As I have opined in my previous writings, investors tend to monitor the movement in the US in confront of major emerging market (EM) currencies due to the sensitivity element. In theory EM dollar denominated debt tend to weaken in value when the dollar appreciates and vice-versa, due to the fact of higher re-financing costs. In fact, we have experienced such situation post-Trump victory, whereby the dollar spiked, while EM bonds weakened markedly. Following the spike in the dollar currency, investors realised that this was a short-term spike and that yields in EM bonds were more attractive than ever following the sell-off.
So should investors opt now for an overweight position in their portfolio?
My call is yes, selectively. The current situation is quite different from the previous historical rate hike scenarios, and thus the market is interpreting a different situation. In my view, the main reasons for a still attractive EM allocation are various.
A better global economic outlook
First and foremost, the better global economic activity should be beneficial for EM. Primarily a better global economic outlook should also imply a better outlook for commodity prices. In this regard, as commodity prices improve, EM countries should reap the benefits of such increases.
Attractive yields
In addition, European fixed-income investors are still in search for attractive yields and now only EM countries can offer such returns. This is one of the reasons why to date EM bonds are heading the list of gainers amongst the fixed-income asset class.
The fundamental aspect
Another very important rationale that at times investors tend to ignore is the fundamental concept. Factually, many EM countries are better positioned from a fundamental perspective. For instance, Indonesia has a debt-to-GDP ratio of 27% and unemployment is at low levels of 5.6%. On the contrary, on average debt-to-GDP ratio for the Euro area now stands at 89.2%, while unemployment now stands at 9.5%.
Demographics
Another very interesting economic aspect in EM are demographics. The share of population under the age of 16, i.e. those progressing towards the labor force, is much higher than developed countries. This would imply that EM countries can deploy more labor-to-capital and the possibility of more output, i.e. economic growth is higher.
That said, I think it is imperative to be selective. This year my top picks are Brazil, Indonesia and Russia. In 2016, Brazil registered a negative GDP growth of 3.6%, it was a very negative year from all fronts with the political saga amplifying the economic downturn. In January 2016 inflation rates spiked to over 10 percent, unemployment rate touched over 14%, while interest rates jumped also the 14% mark. At those levels valuations were hammered lower and in my view very selective credit names offered and are still offering very positive risk-adjusted returns. In this regard, in my view an overweight allocation to Brazil should prove beneficial when considering the fact that economic figures have now improved, with the inflation rate now standing at 4.6%, while the country’s risk premium has also lurched lower over improved economic sentiment.
Indonesia is another attractive niche market when considering the very successful tax amnesty announced by the government in mid-2016. We should continue to note decent inflows, with financial companies and real estate developers being positively impacted from such flows.
From the commodity front, as we are seeing more stabilised commodity prices, mainly the price of oil, and the possible ease in sanctions, Russia should continue to benefit from such movements.
Overall, despite a strengthening dollar and a slowdown in the global economy would be very bad for emerging markets, my view is that the dollar will maintain its current trading range and in this regard, EM should continue to do well. Being very selective is crucial and at times taking a contrarian approach will emerge as the outperforming element when compared to other peers.
Disclaimer: This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are 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.