The growth spread of Emerging Markets (EM) versus that of Developed Markets (DM) is falling back to its modest historic range, as can be seen in graph 1. Some developed markets are even starting to outpace emerging market growth.
The dollar down cycle during the last decade encouraged heavy capital inflows into EM, resulting in a credit boom. The weak dollar also meant the rising of both oil and commodity prices, hugely benefiting EM exporters. This in turn led to increasing exchange rates which lowered EM inflation rates, further extending the cycle.
We currently see that equity pay-out ratios are stalling and falling in EM whilst increasing in DM, especially in the US. The growth spread of EM over DM is currently at a five year low. Using models from Deutsche Bank (graph 2), we see that investors are discounting for negative economic profit. Furthermore, we see that relative discount rates have widened. Also, the strengthening of the US Dollar and outflows from local bonds add further pressure on EM. This means that even despite the underperformance of EM over the last few years, there are still large downside risks in regard to emerging markets.
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Gelein has been interested in the financial world and global economics since high school. For over 3 years he has been a member of a university investment team, of which one year he was the treasurer.