The resurgence of trade tensions caused a shift in the backdrop for emerging markets in May, weighing on investors’ appetite for risk. Even so, local bonds ended the month up 0.30%, as measured by the JP Morgan GBI-EM Global diversified index, and the rally in local bonds offset modest FX weakness. Hard currency bonds posted a gain of 0.41%, as measured by the JPMorgan EMBI index.
Surprising markets, trade negotiations between the US and China took a negative turn, culminating in the US imposing tariffs on imports from China. This weighed on China’s renminbi and other currencies. However, as we wrote recently, we believe fears surrounding the Chinese currency are excessive.
A more uncertain global growth backdrop also weighed on sentiment.
Side-stepping the general apathy, Turkish assets rallied on hopes that Erdogan will delay a deal with Russia to buy S-400 missiles – which is strongly opposed by the US – and concede the second Istanbul election where his party is trailing in the polls. Other positive moves included the Egyptian pound continuing its rally as the country saw record foreign inflows. And Nigerian local bonds performed well after central bank governor Emefiele was nominated for a second term, suggesting a continuation of relatively tight monetary policy.
In Latin America, weak economic growth data in Colombia and concerns over the country’s balance of payments weighed on local bonds and the peso. Growth data also disappointed in Brazil. However, Brazilian assets ended the month up – Fitch affirmed the country’s BB- credit rating and stable outlook, adding that an upgrade is possible if political reforms progress. And in Argentina, markets reversed their April losses when populist opposition leader Cristina Kirchner said she will not stand as presidential candidate, instead putting forward a more market-friendly candidate, with Kirchner running for vice- president. Elsewhere, the African National Congress’s Cyril Ramaphosa held onto power in the South African national elections, as we commented on here. The rand rallied after the results, however weakened again after the president announced the cabinet which, although now a more manageable size, retained some familiar faces.
In Asia, the fiercely contested Indonesian election saw a comfortable win by incumbent president Widodo, resulting in a rally in the rupiah and bonds, with a sovereign ratings upgrade from S&P coming at the end of the month. And in India, incumbent prime minister Narendra Modi secured a sweeping victory in the general election, lifting the Indian rupee and bonds somewhat, as we discussed here.
Our general outlook for emerging market fundamentals remains relatively positive. In the medium-term we believe emerging economies have the potential to pick up and outperform developed market economies. Emerging markets on aggregate are early in the cycle with plenty of slack in many economies. This provides room for growth to accelerate without stoking inflation or causing a deterioration in trade balances.
While we retain a positive longer-term outlook for the asset class, the nearer-term outlook for emerging markets has softened since the start of the year and we have tactically shifted to a more neutral overall risk exposure.
Trade developments are inherently hard to predict, as evidenced by Trump’s recent actions in Mexico, so the themes we are positioning for are a slowing global economy on the back of the trade uncertainty; falling investment; the end of US fiscal stimulus; and the ongoing rebalancing of the Chinese economy.
We remain confident that monetary policymakers – notably the US Federal Reserve (Fed) – will continue to provide the necessary support to help ensure a soft economic landing and we are favouring exposure to markets which we expect to benefit from this environment. This includes being overweight local currency bonds – especially in relatively high credit quality countries, as we expect these assets to benefit from falling interest rates. However, we are hedging the associated currency risk given the uncertain outlook for global trade and slowing global growth.
This positioning has the effect of reducing our overall risk level, allowing us to take other high-conviction positions in some high-yield hard currency debt markets which are driven more by their own fundamentals than what’s going on in the global arena.
*Keep an eye on our Emerging Perspectives page for forthcoming insights.
Past performance is not a reliable indicator of future results and all investments carry the risk of capital loss.
This content is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contains statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual outcomes may differ materially from those stated herein.
All rights reserved. Issued by Investec Asset Management, June 2019.
With swine flu sweeping through China and its neighbours, our Corporate Credit colleagues recently considered the implications for the corporate credit market. Here we share their key insights.
As Asia’s wealth has grown, so too has the portion size of protein on the average plate. Fish tops the menu, accounting for just over two-fifths of protein consumed in Asia. Pork (35%) is a close second, largely due to demand from China, which consumes five-times more pig meat than any other country.1
The swine flu spreading across Asia is squeezing pork supply hard. Some 200 million of China’s 360 million pigs could die from the disease or be culled, and pork prices may rise by 70%.2 The market for pig products could take a decade to recover.
