‘Loosen your seatbelts’ in emerging marketsJanuary, 29 2013
Return of the risk appetite
In perspectives 2013 -see HSBC Eight Key Calls for 2013-, like us at Investlogic -see our blog The Search For New Emerging Markets and Emerging Markets Forecats– HSBC recommended investors ” to loosen their seat belt “, because the return of this appetite was going to drive a return of the investors into emerging markets.
Flows into emerging markets are likely to remain solid this year, when the dynamics of the ‘risk-on/risk-off’ trade will be less sharp than in the past 18 months, thus encouraging risk-taking. The risks confronting the global economy have not disappeared; yet, things do not have to be perfect for EM economies and assets to perform well once again. A combination of a “calmer” atmosphere in developed markets and accelerated economic growth should attract inflows into emerging markets despite valuations being “more stretched” than at the beginning of last year, and should lead to credit rating upgrades for some countries.
HSBC even made the list of the countries which will be at the lead of the rally in emerging.
Indonesia, the Philippines, Turkey, Peru, Uruguay, Chile, Mexico, Kazakhstan, Belarus and Latvia are countries that could potentially be upgraded by credit rating agencies this year, while South Africa, Hungary, Ukraine and Argentina could see downgrades.
And it means at first for us a good news: the demand for raw materials restarts.
PREMIUM RECO : see Scouting Outside China for Growth
Two Asian countries match the criteria that we’ll be researching for a potential play.
- Mongolia: GDP rates were -1.3% in 2009, 6.4% in 2010, 17.5% in 2011
- Kazakhstan: GDP rates were 1.2% in 2009, 7.3% in 2010, 7.5% in 2011
- optionally (not in for obvious reasons) we could add : Turkmenistan: GDP growth was 6.1% in 2009, 9.2% in 2010, 14.7% in 2011
In the absence of triggers for the “risk-off” trade, flows to emerging markets will remain strong this year, supported by quantitative easing (QE) by the major central banks such as the Federal Reserve, the Bank of Japan and the Bank of England.
Asia will be the fastest-growing emerging region, points out the fact that China’s economy is now lifted by earlier stimulus, but without significant further policy support it is unlikely to accelerate.
Sub-Saharan Africa will be the second fastest-growing region, and France among other recognized it, on the back of strong growth in Nigeria and Ghana. But, as mentioned before, political uncertainties will weigh on growth in both South Africa and Kenya.”
We can expect Latin American currencies to outperform over the next 6 months, as they see the Brazilian real and the Mexican peso rebounding on the back of improvement in US macroeconomic conditions. However, the “currency war” theme will come back, becoming dominant in Latin America and partially offsetting the positive impact of ample liquidity and better growth prospects, they warned.
Argentina and Venezuela could be set for hard landings as falling commodity prices and slower credit growth will take the steam out of the region’s consumer credit boom. Brazil looks particularly exposed to that risk.
Turkey and Russia, two big emerging markets, are positive exceptions in the European region, Turkey because it diversified its exports away from Europe and its central bank’s unorthodox policies have helped ease pressure on the current account deficit to some extent, and Russia because of its energy resources but also because of its opening of the local bond market more to foreign investors from next year.
The oil producing economies in the Middle East should hold up well even if oil prices fall, as they have built surpluses, but for resource poor countries the picture will be very different. Private capital inflows have been decreasing for the Middle East and North African countries, strategists at Societe Generale noted, forecasting that Morocco, Tunisia and Egypt will remain deeply in deficit as these countries use spending on subsidies for goods and services and on wages as a tool to contain social pressures. Further credit downgrades and some currency weakness could follow for the region’s distressed economies since no noticeable improvement is foreseen on the fundamentals.
The region with the most risks is, according to most analysts, emerging Europe, where economies are closely linked to the eurozone, both via the trade channel but also due to the presence of Western European banks, which have been deleveraging.
Demand for emerging markets assets will exceed supply significantly due to the overall increase of money-seeking assets at a global level, the overall size of the emerging markets asset class being smaller relative to the global pool of financial assets and relatively stronger compared to other asset classes. Bonds in emerging markets benefited the most from quantitative easing in the developed world as each round of easing played more of a role of containing further deterioration, rather than promoting economic activity and investors went for the more secure asset class.
A muddling-through investment environment should encourage positioning in the most volatile portions of the asset class. Emerging markets growth should accelerate in 2013 and 2014, widening the gap with developed markets even further.
The different rounds of QE have had a decreasing effect on inflows into EM equities, while its force has been increasing in the case of EM bonds.
Global allocations to equities are at a low secular point so stocks find themselves in a very good technical position for a sustained rally. For bonds, the upside is more limited this year than in 2012 but the returns will remain positive. Emerging markets hard-currency bonds have matured and became a destination for not only those searching for yield but also for safety.