Funds Europe – Three EM debt waves taking place between the 1970s and the present day were followed by crisis, bringing financial pain for issuers and bondholders alike. With borrowing levels high across emerging markets, are we seeing possible signs of an impending crisis? If so, what can be done to mitigate the damage?
Slabber – A crisis won’t happen because of debt levels. Look at the debt levels in Japan, you can’t beat that. They’re second only to Venezuela. The USA is also up there. Debt levels are something that can be discussed across developed or developing countries, it’s not for one or the other, so that’s not a signal of a crisis or a pending crisis.
As investments in emerging markets are cyclical and speculative at best, it’s not long-term. Even if you just use the emerging market as your total universe, you will have a core set of emerging markets in your portfolio and you will have the speculative ones.
When you want to look at whether there is going to be a crisis or not, let’s look at what makes emerging markets tick and what makes them move from time to time. That’s basically factors like the flow of tourism, cash into the country, cash out, commodities. As soon as you see a commodity uptick, you see all the commodity producers going up with it as well. Then its sustainability needs to be taken into account: will we have a 20-year commodity cycle? People talk about super-cycles – are we going there or not? Is it cyclical coming out of a mini recession, if one wants to call it that? I don’t see a crisis because of debt, but history will probably repeat itself – after an upcycle, there will likely be a downcycle.
Varsani – If there are concerns around borrowing or excess leverage, then there are tools that investors can use to express their allocations in a different way. In equities, they could take quality exposure and screen for stocks that have low levels of leverage, stronger balance sheets, smoothed-out historical revenue streams and so on. In fixed income, if investors are concerned about asset price bubbles or inflation picking up or central banks withdrawing liquidity, then there are better-quality credit EMs that could be allocated to as well, or perhaps shorter-duration exposure than may be in the portfolio.
Spano – There is a correlation, especially in the last seven or eight years, between credit impulse in China and crises across the world. By the time credit tends to go down in China, sooner or later you are going to have a crisis all over the world. At the end of the day, China is a massive economy now. It cannot be merely considered as an emerging market country; it is the second economy in the world!
Meanwhile, valuations, especially in the US market, are extremely stretched. In the US, we have signs of bubbles. Usually when you have a divergence between the MSCI China and the US, sooner or later in three to four months, the S&P 500 will follow. We have already had this divergence since the second half of February. We are starting to see some volatility in the US and Europe as well. The data needs to be confirmed, but we should closely monitor this aspect. The credit cycle in China could cause financial turbulence all over the world, and even the Chinese equity market is a good indicator for what might happen globally in the near future.
Bao – There isn’t any imminent risk for other emerging markets entering into crisis for the time being. Almost all the central banks now agree that the recovery has been weaker and needs to be protected so that we can go back to normal. If all is normalised after around 12 months, all the growth we start to see will not have any feasible low base effect. Then there will be new risks emerging: this round of recovery has indeed a lot of inflationary risks, especially from commodities. If some of the new capacity expansion is based on the inflated economics of the high pricing that we are seeing now, that could inflect further risks later on.
Slabber – If something goes so low that it can’t go any lower, at some time or another it’s going to have to be a buy, right? Let’s take Venezuela, for example, you have to keep your eyes peeled because there’s going to become a time when you have to go there. Do you want to stay there? Not necessarily, but do you want to stay in China? Do you want to stay in Russia? Do you want to stay in, let me use my own country, South Africa? There are always uncertainties in emerging markets, Let’s be honest, this is a game we play, you have to accept the rules and then you have to work within those rules to try and win the game better than the guy next to you.
Cardinale – One of the biggest concerns at the moment for investors globally is the resurgence of inflation. Suddenly we are seeing how breakeven inflation in the US has moved, and if we look at the global fund manager surveys, it tops the list of concerns. Emerging market exposure can be very helpful in a more inflationary world. Higher exposure to emerging markets assets makes a lot of sense in a world of higher inflation, especially to those with explicit linkage to higher inflation trends in emerging countries like Brazilian or Mexican inflation-linked bonds.