The Technical Backdrop Is Much Cleaner
Need another reason to consider EMD exposure in 2019? How about this: the supply/demand dynamics are likely to favor investors. Net issuance of EM sovereign and corporate debt is expected to be lighter than in recent years. Net EM sovereign issuance, for example, is likely to be just half of what it was in 2018.
At the same time, positioning in the market is cleaner than it was. This is the result of heavy selling last year, particularly by crossover investors who dip into and out of EM assets, depending on prevailing economic and credit conditions. The result: dedicated EM investors who have done their homework can step in and snap up attractive assets that were unfairly punished. And with supply limited, increased inflows are likely to drive up asset prices.
Sifting Through the Risks As Liquidity Declines
Of course, macroeconomic and geopolitical risks still loom, and they’re likely to keep overall market conditions volatile in 2019. Worsening trade tensions or a larger-than-expected slowdown in China’s economy could slow growth and pressure some EM assets, as could a US recession. Uncertainty surrounding Brexit and Italy’s debt sustainability also bears watching.
But when it comes to individual countries, there’s still variation in macroeconomic stability, governance and fiscal policy. But remember, financial conditions have tightened and liquidity isn’t what it once was. In this environment, investors must be selective.
For example, we see potential in Brazil, where a new government is pushing an ambitious agenda of privatization and pension reform, and trying to reduce bloated public sector debt. We also see tactical opportunities in Turkey, where a shift toward more orthodox policies has staunched a sell-off in the lira and lower oil prices have reduced the country’s current account deficit.
Elsewhere, political risk warrants caution. Mexican President Andrés Manuel López Obrador’s populist tendencies and doubts about his commitment to keeping the energy sector open to foreign investment are a concern. In Argentina, investors will have to weigh highly attractive yields against the possibility that its reformist government loses power in elections later this year.
To sum up, investors still need to do their homework. With volatility likely to stay high, it’s important to carefully manage overall portfolio risk—economic, political and otherwise. That means staying active and taking advantage of market downturns to pick up assets at broadly attractive prices.
EM assets had a turbulent 2018. But they remain one of the most rapidly growing sectors in the global fixed-income market. At current prices, careful investors have a unique opportunity to add long-term value to their portfolios.
