EM debt: rich or risk?
We believe that one of the difficulties with simple arguments that emerging markets have run too fast, or whether emerging markets have much more upside, is that we are in an era where historical comparisons largely lack relevance.
Misled by history?
With $13-ish trillion in government debt trading at negative rates determing what is "risk" and what is "rich" have become exercises without comparative anchors. Nevertheless, the answers we read in Wall Street research still cling to the traditional concepts of comparisons between other periods of relative historical exuberance.
We don't have a solid metric, but we suspect that historical comparisons will lead investors astray.
Without those valuation anchors and an ability to determine with confidence overall market valuation metrics, we think that following our historically reliable indicators that have been well correlated with investor returns remains the best investment path. Those indicators remain positive.
Central banks in centre stage
The key reason for that is the stance of developed market central banks. The commitment to asset purchases remains intact by the Bank of Japan (BoJ), the European Central Bank (ECB), and the Bank of England.
With so much debt subject to purchase by a price insensitive buyer with an unlimited balance sheet, valuations seem to matter less than detecting whether those commitments flag and those central banks return to a more traditional policy framework. There is no sign of this, primarily because those policies continue to show no convincing signs of producing results in the form of growth.
The exception of course is the Federal Reserve (Fed), which continues to jawbone markets when rate hike expectations sink too low and asset prices rise too high too fast.
Earlier in August was a good example when one governor stated that September was still possible for a rate hike, and at least one hike this year was suggested. Rate hike probabilities predictably rose, but the dollar remained relatively unaffected.
The chart below shows the ten trading days in earlier August for the dollar, without a whole lot of volatility or a meaningful trend change to stronger levels.
The dollar over ten days in August
We suspect that the market's sensitivity to such pronouncements is waning. The dollar remaining stable to weaker is historically a very benign environment for emerging markets. Thus we see little reason to guess that that environment will turn around in the absence of observable evidence.
Investors forget that what sent the dollar soaring from June 2014 to January 2016 and caused historically negative returns in emerging market local currency investing was the divergence between these central banks. Both the ECB and BoJ were leaning on negative interest rates and weaker currencies while the Fed was wrapping up quantitative easing and expected to begin a rate hiking cycle.
New world order for monetary policy
Today, negative interest rates have been replaced with a reliance on asset purchases--a much better tool if you are an emerging market investor--and the Fed seems unable to commit. Thus we prefer maintaining risk exposures rather than pointing towards increasingly discredited historical metrics in what is most assuredly a new world order for global monetary policy.
Any security(s) mentioned above is for illustrative purpose only, not a recommendation to invest or divest.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Opinions stated are matters of judgment, which may change. Information herein is believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. Exchange rate changes may cause the value of the overseas investments to rise or fall. For risks associated with investment in securities in emerging and less developed markets, please refer to the relevant offering document.
The information contained in this document is provided for information purpose only and does not constitute any solicitation and offering of investment products. Potential investors should be aware that such investments involve market risk and should be regarded as long-term investments.
Derivatives carry a high degree of risk and should only be considered by sophisticated investors.
The fund is authorized by the SFC but such authorization does not imply official approval or recommendation.
Schroder does not provide any securities or investment products for offer, solicitation or trading within The People’s Republic of China (PRC). Should illegitimacy arise thereof, contents of this document shall not be construed as an offer or solicitation or trading for such securities or products. All items mentioned herein are sold through financial products issued by commercial bankers in the PRC under regulations by the China Banking Regulatory Commission (CBRC). Investors should read the relevant documents clearly before invest in the mentioned funds. Please consult the relevant commercial bankers in the PRC and/or professional consultants if necessary.
This material including the website has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.