Big banks: Emerg­ing mar­kets are riskier

Global growth ques­tioned; in­vestors urged to ‘start look­ing for well-priced hedges’

The Detroit News - - BUSINESS - BY ALINE OYA­MADA Bloomberg

The time has come for in­vestors to con­sider pro­tect­ing against emerg­ing-mar­ket losses, ac­cord­ing to three of the world’s big­gest banks.

Af­ter a strong start to the year, So­ci­ete Gen­erale SA, Bank of Amer­ica Corp. and Wells Fargo & Co. are ques­tion­ing how much value is left in de­vel­op­ing na­tions while flag­ging the po­ten­tial pit­falls to the Goldilocks story that gained so many ad­her­ents. While riskier as­sets ben­e­fited from the more dovish turn by the Fed­eral Re­serve, global growth is still a ma­jor source of con­cern as prospects for an ex­ten­sion of a U.S. trade truce with China are fad­ing. Not to men­tion – the wide­spread con­sen­sus is still bullish.

“EM’s struc­tural weak­nesses will re-emerge from the dark sooner rather than later,” Bank of Amer­ica strate­gists in­clud­ing Lon­don-based David Hauner wrote in a note to clients. “We strongly ad­vise look­ing for well-priced hedges.”

The Mex­i­can peso has his­tor­i­cally been used as a proxy for emerg­ing-mar­ket cur­ren­cies given its round-the-clock trad­ing, rel­a­tively good liq­uid­ity and the coun­try’s ex­port-ori­ented econ­omy. Af­ter ral­ly­ing for nine straight weeks through Jan. 25 – the long­est win­ning streak in two decades – peso gains ap­pear to have stalled, and short­ing the cur­rency may turn into a pop­u­lar trade in case of a wider sell­off.

Bank of Amer­ica strate­gists rec­om­mend buy­ing USD/MXN calls and Mex­ico CDS for hedg­ing, in­stead of sim­ply go­ing long dol­lar-peso spot. One bar­rier against short-peso wa­gers is that the bench­mark rate stands at a decade high, mak­ing it costly to bet against the cur­rency.

So­ci­ete Gen­erale’s Ja­son Daw, a Sin­ga­pore­based strate­gist who was one of the few to an­tic­i­pate the slump in emerg­ing mar­kets last year, says in­vestors should hedge against a U.S. re­ces­sion that may come in the first half of 2020, ac­cord­ing to the bank’s econ­o­mists. Judg­ing by past moves at times of eco­nomic weak­ness in the U.S., in­vestors should fa­vor the In­dian ru­pee, the South Korean won or Tai­wanese dol­lars as hedges.

“Tim­ing the U.S. re­ces­sion or judg­ing the mag­ni­tude of the U.S./global slow­down is not easy,” Daw wrote in a re­port to clients. “But when it starts, hav­ing some re­ces­sion hedge ideas in the back pocket can prove use­ful.”

In­vestors need to iden­tify where the mar­ket rally has got ahead of it­self, be­cause those as­sets will be the first to de­cline.

For Wells Fargo, Brazil is one case where in­vestors have be­come ex­ces­sively op­ti­mistic. The real is among the best per­form­ing cur­ren­cies this year on ex­pec­ta­tions the new ad­min­is­tra­tion of Pres­i­dent Jair Bol­sonaro will pass an un­pop­u­lar so­cial se­cu­rity re­form, pri­va­tize state-owned com­pa­nies and re­vive growth.

“Now would be a good time to hedge EMFX risk, es­pe­cially for some of the cur­ren­cies that are still frag­ile,” said Bren­dan McKenna, a cur­rency strate­gist at Wells Fargo in New York. “Brazil is a good ex­am­ple. I have a longer-term bear­ish view on the real, and would say now would be a good time to put a hedge on as the real has strength­ened a fair amount.”

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