According to Lafferty, the nature of investing in emerging markets has changed significantly since 2008. Where before most were driven by common factors, like growing exports and strengthening local currencies, increasingly, each one trades on its own fundamentals. And, as a result, performances are likely to diverge.
“U.S. dollar strength has brought back echoes of the currency crises of the 1980s–90s as dollar-denominated debt is harder to pay back,” Lafferty said in a recent note, adding: “Local currency weakness creates inflation (i.e., imports become more expensive), and curbing that with higher rates hampers growth. Finally, falling commodity prices, particularly for oil, may severely weaken growth due to lower exports in major emerging markets like Russia, Brazil, Venezuela, the Middle East, and parts of Africa.”
However, Lafferty remains bullish and says that dollar strength is not quite the bogeyman many people think it is. The first reason for this, in his view, is there is a great deal more local currency debt, than there used to be, so the burden of dollar-denominated debt is less than it used to be. Second, weaker local currencies tend to boost export growth and, finally, “As the EM consumer base grows, they contribute to their own economies and are less dependent on trade and external funding.”
“Across equities, valuations may be deceiving,” he said, adding: “EM stocks have a lower relative Price-to-Earnings than other markets, but this is skewed by unique risk factors and state-owned enterprises.”
In the fixed income space, EM bonds still offer attractive yields, Lafferty said, with credit quality steadily improving. While sovereign debt levels have grown, so has GDP, so debt remains manageable, he said.
According to Lafferty, the firm’s favoured markets are Mexico and India.
“Mexico is becoming more competitive thanks to structural reforms in energy and education, and its cost of production is becoming more favorable when compared with rising labor costs in Asia,” he explains, while India’s continued eceonomic reforms under new President Nahendra Modi continue to bode well, he said.
