Money being driven into higher-yielding emerging markets – but have they peaked in value?
Developing economies are being bolstered by a remarkable calm in global markets. The Vix index, Wall St’s so-called ‘fear gauge’ has fallen to its lowest level since December 1993
Jeffrey Gundlach, an influential bond investor, has proved prescient in his predictions of late.
Exactly a year ago, the head of DoubleLine Capital told attendees at the annual Sohn Investment Conference in New York, the premier event for the hedge fund industry, that they should prepare for a Donald Trump presidency.
Last month, Gundlach warned that the so-called “reflation trade” – a repositioning of investors’ portfolios based on expectations of faster growth and inflation – would continue to lose momentum as the US economy slows. Disappointing first-quarter gross domestic product data and a marked decline in inflation expectations suggest he may once again be proved right.
Gundlach’s latest recommendation, presented on Monday at this year’s Sohn conference, is to buy a popular emerging-market exchange-traded fund – index-tracking funds that can be traded on exchanges just like a stock – called the iShares Emerging Markets ETF, which has already returned 15 per cent this year.
Yet what is striking is that he is taking a bullish bet on emerging markets – Gundlach also advises investors to buy the debt of developing economies – while also anticipating a further fall in oil prices, usually a reason to steer clear from the asset class.
Gundlach’s evident enthusiasm for emerging markets in the face of significant risks confronting developing nations – the uncertain fallout from China’s efforts to tame its credit boom, the strain that the clampdown is already exerting on commodity markets and, just as importantly, the threats posed by both US trade and monetary policy – is indicative of both the resilience of the asset class and the appeal of higher-yielding assets in what is likely to remain a low-interest-rate environment for a considerable period of time.
Over the past year, which has seen Britain vote to leave the European Union and Trump elected US president, emerging-market equities have risen a whopping 24 per cent rise in US dollar terms.
Meanwhile, net inflows into emerging-market bond and equity funds since the start of this year have surged to nearly US$60 billion, exceeding the US$44 billion for the whole of 2016, according to JPMorgan.
Moreover, the average yield on JPMorgan’s benchmark index of local-currency emerging-market bonds currently stands at nearly 6.5 per cent, compared with a 10-year US Treasury yield of 2.4 per cent and equivalent borrowing costs in Japan and Germany that are barely in positive territory.
Make no mistake, money is being driven to higher-yielding emerging markets.
Sentiment towards developing economies is being bolstered by the remarkable calm in global markets. On Monday, the Vix index, Wall Street’s so-called “fear gauge” that measures the anticipated short-term volatility of the S&P 500 Index, fell to its lowest level since December 1993, pushed down by the favourable outcome of France’s presidential election.
Even the recent sell-off in commodity markets – Brent crude, the international oil benchmark, has dropped 12.5 per cent over the past month to below US$50 a barrel – is having a muted impact on emerging-market asset prices. JPMorgan notes that emerging-market debt markets “have recently become a lot less sensitive to moves in oil”.
This is partly due to the weakness of the dollar.
Last time oil prices were falling sharply, in the final quarter of last year, the dollar index, a gauge of the greenback’s performance against a basket of its peers, was surging, fuelled by expectations of stronger growth and inflation in the US.
Yet after reaching a 14-year high in early January, the index has since fallen 3.6 per cent, buoying emerging-market assets.
Yet it is not just the technicals that are working in developing economies’ favour. Economic fundamentals are also improving, with the International Monetary Fund expecting growth in emerging markets to pick up from an average rate of 4.1 per cent last year to 4.5 per cent and 4.8 per cent in 2017 and 2018 respectively. Even recession-plagued Russia and Brazil are expected to post growth.
With China trying to rein in its shadow banking sector, commodity markets are under strain and the Federal Reserve appears determined to continue tightening monetary policy, emerging-market investors would still be unwise to throw caution to the wind.
Valuations, moreover, are becoming a major concern.
Spreads on emerging-market corporate bonds are currently at their tightest level since the global financial crisis, particularly in the Asian high-yield, or non-investment-grade, segment of the market.
With markets already priced for perfection, the scope for further gains is limited.
Emerging-market asset prices may have already peaked.
Nicholas Spiro is a partner at Lauressa Advisory