown in China, for example, that could hurt export growth and investment, and "idiosyncratic risks" such as in-country elections that could create political uncertainties.

But Fordham noted that some of these were not constrained to EM and "could impact a number of developed markets as much as, if not more than, emerging markets."

BofAML: 2018 could be toughest test yet for emerging markets

"Certainly, the risk-return ratio for developed markets looks poor relative to many emerging markets when based on global cyclical factors," Fordham said.

There are idiosyncratic risks across a number of emerging market countries, Fordham said, with many related to elections in 2018. However, this in-country risk was not restricted to EM and looked "just as elevated in many advanced economies."

"The acid-test for EM as an asset class will be just how well the markets are able to absorb these shocks when they occur. On the evidence of 2017, this resilience is rising. The ability to absorb shocks, particularly when viewed as an aggregate diversified portfolio, has been impressive. Certainly, emerging markets deserve serious consideration," Fordham said.