When the United States sneezes, emerging markets catch the flu. That old adage has changed somewhat in the past 20 years. These days if either America or China sneezes, emerging markets (EM) will likely be bedridden for a few quarters.

While trade and financial flows (think investors buying stocks and bonds abroad) from the United States play a huge role in EM economies, China has surpassed America as a trading partner for many EM countries. Thus, a slowdown in China’s growth is contagious throughout the EM world and can quickly result in falling currency, bond and equity prices.

This appears to be the case now. EM equities have fallen more than 20% from their high as China’s growth has decelerated relative to its trend. The slowing Chinese economy fits a recent up-and-down pattern as its government tries to reign in excessive debt creation. The deceleration in Chinese growth is likely to end in the next few quarters assuming the world avoids a trade war.

But AMG doesn’t believe prices are cheap enough yet to warrant increasing EM investments for two reasons:

  • The growth in private-sector debt throughout the EM world is a risk. A substantial debt buildup in China is a glaring example of this. While China can fix its debt problems, and it is, the potential disruptions to economies and financial markets during the correction process could be significant. A number of other EM countries are not in a position to fix their debt problems.
  • Trade is integral to global growth. Disruptions in global trade can force costly and time consuming changes in the global supply chain and change the size and direction of financial flows.

It is possible China will stop sneezing and global-trade concerns will dissipate in the coming months, creating an improved environment for EM investments. But that time hasn’t come—yet.

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