Worried about rising US bond yields? Emerging markets and junk bonds are usually among the first to sell off when global risk aversion strikes. They may provide more protection this time around.
Emerging markets are looking relatively calm amid the current turmoil. As of Friday afternoon, the benchmark MSCI Emerging Markets Index was still hanging on to a slight gain for the year, even after the S&P 500 Index sank 3.8 per cent on Thursday to enter a correction. The US gauge is down 3.5 per cent in 2018.
Look at what happened this decade. Until 2017, the US had outperformed the faster-growing economies for years, underlining just how complacent investors in the world’s favourite bull run had become. It’s only to be expected that, now trouble has finally arrived, the strongest rallies are suffering the sharpest reversals.
After all, there’s little reason to be concerned about the economy. Few are warning of a global recession. All of Wall Street seems to be saying that the economy is fine; it’s just stocks.
This has key implications for corporate bonds. While interest-rate risk is now a real concern, we don’t need to worry about credit risk just yet. That means that shorter-dated junk bonds may provide more protection than higher-rated securities with a longer tenor that are more sensitive to changes in interest-rate expectations.
Take, for example, the 40-year 4.44 per cent bond issued by A-plus-rated Alibaba Group Holding Ltd. The security, which was sold at a tiny 1.58 per cent spread to Treasuries at the end of November, has fallen about 8 per cent this year. By contrast, the three-year 8.75 per cent debenture issued by high-yield developer China Evergrande Group has dropped only about 1 per cent.
Still, all bets are off if China can’t keep a steady hand on its policy levers. And I have real trouble understanding what Beijing is doing right now.
First, does the People’s Bank of China have to scare the world with a suddenly weak yuan fix? On Friday, the central bank lowered its yuan guidance by the most in a year, rekindling mutters of a surprise devaluation.
To be sure, China is probably frowning at the persistently weaker dollar. The yuan’s 8.6 per cent advance against the greenback over the last year can’t be good for Chinese exporters. But with global markets tumbling, Beijing doesn’t need to add to the anxiety. Let’s not forget that the S&P 500 dipped 11 per cent after the yuan’s August 2015 devaluation.
Second, stock-market regulators are giving investors the jitters. The China Securities Regulatory Commission urged brokerages last week to roll over stock pledges instead of selling the shares when prices drop, Bloomberg News reported Monday.
While that’s aimed at averting sharp market declines, it may have the opposite effect. Every year, the A-share market faces selling pressure before the weeklong Chinese New Year holiday. The commission’s seemingly innocuous “window guidance” can easily be interpreted as a prelude to market-wide trading halts. That may make funds even more tempted to close their books early, fuelling a downward spiral.
Third, as I wrote earlier today, traders are pointing fingers at local media reports that say the banking regulator will make cutting consumer debt a top policy consideration this year.
This is a huge problem for the market, extending well beyond banks, which have been relying on consumer loans for earnings now that the China Banking Regulatory Commission has clamped down on wealth-management products. What will happen to real estate developers if China reins in mortgages? Or to carmakers, whose sales flourished last year in part because auto loans became widely available?
Keep in mind that real estate and automakers were among the Hong Kong equity market’s biggest winners last year, with Sunac China Holdings Ltd. soaring 402 per cent and Geely Automobile Holdings Ltd. up 266 per cent. Once the sales momentum is gone, these high-fliers will return to earth.
This isn’t the time for Beijing to muddy the waters.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.