The recent exodus from emerging market credit
To the surprise of many, or of the few, over the past days, those assets which a few days ago were considered to be the winners are now the remarkable losers.
I am referring to emerging market (EM) credit that recently was hammered by primarily a strengthening dollar, which triggered a sell-off over the region. We are not surprised, as this is not the first market reaction of a stronger dollar, we have experienced this several times in recent history, however what comes to us as a surprise is the magnitude of the correction.
As many market participants are aware, we are currently in the thick of earnings season and I would say 90 percent of the reporting companies coming from the EM region have reported positive numbers. Therefore, the question being posed is whether the recent sell-off is justified.
As I have pointed out in previous writings, the technicalities do make sense. A stronger dollar is seen as a threat for higher financing costs, primarily for companies which issued dollar denominated debt but in turn receive their revenue generation stream in local currencies.
Yes in such cases, this makes sense to a certain extent but it surely does not make sense for those credit issuers which purposely hold dollar cash and can service their financing costs without the risk of currency fluctuations.
The current situation seems to fail to consider the aforementioned rationale, in addition to the fundamental preposition. Looking at it from a more logical perspective, I would say the market is strongly over reacting given the benign global pick-up.
The latter is also being factored-in in the recent commodity price levels, which have surged of late, in line with better prospects of global growth. With this in mind, EM countries which are net exporters of commodities, should improve their balance sheets and thus do well.
A factual case in point is Petrobras, the multinational Brazilian company which operates in the petroleum industry, which this week booked its best profit in the past five years triggered by the recent oil price rally. In line with these strong numbers for the first time since 2014, the company will pay a dividend to its shareholders. Nonetheless, its bonds were succumbed to selling pressure in line with other EM bonds.
In my view, despite a justification in the upward movement in yields and spreads, the deemed to be too wide to justify the strong fundamentals. I once again reiterate the importance that bond picking should be based on fundamental analysis and in the current market environment, a bottom-up approach might be a more suitable approach rather than a top-down approach.
Thus identifying credit names with strong metrics will be crucial for returns. A key element is understanding the cash flows of those companies; as lenders we need to make sure that first of all we are paid the interest on a bond, and secondly that we will be repaid at the maturity of that bond.
Other factors to consider are the business and industry outlook, management team, company ownership and the legal protections afforded to the bond. If we are comfortable from this end, we can move on to capture the possible attractive yield.
And yes given the recent, to a certain extent, unjustifiable exodus, there are now companies offering very attractive returns. Be cool, act rationally but do take the plunge to beef up your returns.
Disclaimer: 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.