Emerging market stocks 'will recover in 2016' once China jitters overcome

While China's stock market jitters spark a widespread equity sell-off, especially around emerging markets, Capital Economics remained convinced they will bounce back once these fears ease.

Though he admits these fears may persist for a while, senior markets economist David Rees said the latest sell-off in equity markets in the emerging world was largely due to bad communication by Chinese officials, as many EM economies were showing some signs of improvement.

Thursday saw the second 7% fall in China's stock indices in the week, again setting off the new circuit-breaker mechanism, again sparked by the People’s Bank of China lowering its daily fix for the renminbi/dollar exchange rate by 0.5%, reinforcing fears of a competitive devaluation.

Admitting he had been out on a limb for some time in predicting that EM equities will perform well this year, Rees stuck to his view for several reasons.

First, that poor communication by the central bank was at fault rather than a deliberate devaluation.

"Last month’s announcement of a new trade-weighted basket for the renminbi appeared to signal a shift to managing the currency against a basket of others, rather than solely against the dollar. But this was never explicitly announced, while the PBOC is only publishing the basket on a weekly basis."

He suggested the large gap that has opened up between the onshore and offshore yuan implied the PBOC was still supporting the renminbi, an idea backed up by the record US$108bn decline to US$3.3tn in foreign exchange reserves last month that was also reported on Thursday.

Rees' second argument was that equity markets in China are not a good barometer of the health of the economy, with the 7% daily falls in equity prices by no means evidence that the economy is contracting more sharply.

"Indeed, while there was a small decline in the December Caixin/Markit manufacturing PMI, one point that was glossed over on Monday is that at 48.2 it is still consistent with manufacturing growth of around 8% y/y. And other indicators have been more positive."

As such, he still expects the Chinese economy to perform "reasonably well" this year and that other EM economies, outside of commodity producers such as Brazil and some in Africa, seem to have turned the corner and many, like India, ASEAN, Central Europe and even China, will benefit from lower commodity prices.