To put it mildly, it’s been an interesting time in global markets since the Brexit vote in the UK in late June.
Following the unexpected outcome, many global equity markets have reached new highs.
Meanwhile, foreign bond yields in places such as Europe and Japan have plummeted to depths not seen, in many cases, for centuries or indeed ever.
All this has been engineered by a central bank community pulling what may be its last monetary policy lever.
With central banks appearing to have done pretty much all that they can do, the responsibility for stimulus passes to global governments — raising expectations that they will now take their foot off the “fiscal brakes”.
Amid all the various forms of stimulus-related euphoria, some of the most interesting developments have been in emerging markets, both debt and equity.
July saw the biggest-ever inflow into emerging equity markets, while emerging debt markets have seen similar enthusiasm from investors.
Following the Brexit vote, some investors have been trying to escape from the epicentre in case of aftershocks.
Many investors have interpreted Brexit as a developed-market problem, which will drag primarily on growth in the developed world and ensure that monetary-policy support will be provided for even longer.
Although investors have, for the time being, deemed Brexit a UK-European difficulty rather than a global one, they appear keen to park their investments as far away from any potential trouble as possible. The emerging market world fits the bill.
Emerging markets generally have more locally-focussed economies, with most of their goods and services consumed domestically or by immediate geographic neighbours, although there are naturally the obvious exceptions in some of the more commodity-reliant economies.
The chart below highlights the level of exports to the UK and Europe from various emerging market countries and regions.
It demonstrates that emerging market economies have minimal reliance on the UK (shown in blue) for their exports.
This is particularly true of Asia and Latin America (LATAM) where less than two per cent of exports end up in the UK. Europe (shown in orange) accounts for a greater proportion of emerging market exports although this is very much driven by those emerging market countries either in Europe or in peripheral regions like the Middle East and parts of Africa.
Overall, emerging markets have low reliance on the UK and Europe as markets for their exports and therefore should be able to withstand quite strongly any further aftershocks from the Brexit vote.
Another point of difference is the fact that the developed world’s consumers and governments are a little short of cash whereas the majority of emerging market countries have higher official interest rates.
This gives them the potential for monetary policy responses should times get a little tougher — not an option available to many central bankers in the developed world.
A stronger US dollar is a factor that has worried emerging market investors because it can hit commodity prices and suck liquidity out of the developing world, which would not be helpful.
But while a stronger US dollar has been widely forecast and much talked about, of late it’s been the “dog that hasn’t really barked”.
It’s certainly a risk — particularly now that rising US interest rates seem to be back on the agenda — but perhaps not to the extent that has been expected.
China is a perennial worry for all things related to emerging markets — and, to be fair, there are some valid reasons for concern, not least the level of corporate debt accumulating there.
But there has also been a substantial policy response — one that could satisfy the worriers for some time.
And finally, there are good companies to buy across the emerging market spectrum and, in the debt markets, good companies, and countries to lend to. That is another reason why these markets are proving so popular with global investors.
For these reasons, we have generally been increasing our holdings in both emerging markets equities and bonds within our multi-asset portfolios in recent weeks.
Investments in emerging market equities were made despite our broader view of a weakening outlook for other global developed equity markets.
The aforementioned challenges facing the UK and European stock markets prompted us to sell equities from these regions.
Within bond markets, the range-bound US dollar, a comparative lack of volatility and the shift in financial liquidity conditions in favour of emerging markets have created conditions that are supportive for emerging market bonds.
We have therefore generally increased our allocation towards this part of the bond market at the expense of developed-market bonds, where yields are at record lows, and in many cases negative.
Overall, we are in a unique environment where the performance of assets has more to do with liquidity flows than a genuine investment case.
But amid all the post-Brexit turmoil, it’s just possible that emerging markets are finding favour on fundamental — and therefore durable — grounds.
For emerging market investors, things have been developing nicely in recent weeks and we are increasingly confident this is a trend that can continue over the longer term.
Josh Hall is an investment specialist at Aberdeen Asset Management.
