Imbalances developing in the emerging markets in the past decade could result in profit growth plunges, currency drops and unbearable debt repayments, says Principal Global Investors.
In its 2015 outlook Great Unwindings, Principal Global Investors said the emerging markets have enjoyed a decade of “strong growth, surging commodity prices, spectacular equity performance and terrific profits driven by industrialisation in China”.
The report said that during such long economic booms, however, imbalances always develop.
“Businesses expand, build plenty of capacity, and invest assuming that the fast growth will always be there; they borrow lots of credit assuming that the stupendous profit growth will continue and the debt will be easily repaid,” said the report.
“However, the fast-demand growth on which all that expansion, borrowing, and investment were based disappears.”
As the emerging markets did not experience the same type of financial crisis that the United States and much of Europe did from 2008 to 2012, the report said the imbalances that have developed in China and the emerging markets “have not been cleansed”.
The report also said the liquidity on which the emerging markets rely is diminishing.
“The US dollar is strengthening; the Fed is gradually taking away its provisions of liquidity; and the US trade deficit is shrinking,” said the report.
Not all emerging markets are equally exposed to these risks however, the report said, with commodity exporters and countries with closer trade ties to China more vulnerable than importers or countries more aligned with the US.
The report said US markets could also face more volatility in 2015 with the US Federal Reserve exiting its accommodation the report said.
It also said fixed-income investors may struggle to find acceptable returns in 2015 with low rates and a lack of upside for prices.
The report added that this is the result of five years of zero interest rates, which have raised the prices of most assets.
The asset management company was also concerned that if the Eurozone does not implement economic reform, this may drag on global growth.
“The interconnected nature of the global economy means that if one major economy gets sick, the rest may start to show symptoms,” said the report.