London/Singapore: The year threatens to end as it began for emerging markets — with losses.
After spectacular returns between end-January and October, emerging market stocks and bonds are again in retreat, disappointing investors who had hoped the sector had finally turned a corner after lagging its developed market peers for years.
Money managers who attended last year’s Reuters Global Investment Outlook Summit had correctly called a turn in favour of emerging markets. At this year’s summit, held November 14-19 — just after Donald Trump’s US presidential election victory — the mood was far less buoyant.
In the wake of the election, investors pulled a record $6.4 billion (Dh23.5 billion) from emerging bond funds tracked by JPMorgan — a full 10 per cent of what had been received year-to-date. Equity funds shed a third of year-to-date inflows, data showed.
Returns for 2016 are still positive. But foreseeing more pain, many summit participants said they had cashed out their emerging market trades. Among them is NN Investment Partners, which turned positive on emerging markets towards the end of 2015 but recently reversed gear.
“For us, Trump has been a game-changer for emerging markets,” Valentijn van Nieuwenhuijzen, NNIP’s chief strategist, told the London leg of the summit.
He said Trump might or might not carry through on pledges to slap tariffs on trade partners or build a wall to keep out Mexican immigrants.
But he is seen unleashing a trillion dollars of stimulus through tax cuts and infrastructure spending. That is feeding through to US bond markets, where rising yields are pricing in a jump in inflation.
“It’s not just the risk of protectionism that we are worried about in emerging markets, it is the combination of that risk along with reflation which is undermining the story,” van Nieuwenhuijzen added.
Those “reflation” bets have already taken some steam out of emerging markets since mid-October. A Bank of America Merrill Lynch investor survey just after the Nov. 8 election found emerging equity allocations suffering their biggest month-on-month drop in 5 1/2 years.
Bhaskar Laxminarayan, Asia CIO for Julius Baer, said 90 per cent of his firm’s global equity portfolio was in developed markets, as headwinds from Western protectionism grow.
We’ve achieved peak globalisation ... If you have a couple of years of this to play out, that’s not the best time to be in emerging markets,” Laxminarayan told the summit in Singapore.
The emerging rally earlier this year had coincided with a 5 per cent fall in the dollar index. Since the election, the greenback’s value has risen 5 per cent to 14-year highs.
“Investors had been assuming the dollar had peaked. If that assumption turns out to be wrong ... that does change the landscape quite dramatically,” said Richard Titherington, emerging markets head at JPMorgan Asset Management.
But Trump’s election may not be unequivocally negative for the developing world if his infrastructure plans reignite commodity demand and boost US growth.
“It’s not time to get out yet. Commodities are stabilising, the fact we’re now seeing earnings growth in emerging market companies, these make us think that, on the equities side, emerging markets can continue to move forward,” said Mark Haefele, CIO of the $2 trillion UBS Wealth Management.
Emerging market debt is another story. Higher US yields don’t just reduce the appeal of emerging bonds, they also make it costlier for governments and companies to roll over maturing debt or raise fresh finance.
Haefele is steering clear, calling emerging market bonds “Ground Zero” in the event of additional unexpected US rate rises.
Bonds in currencies such as the rand and the rouble could be at the sharp end of a sell-off. These rebounded this year after three years of losses, with big-name investors such as BlackRock and PIMCO buying back in.
Speaking in New York, BlackRock’s fixed income CIO Rick Rieder said he wasn’t ready to back off yet, calling emerging markets “a great opportunity” for 2017.
Many summit participants said they might return in 2017, arguing there was potential in parts of the developing world and that rampant dollar gains were likely to prove unpalatable to US policymakers.
Mexico has borne the brunt of Trump-related selling, but Didier Saint-Georges of Carmignac Gestion was among many who said the peso’s huge depreciation would boost competitiveness.
“I would buy [Mexican assets] now, absolutely, with a 2017 perspective,” Saint-Georges said.
GAM Investment Solutions also has hung on to the peso, while trimming other emerging market holdings. Its group head Larry Hatheway however plans to re-enter once bonds and the dollar settle.
“When we look to 2017 and look at parts of markets that should perform, my sense is emerging equities, currencies will be good to be in,” Hatheway said.
“It’s just a not-for-now story.”