Fortune favoured the brave

At a well-attended investment bank research conference on emerging markets last week, a noteworthy chart on show displayed returns across various asset classes over the year to date. In this chart, six of the top ten asset classes were from EM.

Well out in front of the pack, at +27.9%, was EM equities. EM local markets in USD terms returned 14.0%, and our principal indices, EM sovereigns and EM corporates, both in hard currency, returned 9.3% and 7.4%, respectively. The latter was just outside the top ten.

These numbers trumped developed market indices: US HY has returned 6.9%, and US IG 5.3%. In Europe, the numbers were 5.5% and 1.2%.

It’s fair to say that at the start of the year, many people didn’t see such strong performance in emerging markets coming. The pending Trump presidency cast a shadow over EM, and caution was widespread.

Fortune, however, favoured the brave. Since that time, growth across emerging markets has surprised to the upside, led by China, while the Trump presidency has proven to be strong on tweeting, and less strong on delivery. The dollar has lagged.

We think that this is not just a phase, and that emerging markets are poised for continued performance. Some emerging economies were badly burnt by the commodity sell-off, but came back more resilient – growth is now picking up across EM; valuations are superior to those in developed markets, where post-crisis interference has smothered yields; finally, inflows to the asset class provide a renewed and supportive technical.

As ever, the picture is far from perfect: South Africa looks like it will get worse before it gets better; Venezuela is teetering on the edge. However, the overall picture is undoubtedly a constructive one, and against this backdrop, we see widespread opportunities across the emerging market debt space.

The market continues to fear that the strength is about to turn over. We think the greater risk to investor positioning is that it persists.

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Dubai harbours global port success, but will not be contained

To many in the UK, Dubai is best known as a tourism and entertainment hub, perhaps a good bet for some winter sun. Its role as a leading global trading centre is less well known. However, it is the latter aspect of Dubai which is, we think, both the most important and interesting part of its story.

Global ports operator “DP World” epitomises this element of Dubai. Having begun with one asset in Dubai in 1972, the company today operates 78 terminals across 40 countries. In 2016, it handled 64 million TEU (twenty-foot equivalent units), the ubiquitous, work-horse containers of global trade.

We like this company, not least for its core role in Dubai, and its strong global diversification. Its long end bonds have this year performed particularly strongly. However, for the general observer, it is DP World’s experience of and take on global trade that is most interesting.

Yesterday, the company reported its first half results, and the read-across is solid. Firstly, consolidated volumes of TEU were up by +4.7% YoY on a like for like basis. Secondly, performance in the company’s three major regions was healthy.  In the Middle East, Europe, and Africa, volumes increased +4.2% YoY, driven by the UAE and the UK. In Asia Pacific and the Indian Subcontinent, volumes increased a respectable +2.9% YoY. Finally, in Australia and the Americas, volumes gained +13.5% YoY, driven by the latter region.

This sound performance is, importantly, expected to be maintained in the second half of the year. This augurs well for both emerging and developed economies, and also serves to highlight, once again, Dubai’s under-appreciated role as a key link in global trade.

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Qatar and the GCC: not much cooperation here

Experience would tell you that, in the current dispute between Qatar and its neighbours, cooler heads on both sides would prevail soon enough, and the situation in the region revert to normal. However, reviewing the list of demands made overnight by Saudi Arabia and its allies of Qatar provides good reason to think again.

In short, the list of demands is steep, and so it is hard to imagine Qatar engaging in the necessary set of climb-downs that acquiescence would entail. Among the demands is found: Qatar shutting down Al-Jazeera; ending military co-operation with Turkey; paying repatriations; and, best of all, facing ten years of annual compliance monitoring!

Qatar is supposed to agree to all of this within ten days. As one set of mostly very wealthy nations faces off against another, very wealthy, nation, what seems more likely is a medium- or even long-term stalemate. This, both sides can probably manage: certainly, nobody in Qatar is going to go hungry as a result of any current blockade.

The implications are probably more troubling for EM investors’ sense of the region. GCC (Gulf Cooperation Council) assets have historically anchored many an EM portfolio: these are wealthy, stable, well-run economies, after all.

Perhaps not. With a millennial Crown Prince in charge in Saudi Arabia; with oil threatening to break out of its 1Y range to the downside; and, above all, with a far from steady hand on the tiller in the White House, it is not clear if the GCC should, any longer, be taken as the hallmark of stability it once was.

As I said above, we shouldn’t be surprised if a face-saving way out of the current impasse is found, and the GCC thus reverts to type. But at first glance, this morning’s rather surprising list of demands suggests that this time could be different. Investors should prepare accordingly.

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EM Corporates – Stay selective

It’s a difficult time to like EM corporate bonds.

In the first instance, valuations are expensive. In fact, emerging market corporate bonds now trade at a tighter spread than emerging market government bonds.


Source: JP Morgan. CEMBI is the EM corporate index, EMBIG the EM sovereign index.

In addition, the greater part of the build-up in leverage in emerging markets in recent years has been on private balance sheets, not on those belonging to governments.

