EMD Relative weekly notes: Week Ending January 10, 2020
What is cheap in EMD?
It should strain credulity if anyone involved in a broad asset class is touting it as cheap on an absolute basis. Thanks to Central Bankers, Inc. last year was extremely generous to investors. This year is about recognizing that those returns were borrowed from the future, given that economic growth has not changed from its slow march globally.
Of course, while equity investors can dream of ever-expanding multiples for their universe based on low interest rates, for bond investors mathematics is a much harsher taskmaster. Emerging market debt is as beholden to those laws of gravity as any other fixed income asset class, though it has the redeeming feature of a yield advantage over DM fixed income, which by itself we think recommends the asset class.
However, dollar EMD is as cheap as anything else—which is to say: not much. The chart below shows its richness. It displays a three-year timeframe showing the percentile of richness for both IG and non-IG debt, with a lower number meaning it is trading at a rich level. It is clear that investment grade debt is as rich as it has ever been in this time period. Non-investment grade debt, while rich, is not in an extreme position—investors still get paid a relative reward for taking credit risk here.
Source: Bloomberg; data January 2, 2014 through January 6, 2020. Chart displays the IG and Non-IG breakouts of the JPMorgan EMBI Global Index. Performance shown reflects past performance, which is no guarantee of future results. The value of investments can go down as well as up and is not guaranteed.
It has not always been so in times of plenty. The period of 2017-2018 demonstrates that both sub-indices can trade rich together. The key lesson here is that the asset class can stay rich for an extended period of time: so, if one judges that this may be an arena for profit-taking, the risk for investors, in our view, is forfeiting relatively generous current yields in a low volatility environment, with not too many other places to turn.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.