COMBING THROUGH THE COMING YEAR´S EMERGING RISKS / THE WALL STREET JOURNAL

Heard on the Street

Combing Through the Coming Year’s Emerging Risks

Shifting Monetary Policy, Other Factors Will Help Shape 2015

By Richard Barley

Dec. 25, 2014 11:42 a.m. ET
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Emerging-market investors have faced testing times in 2014. Bonds, currencies and stocks have been volatile. The Russian ruble crisis is just the latest shock, and may yet dominate the start of 2015. But deeper challenges still loom.

First, growth isn’t what it used to be: Between 2005 and 2009, emerging-market growth outstripped that in the developed world by 5.5 percentage points on average, according to International Monetary Fund data. Over the next five years, that gap is forecast to be just 2.8 points.

True, expected emerging-market growth of 5% next year is still healthy, compared with 2.3% for advanced economies. But the slower pace will still have implications for those countries that have failed to recognize shifting growth patterns and adjust their economic models accordingly.

Second, monetary policy in the developed world is shifting. The U.S. Federal Reserve, while remaining “patient” on raising rates, is on the road to tightening. The European Central Bank and Bank of Japan are heading in the other direction. But the vast majority of emerging-market liabilities are denominated in dollars, UBS points out: U.S. interest rates will have a bigger effect than those in Europe or Japan.

Third, the fallout from the plunge in oil and commodity prices will continue to reverberate, with Brent crude down more than 40% this year. Not only will it divide countries into winners and losers—broadly, commodity consumers versus producers—it may also change capital flows. Data on this is hard to come by. But to the extent that flows of petrodollars from oil exporters have found their way into emerging stock and bond markets, there could be less support in 2015.

Fourth, some high-profile defaults may test sentiment. Ukraine’s bond debt may yet be restructured, and Venezuela looks headed for trouble. That should only be a minor headwind, however. The problems facing these countries aren’t new, and defaults shouldn’t be a surprise.

More troublesome problems may lurk in the corporate debt market, particularly in Russia if sanctions continue to cut companies off from international capital markets. Corporate debt has been one of the big growth areas for emerging markets as investors have hunted for yield.

Russia looks almost certain to face a tough 2015; political risk in Brazil and Turkey could also cause concerns. But if emerging markets sell off as a whole, investors should be looking for opportunities. Countries such as India and Mexico that are reforming their economies may get caught in the downdraft of volatility, although would offer a chance to add exposure.

That reflects the fact that “emerging markets” is increasingly an inadequate label for a diverse set of economies. They are still vulnerable to some common factors, as the market appears hard-wired to treat them as homogeneous. But with each passing year, smart investors will be rewarded for treating them more as individual nations than as an asset class.