At Kames, our focus is on those stronger sovereign balance sheets. However, we can and do buy the debt of emerging market companies when individual credits’ valuations and fundamentals are attractive. It’s a highly selective approach that takes advantage of price dislocations and disruptions – a necessary approach, too, in what has become an expensive corner of the market.

South Africa: stay cautious for now

On Friday morning President Zuma of South Africa dismissed his Finance Minister and Deputy Finance Minister. Such a move had seemed likely after the highly unusual decision to call back the two ministers from a roadshow in London earlier that week.

Finance Minister Gordhan enjoyed a strong measure of market confidence, in a country where institutional strength has been seen to be in short supply. As such, his sacking represents a real blow to South Africa’s credibility.

Over the course of last week the rand sold off approximately 8% against the dollar. The spread on South African dollar denominated sovereign bonds, as measured by JP Morgan’s EMBIG Diversified index, moved from +239bps to +269bps over the same period.

We would not step in here, however. The currency’s sell-off still leaves it inside the one-year average of 14 rand to the dollar, and well inside the one-year high of 15.9. As for bonds, we expect South Africa to now lose its investment grade ratings from at least two of three ratings agencies. South African paper should therefore trade closer to BB rated Turkey (+314bps).

Overall, the decision to sack Mr Gordhan reveals the high stakes around the battle for power in South Africa this year. As the African National Congress gears up to choose its next leader later this year, the issues surrounding President Zuma’s controversial time in power seem to be coming to a head, as he battles to secure his position and legacy.

With little clarity around how this probably destructive endgame might play out, and value set to leak further in South African assets, we prefer to be on the sidelines here.

China in the age of Trump

China has seen elevated credit growth since the global financial crisis, such that investors consistently raise this issue as a core concern for emerging markets. The more recent rise of President Trump has also added to the pressure on the world’s second largest economy. A recent visit to China for a number of meetings with economists, academics, and policymakers, has helped develop my thinking on these key topics.

The watchword for China this year is stability. The 19th party congress this autumn, where President Xi Jinping will seek a second term as General Secretary, while various other senior members of the party also jockey for position, means that the energies of the state are principally focused on avoiding any unforeseen disruptions. That includes to the economy.

Thankfully for the party, China’s economy is in something of a sweet spot right now. A commodity upswing, trade strength, and government-backed investment demand should see the 6.5% growth target for 2017 comfortably met. At the same time, the PBoC seems able to raise its policy rates, in order to push back at some of the smaller banks’ funding models, without raising its more important benchmark rates.

When it comes to President Trump’s views on China I believe that, for this year at least, his bark will be worse than his bite. A fully blown trade war between the US and China serves neither side’s overall interests. We might well see some tit-for-tat tariffs introduced, but the broader relationship should remain on course. We may even see some ‘gives’ from China at next week’s meeting of the two leaders in Florida.

Over the medium to long term, however, my view of China is somewhat bleaker. Firstly, it is doubtful that China can somehow dodge economic gravity, following its dizzying rise in debt to GDP: a banking crisis or major growth shock will probably come to pass. Secondly, real estate continues to play too great a role in the financial accounts of Chinese local governments and individuals, and indeed in national growth targets. Thirdly, Chinese SOEs continue to play a distorting role in the Chinese economy, and the current leadership does not seem minded to engage in serious reform on this, or related matters.

I am mindful that the contradictions of a ‘socialist market economy’ mean that China could well keep the show on the road for longer than we expect. Equally, genuine growth upturns in China and Asia should not be ignored by market participants when they occur. But with the above questions on leverage outstanding, allied to the challenge facing China in reforming its impossible trinity (of rates, currency, and capital), a crunch moment seems likely in the next few years.

Mixing your metaphors

Monday morning sees our Fixed Income team sit down and thrash what’s what for markets. We assess how our positioning has fared and should it change.

In the debate this morning one of the managers quipped “If you are going to invest in a country with a crazy dictator, you may as well get paid for it” – while discussing the relative value between the US and emerging markets.

This blog doesn’t aim to proffer views on US politics; however, there is no doubt that the Trump era is very different from the Obama regime. So I wondered how EM had faired since the start of 2017.

For the US Treasury market, yields have rallied by just over 10bps using the US 10 year note as a gauge. Overall returns would have earned you a further 2 months of its 2.25% coupon. All in all you’d be up around 1.5%. So my colleague was right – a generic investment grade Emerging Market index has done double that so far this year – just over 3%.

“You are mixing your metaphors” I hear you say – mixing your Sombreros with your Stetsons. It is an observation but it is clear that what happens in the US materially effects EM. Immediately after Donald Trump’s election, markets for all the obvious political reasons, became very bearish on EM. However, as the dust has settled there is a realisation that things aren’t changing overnight and that the Federal Reserve isn’t raising rates as aggressively as some had expected. Clearly there is more to relative value between the US and EM, but so far this year looks likely to repeat some of the key themes for 2016: any softness in the US interest rate cycle is likely to be good for EM economies.