With Emerging Markets growth projected to accelerate and valuations compelling, debt markets in select EM countries merit careful consideration.
Exhibit 1: Growth Differential: EM Versus DM
In the absence of new catalysts, the secular backdrop will play a less pivotal role in driving EM asset prices henceforth. Performance of EM assets in recent years has been decidedly more volatile, reflecting a less conducive global backdrop given escalating risks on geopolitics and trade. At the same time, as secular trends in EM continue to evolve, their influence on markets has become less straightforward. No other large EM economy is close to replicating China's growth feat. Quite the opposite; many EM countries are facing the same socioeconomic challenges as their developed market counterparts, including aging demographics, income inequality and immigration issues. Adding further technical pressure to EM countries is the progressive inclusion of China in widely-used benchmarks. China now competes directly with other EM countries for portfolio capital.
It follows that global EM investors must pay ever more attention to short-term cyclical factors. While long-term fundamental analysis remains a critical pillar of the investment process, an appreciation of cyclical and technical drivers is now more critical than ever, especially given the boom-bust nature of EM assets from time to time. This leads us to at least two considerations as it relates to EM investing—differentiating individual credits and navigating global crosscurrents. On the first, the heterogeneous nature of the asset class will likely bear out more prominently in terms of performance within the mix of benchmark countries which now number over 75. On the second, managing short-term risks and tactical shifts—currency hedging in particular—could help limit fluctuations in asset values and the volatility of total returns. Customized EM strategies developed in close collaboration with investors and that seek to navigate the unique vagaries of the asset class may enhance our ability to achieve desired risk-return objectives.
The encouraging news is that the EM-DM growth differential is set to widen once again as we head into 2020. One major stumbling block on EM has been a persistent macro theme of US outperformance. EM growth is poised to accelerate to a three-year high of 4.6% in 2020, based on the latest IMF forecasts. With the exception of China, most core EM economies are expected to stage a rebound, thanks to aggressive policy easing by EM central banks as well as reduced US-China trade tensions. Of note is the abatement of inflation risk across EM countries. Indeed, valuation wise, real yields in EM remain compelling, currently averaging roughly 170 basis points above those in DM. From a technical perspective, we do not view EM as excessively over-owned, as compared to the period heading into the taper tantrum.
Our EM convictions center on select EM countries with strong fundamentals and institutions, where structural reforms and policy flexibility should pave the way for a growth bounce. The focus list centers on high-grade countries including Indonesia and Russia as well as select credits in the growing Persian Gulf sovereign complex. In crossover strategies, EM credits offer diversification appeal when compared against "quasi risk-free" valuations in DM credits. To be sure, the overriding macro uncertainty is renewed pressure on EM growth if trade tensions escalate. As it relates to the US economy, a repeat of the significant growth outperformance versus EM we experienced in 2018, which could prompt tighter Fed policy, would be damaging to EM. Conversely, a hard-landing scenario in China, while still a low-probability event, could nonetheless lead to a re-pricing of EM risk premium. Further, escalating social unrest as well as heightened geopolitical events are ongoing risks that bear close monitoring.
A basis point is one one-hundredth (1/100, or 0.01) of one percentage point.
Developed markets (DM) refers to countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.
Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries
Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.
The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
The International Monetary Fund (IMF) is an international organization of various member countries, established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements.
The JP Morgan Emerging Market Bond Index Global (EMBIG) tracks the return of external debt instruments that trade in the emerging markets.
The JPMorgan Government Bond Index-Emerging Markets (GBI-EM) indices are comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments
Real yields are calculated by adjusting stated yields to compensate for inflation expectations over the time period during which the yields are expected to be paid.
“Taper tantrum” refers to the financial markets’ reactions, in May-August 2013, to the announcement by the Federal Reserve that it was planning to decrease, or “taper” its $70 bn per month bond buying program.
The World Trade Organization (WTO) is an intergovernmental organization which regulates international trade.
Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.
All investments involve risk, including possible loss of principal.
The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.
The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).
This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.
This material is only for distribution in those countries and to those recipients listed.
All investors and eligible counterparties in EU and EEA countries:
In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6, Building Three, Number One, Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4. D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.
In the UK, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the UK Financial Conduct Authority.
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.
Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.
All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.
This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.
All Investors in the People’s Republic of China (“PRC”):
This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.
This material has not been reviewed by any regulatory authority in the PRC.
Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.
This material has not been reviewed by any regulatory authority in Korea or Taiwan.
All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.
All Investors in Australia and New Zealand:
This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827). The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.