On the point of debt levels, the second factor that concerns many looking at the emerging market space is the level of debt denominated in dollars in a world where demand is slowing.
For those countries that borrowed in dollars to fund expansions on the expectation of continuing growth in China, there are reasons for concern.
Bryn Jones, fixed income director for Rathbone Unit Trust Management agrees that this is a concern, but does not believe it is too early to look at emerging market debt, but says it is not the right time to go wading in.
“The only EM exposure I have in the strategic bond fund at present is dollar denominated, I wouldn’t touch local currency debt right now.”
That said, he does point out that EMD spreads above US treasuries are around 400 points.
“Historically, spreads above 400 have provided reasonable buying opportunities. After we have seen one or two Fed rate hikes you could well see EM spreads at higher levels and, with a higher treasury curve EMD will start to look attractive.”
As Ewen Cameron Watt, BlackRock’s global chief investment strategist, pointed out in a note out yesterday, both corporate profit and currency trends are working against the asset class.
According to MSCI data, he explains earnings per share (EPS) have dropped 25% from their mid-2011 peak – the longest earnings recession in EM history, MSCI data show.
And, he adds, while the previous three earnings recessions were associated with EM financial crises (1997-99) or global recessions (2001-02 and 2008-09), the current slowdown is broad based, both by geography and by industry.
“The materials (down 86%), industrials (59%) and energy (56%) sectors have led the bloodbath, with medium- and small-cap companies hit hardest, according to MSCI data,” he adds that the reason for the declines are tepid domestic growth, profit margin squeezes (reflecting falling commodity prices and a productivity growth slump) and a stronger US dollar due to the looming end of US zero interest rates.
However, he too is not entirely negative on the asset class. While he does not expect dollar strength to level off any time soon, nor is he banking on improving earnings, he does believe there is a good argument to be made for growing dispersion within the asset class.
“Emerging markets are increasingly becoming diverging markets. As a result, economic growth and asset price performance could start to vary greatly across economies,” Cameron Watt said.
“Averages can mask a lot of dispersion – and offer a lot of opportunity to outperform,” he says, adding: “the EM asset class as a whole may not yet have found its floor. Yet there are opportunities within, for example those economies with structural reform momentum.
But, he cautions, picking exposures and risks selectively will be crucial for future returns.
Beckett too advocates caution, but says the pendulum is swinging for all EM assets from the risk of owning them to the risk of having none or majorly underweight allocations.
“Of course it would be utterly naïve to suggest that underperformance will not persist, but it should be clear that EM assets have had a lot of pain already. It might get worse before it gets better, but I would suggest on a three year view the chances of Asian equities and currencies being higher are good.”
