Economically, EMs are in far better shape than previous periods of market stress – including the ‘taper tantrum’ in 2013 and Asian financial crisis in the late 1990s. It is helpful to look at just how far emerging economies have readjusted, with growth surprises picking up materially, current accounts correcting (Figure 1) and credible fiscal policy returning to some of our key markets. Unlike the ‘taper tantrum’, valuations don’t appear stretched by conventional measures, which should provide an additional buffer when markets begin to normalise.
Figure 1: EM current accounts have recovered materially from their lows
We believe the traditional view of EM corporates as over-leveraged and risky generally no longer applies. Compared to the US high yield market, for example, EM corporate net leverage looks very attractive indeed, while default risk looks well contained compared to developed markets (Figure 2+3)
Figure 2: Net leverage (Q2 2016) at attractive levels
Figure 3: Default risk looks well contained
EM bonds and currencies do not appear overvalued given the extent of the sell-off in recent years, and investor positioning is generally light. GBI-EM real interest rates are at 2.9%, a differential of 3.7% vs developed markets after post-election yield increases. This differential was less than 2% in late 2012. On the currency side, the gap between GBI-EM currencies and their terms of trade is the largest since the 2008 global financial crisis.
Figure 4: Historically wide yield differential is providing a solid valuation buffer in support of EM
The Trump election victory has followed close on the heels of Brexit, which was also arguably linked to protectionist and less market-friendly politics. However, in EM we have noticed a sharply different trend. While there have been some negative developments in Turkey and the Philippines, political developments in South Africa and Latin America have been strongly positive. In some cases, such as Brazil and Argentina, we now see some of the most competent, technocratic administrations globally.
We believe the scale of the EM debt sell-off since the US election was exacerbated by short-term market illiquidity and excess positioning. There will be inevitable winners, losers and risks of a Trump presidency, but this does not undermine the thesis for investing in the asset class as a whole. EM debt currently enjoys a strong valuation buffer relative to developed markets, and currency valuations have not fully recovered from a three-year bear market. The recent weakness only strengthens this argument, given the underappreciated resilience of emerging market economies and companies. We believe the short-term market dislocations have created interesting investment opportunities. More broadly, the case for emerging market fixed income, and active management within this asset class, is likely stronger now than at any time over the last five years.
Figure 1 source: Bloomberg, Haver, Investec Asset Management, January 2017. See important information for countries covered. Time periods shown covers the period for which we have reliable data. Figure 2 & 3 source: BoA Merrill Lynch, 31.12.16. Figure 4 source: Haver Analytics, IMF World Economic Outlook, JP Morgan, Bloomberg, IAM Calculations, January 2017. EM Weighted by GBIEM Global Diversified Weights excluding Romania. See important information for countries included. Real yields calculated as 5-year nominal rate less 1-2 year forward expected inflation. January 2017. Time periods shown covers the period for which we have reliable data. For further information on investment process, please see the Important Information section.