- Risks to emerging market (EM) assets have increased, but we see positives outweighing the risks and supporting a selective approach.
- The Organization of Petroleum Exporting Countries (OPEC) agreed to cut supply, driving oil prices and energy stocks higher.
- This week could bring clarity regarding whether the European Central Bank will start tapering asset purchases next year.
1. Reasons to like emerging markets
Risks to EM equities and bonds have increased since the U.S. election, with the incoming Trump administration’s policies on trade uncertain. Yet a cyclical growth pick-up benefitting EMs outweighs these risks for now, we believe, and supports selectively investing in EM assets.
Chart of the week
Emerging market debt, equities and industrial metals performance, 2016
EM equities and bonds took a hit immediately after the U.S. election, as investors feared the new administration would be negative for global trade and capital flows. As the chart shows, industrial metals and other commodities quickly rebounded on hopes for increased infrastructure spending and amid signs of a pick-up in global growth.
Scope to play catch up
EM assets have stabilized somewhat but lagged a recent rally in commodities. Our conviction is that U.S.-led reflation – rising wages, nominal growth and inflation reinforced by an expected shift to fiscal stimulus – should be a big positive for many EM assets. Greater infrastructure spending should boost demand for the commodities exported by EM producers.
Risks abound in the short term, including a sharper rise in U.S. Treasury yields and the U.S. dollar as well as a quicker fall in China’s yuan. But we believe a gradual Federal Reserve, wary of tighter financial conditions, should limit dollar gains from here. Over the past three years, EM assets have already weathered an economic downturn and dollar appreciation: Currencies are weaker and current account balances are generally in better shape. Commodity markets, a key source of earnings for many EM companies, have found a better demand/supply balance – including crude oil after OPEC’s decision last week to cut supply.
We like selected commodity-producers but are wary of manufacturing countries vulnerable to a tougher U.S. stance on trade. We prefer countries where structural reforms show a willingness to sacrifice short-term economic pain for long-term gain, such as India’s move to eliminate high-denomination banknotes. Finally, we prefer hard-currency EM bonds – particularly in high-yielding oil exporters such as Russia, Colombia and Kazakhstan – and short-duration local currency bonds in some countries.
- PEC members and Russia agreed to cut production, driving oil prices above $50 a barrel and energy stocks higher.
- Value stocks outperformed and bond yields hit new highs on the reflation theme. The U.S. dollar’s rise paused, helping EM equities.
- As-expected U.S. jobs growth cemented expectations for a Fed interest rate increase in December.
|Dec. 5||U.S. ISM Non-Manufacturing Index|
|Dec. 7||U.S. JOLTS; China foreign exchange reserves|
|Dec. 8||ECB monetary policy meeting announcement|
|Dec. 9||U.S. consumer sentiment; China consumer price index, producer price index|
The ECB will be the focus this week as the market looks for clarity on whether the central bank will begin tapering asset purchases in 2017. Chinese data will provide more details on whether capital outflows have accelerated and may show further evidence of reflationary trends.
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Sources: Bloomberg unless otherwise specified.
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