Emerging Market Developments

While developed-world politics hog all the headlines, there is a lot happening in Emerging Markets-much of it seemingly chaotic. Yet as with their developed-world counterparts, there is more than meets the eye. In some, where headlines might see chaos, markets likely see room for uncertainty to fall. In others, they show the danger of investing on too-high hopes for reform. Even if you don't invest in Emerging Markets, it's worth keeping an eye on these trends and understanding how and why markets are reacting-lessons with global applicability.

Turkey Gets Less Murky

Turkish President Recep Tayyip Erdoğan-who has steadily consolidated power since becoming Prime Minister in 2003-took another step toward autocracy on Easter Sunday, when a constitutional referendum gave him sweeping new powers. Opposition groups are challenging the results, citing a host of irregularities, but given Erdoğan has largely purged political opponents from Turkey's institutions and stacked them with loyalists, the results seem likely to stand. Meanwhile, after a failed coup last summer, Turkey remains in a state of emergency, which was extended after the referendum to July 19, and the authorities have arrested dozens of protesters in Istanbul.

Generally, you might assume the erosion of democracy is something markets dislike-and certainly, from a human perspective, it isn't good. All else equal, societies do best when free, and Turkey has backslid significantly in that department. Yet stocks, callous as they are, have looked past this. Instead, Turkish stocks appear fine with the result, buoyed by the end of uncertainty over the referendum and eager to have the past few years of political instability behind them. For better or worse, the referendum extends a government status quo (i.e., Erdoğan in charge and able to do as he pleases) that has been more or less fine for Turkey's economy. Many are now optimistic over the prospect of a more active government pursuing some reforms they've been forced to shelve in recent years, while politics were less stable. Let this be a timely reminder: Stocks care more about policies and falling uncertainty than personalities.

Brazil Needs a Good Scrubbing

Operation Car Wash-the biggest political investigation in Brazilian history-toppled President Dilma Rousseff last August. Now, the probe centering on bid-rigging at Petrobras (the national oil company) is encroaching on President Michel Temer and eight members (a third) of his cabinet. Temer is unlikely to be removed, despite bribery allegations. As head of state, he can't be prosecuted for acts committed before he took office, and the incident in question supposedly occurred in 2010. However, with his approval ratings plumbing 10%, it will be harder to advance tough legislation that would help put Brazil's finances on surer footing and bolster investor confidence after two years of recession-the worst on record. While default isn't imminent-Brazilian bond yields are their lowest in four years-reforms could improve economic recovery prospects.

Pension reform-raising the minimum retirement age to 62 for women and 65 for men from the mid-50s-is next on the docket, and widely seen as a litmus test for Temer's ability to push through tough changes. It has also been heavily watered down from initial proposals, which doesn't bode well for planned education, labor and tax laws. The economic outlook isn't much better, as Brazil's commodity-heavy economy depends on a sustained rise in natural resources prices.

High hopes for reform drove Brazil to be one of the world's best-performing markets last year, but now the party is fading. The MSCI Brazil is still up 11.3% year to date, but it is trailing the MSCI Emerging Markets index's 14.4% rise.^[i] Unless political and economic reality beat expectations, Brazilian stocks should continue disappointing.

South Korean Uncertainty Winds Down

May 9, South Korean voters go to the polls to elect a new president to replace Park Geun-hye, who recently became the first Korean president to be removed from office. The Democratic Party's Moon Jae-in is neck and neck with upstart Ahn Cheol-soo-a doctor and software entrepreneur who founded the centrist People's Party after his failed independent presidential bid in 2012. While differing on foreign policy towards North Korea-Moon favors rapprochement, while Ahn is more hawkish-both back ending the government's preferential treatment of the family-controlled business conglomerates known as chaebol.

Chaebol reform has long featured in Korean campaign speeches, but many believe the chances are greater this time given the February arrest of Samsung heir and Vice Chair Lee Jae-yong-currently on trial-and recent indictment of Lotte Group Chairman Shin Dong-bin. Chaebol leaders are no longer untouchable. Although reform will be difficult-chaebol still wield considerable power-markets seem happy about the potential for less corrupt, better-run firms that are more accountable to shareholders.

More broadly, though, Korea is rallying on falling political uncertainty. Korean stocks first fell as the Park scandal broke, but as impeachment became increasingly likely, they moved on. Neither her impeachment nor eventual removal derailed Korean markets. Nor was the shakeup that huge-it simply pushed December's election up by seven months.

South Africa Shuffling a Stacked Deck

Political turmoil is engulfing South Africa after President Jacob Zuma fired widely respected finance minister Pravin Gordhan last month over budgetary differences and sidelined 19 other members of his cabinet. Zuma also remains under fire over alleged influence peddling with the Gupta family, who control a sprawling South African business empire. Opposition parties and influential members of Zuma's African National Congress (ANC) are calling for Zuma to resign, with some lobbying for an ANC National Election Committee (NEC) to formally address the situation.

The probability of Zuma's removal has risen, but it also seemed that way last year when the NEC ultimately declined to sack him following the release of a report detailing alleged ties between the president and the Guptas. However, his political capital has eroded further since then. If he is ultimately removed-similar to Park in South Korea and Rousseff in Brazil-the resolution to the uncertainty and prospects for greater reform could lift South African stocks, but the prospect remains speculative at this point. Moreover, like Brazil, South Africa is a commodity-heavy (mining) nation. So its fortunes likely rest as much on the direction of metals prices as they do Zuma's presidency.