Emerging markets should resist systemic crisis

The eerie post-taper calm is over. Disappointing Chinese data appears to be the proverbial straw that broke the back of emerging market confidence. Arguably, disappointing economic news from Beijing disrupts emerging market capital flows as much as any monetary missive from Washington. Unsurprisingly so, since so many emerging economies fortunes are closely tied to China. Whatever the trigger, capital outflows have been dramatic in the last week, with currencies in Turkey, Argentina and Russia hitting record dollar lows.

Recent history has makes it hard to rule out widespread contagion. However, emerging economies aren’t a homogenous group on the precipice of a systemic crisis. Overall, economies have strengthened and diversified since the crises of the late 1990s. Many have added better – albeit imperfect – shock absorbers in the form of flexible exchange rates, higher reserves and lower external debt.

Without a geopolitical shock or major policy mistake to escalate concern to crisis and paralyse the markets, capital flows should remain stop-start – rather than just stop. This will confine the majority of the pain to countries that have done least to strengthen their balance sheets and those subject to serial economic mismanagement. India, South Africa, Turkey, Ukraine (in both categories) spring to mind.

That said, the stakes are higher than the late 1990s, given the increasing levels of capital market integration and increasing reliance on emerging markets to drive growth. Complacency isn’t an option. And, whilst the long-term story for emerging markets remains positive, companies will need to adjust their expectations and work harder to achieve profitable growth in these markets.

US shutdown and emerging market concerns spark profit warnings

This shift in emerging market expectations is increasingly becoming apparent in UK trading statements. According to EY analysis, UK profit warnings rose by 30% in Q4 2013, with significant downgrades to forecasts following the US shutdown and concerns over emerging markets.

Forecasts had almost been set to ‘perfection’ by mid-2013, which was always destined to end in tears given the capricious nature of the recovery. The international profile of FTSE 350 sales means these companies took the brunt of the US and emerging market downgrades, issuing 31 profit warnings in Q4 2013 – equal to the number issued in Q4 2008 at the height of the financial crisis. Companies also reported continuing domestic pressure on prices and margins. UK consumers and companies haven’t relinquished their austerity mentality just yet.

This pace of profit warnings has continued into 2014, with many companies continuing to report a double-whammy of falling demand and weaker currency translation from emerging markets and heavily linked economies, like Australia. A quarter of companies warning so far in 2014 have cited adverse currency trends, against a long-run average of around 3%.

Managing expectations is always tough in periods of volatility and emerging market earnings have become an increasingly significant proportion of companies’ portfolio – much more so than in the late 1990s crisis – increasing the importance of any shortfalls to investors and shareholders. Companies must ensure they have a high level of visibility across all of their divisions to ensure they identify and deal with problems quickly.

Open to offers…

Problems in emerging markets are muddying the recovery waters. However, the overall global outlook is improving and – with valuations improving – thoughts are turning to disposals. EY’s 2014 Global Corporate Divestment Survey shows a third of global companies planning a sale and 80% of global executives are open to offers. Indeed a 30% premium would bring a majority of executives to the table – even the family silver has its price. Selling can create a short-term dip in the top-line, but disposals can yield long-term dividends if companies redeploy capital into higher growth core activities or use to develop new products and explore new markets.