Global impacts include lower soybean demand as there’ll be fewer pigs to feed. While bad for soybean producers, lower feed prices would boost chicken producers’ profit margins. However, rain-delays to planting in the US cornbelt have driven up corn prices, offsetting the helpful impact of cheaper soybeans on feed costs. Longer-term, Chinese appetites may also change, with fish and chicken likely to be the main substitution for pork on Chinese dinner plates, thus taking a larger share of Asia’s protein market. Beef exporters also look set to increase market share.
Producers in Latin America and elsewhere are eyeing higher exports to the huge Chinese market.
High tariffs make it unprofitable for the US to export beef, so producers in Latin America and elsewhere are eyeing higher exports to the huge Chinese market, especially in light of the US-China trade dispute. China mainly imports beef from Brazil, Australia, Uruguay, New Zealand and Argentina, which together captured 90% of the Chinese beef market in 2017.3
Brazil, China’s top beef supplier, looked well-placed to build on its dominant position. But China-bound shipments of Brazilian beef were suspended in early June after a case of mad cow disease was reported in Mato Grosso state. Brazil’s authorities say the occurrence was “atypical” and while Brazil implemented the ban to be prudent, it may lift the export suspension soon. This could further increase scrutiny on Brazilian protein exporters which has ramped up in recent years following some isolated governance-related issues. This suggests an opportunity for Brazil’s Latin neighbours Argentina and Uruguay. Argentina, which exports almost all the beef it produces, already sends more than half of its total beef exports to China.4
While investors may be tempted to pile into bonds issued by protein producers, selectivity will be key. Recent events have provided a boost for some of the corporate bonds we have invested in, but they do not outweigh solid fundamentals and decent valuations in our decision-making process. We are paying particular attention to:
Valuations: some firms poised to gain from a bovine boost are trading at lofty valuations.
Governance: Latin America’s meat producing industry has seen various governance-related issues. Good governance is key to sustainable returns, in our view.
Corporate events: After consolidation in the Brazilian pulp and paper industry, the proteins industry appears to be following suit, seeking product diversification and cost-saving synergies. This will lead to winners and losers.
Swine flu is shaking up the protein market, but other factors will also play a role in determining the investment prospects of individual corporate credit issues. Investors should remain selective.
1United States Department of Agriculture, ‘Livestock and Poultry: World Markets and Trade’, 9 April 2019.
2Reuters, 12 April 2019.
3AP News: PRESS RELEASE: Paid content from BusinessWire
4China Daily: Where's the beef? A lot going to China.
Leah Parento, Portfolio Manager & Tom Peberdy, Product Specialist
Surprising us and many others in the market, trade negotiations between the US and China took a negative turn at the start of the May, culminating in the US imposing tariffs on imports from China. This weighed heavily on China’s renminbi. We retain our renminbi exposure as a relative value position versus underweight exposures to other more free-floating trade-exposed currencies in the region, which we ultimately feel will come under more pressure from souring sentiment, as we explained recently.
While inflation remains subdued across the region, there were a few modest upside surprises, for instance in Korea and Indonesia.
Growth remains mixed across the region, with Purchasing Managers Index (PMI) data weakening in the more trade-reliant countries (like China, Taiwan, Korea) but strengthening in the more domestic-orientated economies (e.g. India, Indonesia, Philippines). Growth indicators in China disappointed, reversing some of the recent upside surprises. We saw similar trends in Taiwan, with exports – especially in electronics machinery and transport equipment – disappointing. We remain underweight in the Taiwan dollar.
Export data was also weak in the Philippines and growth was lower than expected. The central bank remains dovish and we are moving into a period of weaker seasonal current account performance. We retain our underweight in the peso.
In Malaysia GDP growth was slightly higher than expected. However, we remain underweight in the country’s bonds and currency given the risk of these assets being removed from major bond indices on FX hedging/liquidity grounds.
The fiercely contested Indonesian election saw a comfortable win by incumbent president Widodo, resulting in a rally in the rupiah and bonds. We retain our underweight position as we see little improvement in the current account and expect more tolerance from the central bank for currency weakness post-election.
