- Deutsche Bank discusses the recent stress in global credit markets and notes the remarkable strength of EM assets. It argues that the apparent “safe-haven” behaviour of these assets has a fundamental basis due to the broadly favourable macro environment and strong fundamentals. It says that “we are impressed by the resilience of EM assets to the widening in US and European credit spreads over the past week, despite the fact that we have been arguing for more than a year that EM fundamentals justified a decoupling from and out-performance of developed credit markets.”
They also argue that, given the magnitude of credit spread widening in the US and Europe, EM is benefiting from a flight-to-quality effect. “The improvement in the relative performance of EM during each successive shock to global credit spreads over the past year could be an indication that the asset class is indeed being treated as a safe haven.”
They also explain that local currency markets have entirely weathered the shock in global credit. “This solid performance by the traditional ‘barometers’ of EM risk appetite suggest that those investors suffering losses as a result of the shock to credit spreads do not hold a significant amount of EM local currency assets, otherwise there would likely have been some contagion as a result of general risk-reduction.”
They recommend “the best risk-reward in EM being in long exposure to BRL, TRY, COP, PEN, SGD, RUB and EGP. In local rates we like real rate exposure in Argentina and Brazil, nominal rates in Colombia and Taiwan and curve flatteners in Hungary, Poland and South Africa.”
Barclays Capital in their “Global Outlook – Implications for financial markets” report cautions that this remarkable resilience is marred in the short-term by a global growth slowdown rather than higher core market rates. “If core market measures of underlying inflation do not remain so well-behaved, the issue for EM is whether this has (negative) repercussions for US growth and equities. Only if the latter issues come to the fore would we view EM with a more cautious lens. “
But, overall it has an optimistic assessment of EM asset valuations due to improvements in macro-fundamentals and long-term potential. “EM economies are seeing more diversified sources of growth – domestic demand is rising sharply and external demand is increasingly diversifying away from the US economy”
- Mohamad Hawa of Credit Suisse in ‘GCC Equity Strategy’ argues that the region’s equity markets are the most attractive globally according to the EV/EBITDA ratio, adding that the region is witnessing the most favourable conditions in over two years.
Assuming oil prices remain high and fiscal disciple remains, he recommends that long-only portfolios take the following positions against the MSCI GCC Index: an overweight stance on UAE (1.33x the index) and Qatar (1.27x); a market weight stance on Saudi Arabia, and an underweight stance on Kuwait (0.7x). But he cautions that significant risks cloud this positive view, including a crash in the real estate market in Dubai that would have an impact on UAE banks’ asset quality, as well as risks from “high structural inflation and overall corporate governance”. Additionally, he cautions that a war against Iran could stimulate a flight to safer assets such as sovereign bonds and gold.
On the banking sector, he notes that the market is more mature than its emerging markets counterparts. “With the exception of the Czech Republic, all countries in our comparison universe have lower deposits-to-GDP and loans-to-GDP ratios than the GCC Banking sector.” He projects growth to be higher in markets with lower penetration, such as Saudi Arabia, and also expects infrastructure financing activities in Abu Dhabi to see strong growth.
“In the short term, we expect growth in highly penetrated markets to be fuelled by sourcing funds from international markets through medium-term notes and Sukuks (UAE banks in particular). We anticipate cross-border mergers and acquisitions as a potential growth driver in the medium term, as they enable banks to diversify risk, decrease the cost of funding, and provide the balance sheets needed to tap into the infrastructure and mega-project financing business.”
- Dmitry Shishkin of Standard Bank argues that the Russia banking sector offers significant arbitrage opportunities. “Some rouble bonds are trading above and some below their respective external debt curves (HCFB and RosBank are the most striking examples). Buying the yield premium in one pair of bonds while selling the other minimizes exposure to credit, currency and duration risk whilst still providing positive carry.” It recommends going long in RUB-denominated bonds as hedge against a USD/RUB downside.