Emerging Markets: Buying Fear

Mid Week Bond Update

Emerging Markets: Buying Fear

Emerging market bonds and Italian government debt bounced back from market lows; 10 years after the financial crisis, the market for residential mortgage backed securities looks very different.


Real yield differentials between emerging and developed markets are at 10- year highs -- reflecting the undercurrent of fear that continues to ripple through the developing world, as one country after another is sold off and then bought back at yields high enough to tempt back value and yield hungry investors.

Argentina kicked off the current round of market upheaval;  with yield on 10-year US dollar denominated debt peaking for the month at 11% on August 31. Turkey, South Africa and Brazil followed with yields peaking on September 5 then Poland and Indonesia on September 6 and Russia on September 10. As of September 11 it is China, India, Thailand and Mexico that are pushing recent highs as part of a global selloff in bonds as US equity markets rebound.

On the Rise: Mortgage-backed securities

This week marks the start of a series of unhappy 10-year anniversaries of events from autumn 2008 that started the global financial crisis. A key cause was a steady rise in mortgage delinquencies over the course of that eventful year from just under 3% to 6% as measured by the Federal Reserve Percentage Balance 90+ Delinquent Mortgage Index.

A decade on, that same market appears to be an oasis of calm, with delinquencies at an 11 year low of 1.1% at the end of June 2018 – the next figures will be released in early October. The turnaround is largely a result of regulations that have set a much higher bar for mortgage approvals, but better growth, low unemployment, rising house prices and relatively low historical supply of homes have all contributed to a benign environment for residential MBS (Mortgage Backed Securities).

 

Federal Reserve Percent Balance 90+ Day Mortgage Delinquency Rate (%)

June 2003 - June 2018, quarterly basis

 

Source: Bloomberg, as of 6/30/18. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

On the Slide: Italian bond yields

One of the most dramatic reversals in fortunes of the past week was the rally in Italian bonds from four-year high yields of 3.3% at the end of August and start of September to 2.8% this week. However, some of these gains were subsequently lost in a global bond sell off on Tuesday, so the true resilience of investor confidence in the new government remains to be proven. Markets had been spooked ever since the election of a populist alliance to government in March that talked tough on its future relationship with the European Union and on its willingness to spend big to meet election promises. The markets moved so strongly against such suggestions that the new coalition government has explicitly said this week that its new budget, to be announced in October, would be ‘sound’ and not seek a confrontation with the EU over its 3% deficit ceiling.

Italy 10-Year Government Bond Yield (%)

January 1, 2018 - September 11, 2018

 

Source: Bloomberg, as of 9/11/18. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


All data Source: Bloomberg as of September 11, 2018, unless otherwise specified.

 

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IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

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.

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.

Yields and dividends represent past performance and there is no guarantee they will continue to be paid.

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.

High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.

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