In India, incumbent prime minister Narendra Modi secured a sweeping victory in the general election, lifting the Indian rupee and bonds somewhat, as we discussed here. We think it will be challenging to re-ignite the reform agenda and remain neutrally positioned in Indian rupee and local bonds.
Growth data from Latin America was generally weaker in May.
In Colombia, weak economic growth data combined with concerns over the country’s balance of payments weighed on local bonds and the peso although this has subsequently reversed. We are now largely neutrally positioned on the peso but remain overweight the bonds. Inflation has been stable and close to the central bank’s target and growth data has been modest with the first quarter GDP lower than consensus, while oil production has improved.
Growth data also disappointed in Brazil, however, Brazilian assets ended the month up – Fitch affirmed the country’s BB- credit rating and stable outlook, adding that an upgrade is possible if political reforms progress. Recent reform momentum has been positive with only a modestly watered down social security reform likely to move to the first vote in Congress in July.
Election-related uncertainty continues in Argentina. Fears over the prospect of populist opposition leader Cristina Kirchner winning in forthcoming presidential elections had spooked the market in April. Markets subsequently reversed direction in May when Kirchner said she wouldn’t stand as president opting instead for a vice- presidential role, with the more market-friendly Fernandez leading the ticket. Ultimately this, together with Macri’s appointment of a moderate Peronist as a running mate, has made the election too close to call but reduced some of the tail risks. We remain overweight in Argentinian hard currency bonds, neutral the peso and underweight local bonds.
In Peru, interest rates were kept on hold against a backdrop of low inflation and below-trend growth in the first quarter. Continuing strong trade data and retained earnings have flipped the current account to a surplus and we are overweight the sol and local bonds.
In Chile, we saw disappointing trade balance data, with exports appearing weak. However, skilled workers migrating from Venezuela is keeping inflation low and a more dovish central bank is positive in the long term, albeit providing a mixed outlook for the currency. We remain overweight in the Chilean peso and have trimmed local bonds into strength maintaining our positive structural view.
Weak data emerged in Mexico, with growth stalling in the first quarter. At the end of May, US President Trump announced step-up tariffs on Mexico, starting on 10 June, citing the country’s lack of efforts in dealing with illegal immigration. These have subsequently been walked back as Mexico and the US reached agreement on measures to address US concerns. We retained our underweight position in the Mexican peso and remain neutral local bonds.
In Africa, we continue to maintain our views from the previous month.
Although the cedi declined in May after a pick-up in domestic dollar demand, we retain our position in Ghana. The country posted strong GDP growth data for the final quarter of last year, reinforcing our positive view on the country.
We continue to maintain our conviction in Egypt as the positive economic momentum extended with the country seeing record inflows recently.
In Senegal, news articles about corruption issues related to development of Senegal’s oil and gas potential. However, we don’t see risk of this upending development of these projects and remain positive on the fiscal and growth trajectory of the country.
Similarly, in Zambia, we continue to hold our hard currency position as we feel that with prices in their current range, investors have the potential to be rewarded for taking risk in Zambia.
In Uganda, we are short FX due to seasonal demand in June-July as well as continued deterioration on the country’s current account which will start to put pressure on the Shilling.
Economic activity in central Europe remains exceptionally strong despite the prolonged slowdown in the Eurozone area. The release of GDP reports for the first quarter of the year revealed that robust capex growth, as EU funds deployment gathers pace, along with solid gains in consumer spending are allowing the region to sustain above-potential economic growth rates.
In Hungary, inflation pressures intensified further but the central bank has yet to react meaningfully. The global economic slowdown may justify an easy stance but monetary policy in Hungary is excessively loose, in our view, risking a de-anchoring of inflation expectations. On the fiscal side, the budget for next year is targeting a lower deficit as the government is planning to take advantage of the favourable economic environment.
In Poland, the pick-up in inflation does not seem to be concerning the Polish National Bank which is keeping policy rates firmly on hold. In fact, according to governor Glapinski, policy rates are likely to remain on hold until 2022.
