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Emerging Markets Brace For Turbulence

Just as investors have gotten used to unexpected battles like the ones over trade and tariffs in the west, they now need to turn their attention to volatility and uncertainty in the developing world.

After two years of political surprises in the developed world, investors now must contend with the possible market fallout from two dozen elections that will soon be decided in emerging markets, according to new analysis from asset manager Invesco.

There are 24 elections in emerging markets that will be decided by the end of 2018, and each may bring significant policy changes, according to Invesco, which manages $964 billion.

In the wake of the global financial crisis of 2008 and 2009, the citizens of many emerging markets gave their governments a mandate to enact economic policies that would encourage calm and stability, according to Invesco. As markets in the developed world were rocked by a banking crisis and high household debt, emerging markets were a relatively stable counterpoint.

Now, ten years after the crisis, nationalist and anti-establishment movements are bringing the possibility of significant policy shifts, said Sean Newman, senior portfolio manager in emerging markets in Invesco’s fixed income division, in an interview.

“Coming into the year, we were fairly constructive on global growth as all three regions in the emerging markets were growing at the same pace, even as the U.S. was normalizing monetary policy,” he said. But the electoral cycle has the potential to introduce volatility, Newman added. 

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As an example, in the lead up to the election in Mexico, the outcome of which was uncertain, the peso sold off dramatically against a backdrop of concerns that a new president would potentially change course, explains Newman. 

“Elections have to be monitored closely, as they can change policy, for the good and the bad,” he said. 

“We expect this volatility in EMs to continue as the likelihood of election surprises and non-market friendly policies is elevated,” he wrote in a paper that is part of a larger research effort on the topic that Invesco will publish the week of July 30. 

Invesco said investors remain nervous in Mexico and Turkey, both of which have politicians with nationalist characteristics. 

“In addition, leftist ideologies in both Chile and Colombia were defeated, but not entirely displaced,” Newman wrote. He added that the firm is looking to see if some of the campaign promises and calls for change are put into policies.

With President Tayyip Erdogan consolidating his power and with the possibility that he could remain in office until 2028, every asset class in Turkey has been among the worst-performing of the emerging markets. Newman fears that Turkey’s central bank will have limited independence and that the country will risk unsustainable growth. 

Investors, for instance, expected a hike in interest rates of about 100 basis points (or one percentage point) at a July 24th meeting of the central bank to battle inflation. But rates were left unchanged.

Invesco thinks that with populists in power in Mexico and Turkey, there will be less official information released. Markets will rely more on unofficial signals, which will introduce volatility. 

“Second, and more importantly, the prospects for diverging policy paths across the EM landscape are enhanced,” wrote Newman in the paper.

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