What emerging markets to invest in as Japan prints money
The decision by the Bank of Japan to boost inflation suggests more liquidity is on the way; but a HSBC strategist says investing it is a different matter
Unlike previous rounds of quantitative easing by the world's major central banks, this new round of QE does not come after a period of risk-off sentiment and depressed valuations, so it should have a different impact across asset classes, Pablo Goldberg, global head of emerging markets research at HSBC Securities, said.
While maintaining its bullish stance on local debt in emerging markets, HSBC Securities reduced the equity position, replacing it with a bigger allocation to external debt, especially dollar bonds from high-grade sovereigns.
In a note on emerging markets cross-asset strategy, Goldberg said he expected hard currency bonds to have "some sort of revival" and was adding to the position.
"We fund that by reducing risk to EM equities across the board, where most of the disappointments have taken place year-to-date," he said, noting that while the S&P 500 accumulated gains of around 9% so far this year, hitting a historical high, the emerging markets MSCI index retreated by around 4.5%.
Some of the underperformance in emerging markets equities can be explained by "disappointing growth data" in countries like Brazil, India, the Czech Republic and Poland, and by the competitive pressures that a weaker Japanese yen puts on economies such as Korea and Taiwan, he said.
Added to that is the fact that almost 60% of companies in emerging markets tracked by HSBC Securities missed earnings expectations for the final quarter of last year.
This is because, as central banks in emerging markets continue to focus on growth despite very tight labour markets, gains in wages are putting pressure on corporate profit margins, according to the HSCB strategist.
However, he still believes emerging market stocks "will have a strong 2013" but will continue to underperform bonds in the near future.
He has an out-of-consensus overweight position on Brazil and is also overweight on China, Indonesia on Turkey. He cut Russia to neutral and maintains underweight positions in Taiwan, South Africa, Central and Eastern Europe and Mexico.
In the debt markets, with the 10-year US Treasury yield consolidating below 2%, "we expect the high-grade [hard currency EM debt] to recover some of the ground lost in the first quarter of the year," Goldberg wrote.
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In the high-yield hard currency EM debt, the HSBC team of strategists continues to be overweight Venezuela and is maintaining an underweight on Argentina, which is embroiled in a legal battle that could lead it to a technical default.
In the local debt market, the Bank of Japan's move should provide "new impetus to foreign appetite" as it pushes down yields on the safest investment categories.
"In this context, we favor the back end of Indonesian, Philippines, and Indian yield curves," Goldberg wrote.
"Elsewhere, we continue to see value in the 10-year sector in Mexico, and the back end of Colombia, Israel, Russia, and Hungary. We also favour the front end of Mexico and Korea, where there is room for further pricing of a new rate cut."
In foreign exchange, with many central banks in emerging markets showing "aversion to prospects of rapid currency appreciation," the recent measures taken by the Bank of Japan would most likely "add to the anti-appreciation mood" and not just in Asia but in countries such as Chile, Colombia, Peru or even Turkey."If there is an emerging market currency you like to own, it is very likely that its central bank will prefer you not to buy it," Goldberg said.
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