In the Czech Republic, following another interest rate hike by the central bank, we increased our exposure to local government bonds. We expect Czech bonds to perform well in the current global environment of sluggish growth, benefiting from relatively high policy rates, well-anchored inflation expectations and a safe-haven status due to their high credit quality.
In Romania, the main ruling party suffered a shocking defeat in the European elections while its leader was sentenced to three and a half years of jail due to corruption allegations.
These events have caused a dramatic shift in the political landscape and risks of a further deterioration in the economic and judiciary fronts have sharply decreased. We expect the central bank to act more decisively in slowing down the economy as the growing twin deficits reflect rising economic imbalances as a result of excessive government spending.
In Serbia, strong economic performance coupled with solid fundamentals and relatively high yields are attracting an increasing number of investors, as evidenced by the extraordinarily strong demand in recent bond auctions. We remain overweight.
In terms of sovereign credit markets in the region, we maintain our overweight exposure in our high conviction markets including Hungary, Croatia, Serbia and Georgia while we are underweight Romania.
Turkish assets rallied on hopes that Erdogan will delay a deal with Russia to buy S-400 missiles (strongly opposed by the US) and concede the second Istanbul election where his party is trailing in the polls. The Turkish central bank has rapidly depleted its limited FX reserves in an effort to stem dollarisation by locals, while the country’s fiscal outlook is concerning. We have reduced our underweight in the lira but remain sceptical that Erdogan will change his stance so we remain cautiously positioned (we are also underweight local duration) – a view we discussed here.
We saw softer data coming from Russia and the consumer price index (CPI) was in line with expectations. In May, news emerged that Russia wants to share OPEC output hikes. We remain constructive on Russia across credit, rates and FX given the strong fundamental backdrop including falling inflation and limited external debt issuance. Given the Russian central bank’s FX intervention regime, Russian assets have become less correlated to oil prices and emerging markets risk in general.
South Africa saw a lot of pre-election optimism. The election turned out to be close, but the ANC didn’t have to go into any messy coalitions, which is a positive. However, the country posted the worst unemployment data in many years, among other weak data releases. Rating agency Moody’s has said that market can withstand shocks, but long-term growth is weakening. The president announced the cabinet which, although now a more manageable size, retained some familiar faces. However, there is good news on the inflation front with headline inflation coming in lower than expected. We retain our underweight position in the rand as we expect disappointing growth to weigh meaningfully on the fiscal outlook for the country.
In Ukraine, GDP remains soft and the currency is slightly weaker. Clearstream has opened to allow easier foreign purchases of local bonds, but foreign participation is already relatively high. We maintained an overweight in Ukraine’s dollar sovereign bonds where we think spreads offer a substantial buffer against perceived risks around the new leadership of President Zelensky.
In Israel, prime minister Netanyahu was unable to form a coalition. New elections are now needed in September. With the rates on hold, Bank of Israel commented on possibly intervening in market to stem shekel strength. We moved to an overweight position in selected strategies in the long-end of the local Israel curve, which remains very steep and we believe is attractive relative to core yields in the US and EU while inflation in Israel remains below the BOI’s target.
In the Middle East, geopolitical tensions weighed on fixed income assets given suspected Iranian attacks on Middle Eastern oil contingency routes. Despite the increased geopolitical risks, oil prices weakened given concerns around inventory build-up and global growth. And this weighed on spreads in oil-exporting high-yield countries such as Oman, Iraq and Bahrain. Investment-grade countries held up much better.
In the investment-grade space we retain our overweight exposure to Qatar where we see value given its low fiscal and external breakeven oil price, expenditure discipline and robust non-oil growth. We see less value in the rest of the region’s investment-grade names.
In high-yield, we remain overweight in longer-dated bonds in Jordan. Jordan has one of the steepest curves in the emerging market investment universe and we expect this to normalise over time given the country’s commitment to IMF-backed structural reform and correcting fiscal and external imbalances. Elsewhere, we remain underweight.
The risk-reward of Lebanese bonds is still not attractive, in our opinion. While a significant fiscal consolidation is planned, even strong budget implementation will not be enough to stabilise the country’s debt-to-GDP ratio on its own, in our view.
Bahrain spreads have increased somewhat, but we still consider valuations tight given implementation risks around fiscal consolidation, large off-budget spending and supply risks moving into the second half of the year.