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2017 - a threat or opportunity for EM currency bonds

In 2016 emerging market (EM) hard currency bonds registered a strong performance.

Bofa Merill Lynch emerging market index posted a total return of 17.3 per cent, despite the fact that investors were aware that the Federal Reserve (Fed), continued to indirectly pronounce the sanity of the US economy.

In the US, the prime mandate of the Fed is low unemployment and price stability and according to the latest economic data these objectives were being achieved.

Thus expectations of rate hikes continued to increase. The unknown was solely the pace of hikes. Theoretically, a rate hike would imply a stronger dollar, which in turn hinders the soundness of EM dollar issuance companies in terms of servicing and re-financing their debt. But what was the magnitude of the impact? Where are we heading in 2017?

Prior to November's election, in periods of a stronger dollar, the movement in EM bonds was minimal as investors continued to hold on to solid credit names which were offering good returns, which investors failed to pursue elsewhere.

Undoubtedly, 2016 emerged as one of the best years for EM bonds with the aforementioned performance being dissected by a 9.6 per cent price return, a remarkable upside, and an income return of 7.7 per cent.

The notable hiccup experienced by the asset class was following November's US election whereby asexpectedly the EM asset class declined by 2.5 per cent following Trump's victory in which the dollar spiked, while EM yields widened.

Surprisingly enough, following the increased expectations by the Fed in its December meeting, in which it increased its path of rate hikes for 2017 to three hikes from the previous two, despite the dollar strengthen further EM bonds just declined by a shy 0.43 per cent.

Moving into 2017, the EM bond asset class once again is topping the list of best performers with a year-to-date gain of 1.1 percent, thus outperforming its peers.

Yesterday, I was listening to a very interesting view being put forward by Mohamed El-Erian, chief economic advisor at Allianz, whereby he stated that the gains registered to date, mainly the US, might have reached their peak. But what was interestingly to hear was his stance on EM, whereby he stated that despite being possibly a bumpy ride a lot of money can be made in the emerging market.

I always said that being selective is crucial, while to some extent taking a contrarian calculated approach might prove to be one of the best investment decisions being taken.

Let's be realistic, the huge Mexican peso devaluation (just below 18 per cent, since the US election in November), in my view is a herding instinct, in actual fact it does not make sense.

The movements in EM currencies, mainly in Mexico has also brought about huge movements in EM bonds which in my opinion are mis-priced and now more than ever offer relative value.

I recently mentioned three attractive EM countries which in my view might be attractive sources of returns in 2017.

Indonesia

I believe Indonesia might be a top-pick following the recent tax amnesty announcement by the government in which it had estimated that some $303bn worth of Indonesian money is secretly abroad in tax havens. Thus some repatriation of the said assets should trigger a feel good factor, mainly in the real estate and the financial sector.

Brazil

In addition, Brazil might also be an interesting spot following last year’s contraction in economic growth. With the improvement in commodity prices and a milder political saga situation, some interesting opportunities might be well in place following the huge mis-valuation throughout the year. Analysts are estimating that the largest emerging market economy will register positive growth in 2017.

Russia

Russia might now also be an attractive spot for investors. In fact, following the stabilisation in commodity prices we've seen remarkable gains across the board, but what could be a further catalyst for Russia is the possible lifting in sanctions which will be definitely a huge positive impact for the Russian economy.

Thus despite the fact of a stronger dollar, some analysts are seeing parity levels despite the recent weakness, the market seems to have priced the three rate hikes for 2017. In this regard, opportunities might be in place. And let's not underestimate the possibility of experiencing another positive year for EM names. Be selective and you will succeed.

This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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