... AND EMERGING MARKETS COULD BE A GOOD BET, TOO
The recent hot streak in emergingmarket stocks and bonds could have room to run as analysts say that the “very under- invested” asset classes could get further boosts this year from additional central-bank rate cuts.
Investors have become well-accustomed to big bond and stock returns in developed-market countries where central banks have slashed interest rates to zero and deployed massive quantitative easing programs. Emerging- market central banks, meanwhile, have kept their interest rates relatively high by comparison.
But recent developments mean that the gap is set to narrow. Inflation is trending down in many emergingmarket countries, while their currencies have rebounded significantly against the U. S. dollar this year. As well, the recent rallies in asset prices will have investors coming back to the market to chase returns.
“People are very under-invested in the asset class and people need to get reinvested to get the returns,” said Jim Caron, head of global fixed income at Morgan Stanley Investment Management.
A return of inflows would coincide with potential interest- rate cuts designed to stoke demand, as countries such as Brazil and Turkey have seen steep drop-offs in inflation this year. Both countries are expected to trim rates this year.
“With the monetary policy tool box nearly exhausted in developed markets, the burden falls on emergingmarket central banks to provide the stimuli,” said Martin Roberge, analyst at Canaccord Genuity.
“A weaker U.S. dollar and stronger EM currencies should now allow EM monetary authorities to lower policy rates, which remain too high relative to inflation.”
There is clear momentum around emerging- market stocks these days as the MSCI Emerging Market Index has soared 20 per cent since its Jan. 22 low. The rally follows a crushing rout last year, which saw emerging-market stocks fall 35 per cent from May to January of this year.
China was the focal point of the sell-off, as investors feared its slowing economy risked triggering a global recession. A surprise devaluation of the Chinese yuan in August exacerbated those fears and led to a flight of capital out of the country.
David Rees, economist at Capital Economics, said investors should continue to get good news from China this year as policy stimulus announced in the past year, including slashing the reserve ratio for banks in February, begins to filter into the economy.
“The sharp sell- off in emergingmarket equity markets last year, largely predicated on a meltdown in China’s economy, was not justified — something that we repeatedly argued at the time,” said Rees.
An economic meltdown, however, is not necessarily needed to derail the current emerging- market rally. The International Monetary Fund warned Monday that it expects the number of financial shocks that China generates on global stocks to increase, as markets are increasingly influenced by developments in the Chinese economy.
There are also ongoing concerns about the massive amount of debt that many emerging-market countries are currently carrying. Credit-rating agencies have been actively warning about the debt levels and lenders are pointing out that many EM countries face a massive debt- servicing bump over the coming years. ICBC Standard Bank said in a report last month that some US$1.6 trillion in debt is set to mature from 2016 to 2020 — a massive amount that overshadows levels seen before the financial crisis.
Much of the debt maturing was issued in recent years, as companies rushed to borrow money and take advantage of rock-bottom interest rates. And because much of the money was borrowed in U.S. dollars, defaults may rise in the coming years as the U. S. Federal Reserve moves to raise interest rates.
On the flip side, accommodative policies from emerging- market central banks could help ease some of the pain in the coming years. Roberge says that if EM policy-makers are more accommodative than expected this year, global growth could surprise to the upside, increasing appetite for risk and propping up the emerging-market stock rally.
“With inflation falling fast in other large emerging markets such as India and Russia, global reflationary efforts should start broadening out,” he said.