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Emerging Markets Could Still Derail Recovery

Stocks in this article: DJI ^GSPC ^IXIC

NEW YORK (The Street) -- Turmoil in emerging markets could blow the economic recovery off course, fund managers warned, as nations from Turkey to Argentina face serious threats to sustainable growth. Yet others predicted the worst impact will be felt this year, with China the key to underpinning stability across emerging nations.

Emerging market woes have shaken global equities in 2014, contributing to a near 5% fall in the S&P 500. Several point to last May as the first hint of problems, when the suggestion that Federal Reserve stimulus could be wound back shook emerging markets. Strong Chinese growth and global stimulus packages had fueled growth in many of these nations since 2009, with around $4 trillion of private capital invested in emerging economies in search of higher returns after the U.S. credit crisis. This capital is now leaving emerging markets as stimulus is wound back, exposing large current account deficits and unsustainable growth.

Strategists said the diversity of problems faced by several emerging nations means there will be no quick fix.

Matthew Beesley, head of global equities for Henderson Global Investors, said there is no homogenous problem with the asset class, but a series of countries being exposed by the withdrawal of capital and its return to the U.S. "It will be an extended long-run issue that is going nowhere," the London-based portfolio manager told TheStreet.

Beesley noted the lack of homogeneity among emerging markets, with Indonesian equities gaining this year as many other markets have tanked.

He is wary of a potentially negative spiral, which could see emerging market fears inhibit the confidence of corporates to invest. "The country specific EM wobbles should remain exactly that -- we will have live with them (in the background hopefully) but the fear is they become the thing that inhibits global economic growth in 2014," he said.

Others were more optimistic.

Wells Fargo Funds Management Chief Investment Officer Brian Jacobsen said he expects the worst impacts to be felt this year. He said emerging nations large enough to influence global equities -- namely China -- are still likely to post solid economic growth of 7.25 to 7.5% in 2014 while drawn-out issues in more "minor" markets such as Turkey and Argentina are more political, and not significant enough to derail positive equity sentiment longer-term.

"China will continue on the long journey to re-orientate its economy and the [recent] weak PMI reading is not a harbinger for a drastic unwinding of economic growth," he said in a phone interview.

Douglas Cote, ING U.S. Investment Management's chief market strategist, agreed problems across emerging markets will not be solved quickly as they transition to a more market-based economy. "The free ride is over also for U.S., Europe and Japan as the Fed continues QE taper," he told TheStreet.

"We need more pro-growth economic policies such as less taxes, less onerous regulations and more free trade." Cote said he still expects equity markets to be higher by the year-end and advises investors to stay globally diversified.

Some liken the tremors from emerging markets to the crisis scenarios seen first in the U.S., then Europe. "We don't know who will bail out these emerging markets, if and when they need it," Newedge director of market strategy Robbert van Batenburg said in a phone interview. He noted fatigue from central banks such as the European Central Bank and Federal Reserve to providing further monetary assistance.

Batenburg said the outlook for China was significant for emerging markets, given many had leaned on the world's second-largest economy for growth. He pointed to cracks in China's large shadow banking system as a threat to its outlook. "Policymakers have steered China through the minefield but we don't know what it has cost," he said. "A worst-case scenario could mean they can't do it anymore and a recession takes China by surprise."

Many dismiss the possibility of a so-called hard landing for China but most agreed: Emerging market woes will not be easily solved with a question mark over their consequences for U.S. equities.

-- Written by Jane Searle in New York 

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