Economics

EMD Relative weekly notes: Week Ending November 29, 2019


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

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Performance Dispersions Widen

In this note we make some observations about what the differing performance within the EMD opportunity set are telling us regarding future prospects for the asset class:

  • There is a well-publicized theme of social unrest in many emerging countries as further attempts at fiscal tightening reach their presumed political limits. We have seen this in Chile, Ecuador, and now Colombia. The countries with the least ability to accomodate this are of course those that are non-investment grade. In our view this has been well priced in—over the past two months IG has bested non-IG in the sovereign space by over 100 basis points. Year-to-date the dispersion is striking: 16.07% returns for IG versus 7% for non-IG.*
  • But it would be a mistake to extrapolate this! For corporates, the YTD returns differ almost not at all with 12.08% for IG and 11.88% for non-IG.* What is the difference? Most corporates, even non-IG ones, reside in more stable countries like Mexico, Brazil, China and Russia. The lesson is that this is not a "risk off" trend that is specific to the entire asset class. In our view, the market has differentiated rationally.
  • Where we think there is arguably a bit of contagion is within Latin American local debt. Regional index currency returns have been -3.54% this month, led by Chile's 7% peso fall, but negative everywhere except Argentina. That contagion definitely stops in the hemisphere, as currency returns have been positive elsewhere.
  • While we expect some of the most stressed sovereigns like Lebanon and possibly Ecuador to continue to face challenges fiscally, other non-investment grade sovereigns that do not fall victim to significant and very public fiscal constraints are likely to do fine—many African countries fall into this category.  
  • Following a year of double-digit returns, it is natural to make the broad assumption the asset class has few further gains to offer. The dispersion we have seen suggests that for investors with access to the full opportunity set of sovereigns, corporates, and local, this does not necessarily have to be the case.

* Source: JPMorgan, November 29, 2019.


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