Emerging markets have recovered this year, however, investors should be careful to avoid a boom turning into a failure in the second half.
The benchmark MSCI emerging market index has grown by 6% since January 1 to reach maximum levels, not seen over 1 year. In some countries stocks have done really well: India has posted a 22% gain, whilst Turkey and Indonesia are up 14%. There are, however, several risks investors should take into account in the rest of 2014. As the Federal Reserve began reducing the flow of easy money, emerging markets got scared that money would move back to U.S. assets. During years cheap central bank cash has kept government bond yields low, as well as encouraged investors to look for riskier returns in stocks and emerging markets. But the Fed's bond-buying program is expected to end later this year, and investors will be watching for clues on the timing of a rise in U.S. interest rates. After a jobs report provided evidence that the economy is finally recovering, treasuries were sold on Thursday, sending yields higher.
Emerging markets have not got rid of all economic problems so far. Slowing growth, high inflation and dependence on foreign capital could return to haunt some emerging markets in the coming months. Last year Morgan Stanley called Brazil, India, Indonesia, Turkey, and South Africa the 'Fragile Five', as they have these risks in common. Little appears to have changed since. However, there is much hope for India's Prime Minister Narendra Modi who was voted into office on a promise of reform. Investors will be watching for evidence of action when his first budget is published on July 10. A growing dependence on credit in countries such as China, Brazil and Thailand sets another risk. As does China's cooling property market, which could hurt commodity exporters in Latin America and parts of Africa.
Politics always come along with economic risks. Some of the major developing economies, including Indonesia, Turkey and Brazil, have important elections ahead. Indonesian presidential elections are set for tomorrow, July 9, with the markets' favorite being Mr Joko Widodo or Jokowi. Defeat for Jokowi could prompt big investors to sell. In Turkey, Prime Minister Erdogan is expected to win the presidential election on August 10. Erdogan's activities like confrontations with anti-government protesters and attempts to influence central bank decisions have scared markets before. Brazil's presidential elections in October are also putting investors in narrow circumstances. Dilma Rousseff is expected to win a second term, but analysts have warned that her fate might depend on if Brazil wins the World Cup. If Brazil loses, it could renew anger over the huge cost of hosting the tournament. Oil prices jumped in June as extremist Islamic militants advanced across northern Iraq, but have since fallen back, partly because of reports that Libya could resume exports. Any significant disruption to oil exports from Iraq, OPEC's second biggest producer, would send world prices back up and could slow down global economic development.
