Analysts and bankers are predicting a strong year-end for emerging market issuers and investors as fears over larger-than-expected global interest rate hikes recede. JP Morgan reckons that the asset class could provide a total return of 7% this year.
Diverse factors have prevented a widely-anticipated rout in emerging markets despite a 75bp raise in US interest rates this year. These include: low yields in developed markets, improving creditworthiness of emerging markets, better debt and fiscal management at a country level and the emergence of a deeper pool of institutional investors.
Mark Dow, a portfolio manager who co-manages $1.5 billion in emerging market debt at MFS Investment Management in Boston, says early-year predictions of high global growth rates and precipitous hikes of US interest rates were overblown. He notes that the performance of individual countries is diverging, placing increasing emphasis on selective investments.
This has been exacerbated by oil price spikes that are having a mixed impact on emerging markets. Exporters including Venezuela, Russia and Ecuador have benefited while importers such as Bulgaria and South Africa have suffered. The exception to that rule is Brazil, which though an oil importer, has seen its bonds perform strongly on the back of strong fundamentals, says Dow.
Other long-term trends are having a significant impact on markets. Financial deleveraging has become a buzzword, says Dow. High levels of debt were seen as acceptable in the 1990s. That is no longer the case and many emerging markets have started programmes to bring down their levels of total debt to GDP. These include Turkey and Brazil where bond prices have benefited from determined efforts to reduce debt levels. "They have plenty more wood to chop," notes Dow.
Paul Rawkins, a senior director of Fitch Sovereign Ratings in London, is positive too. He says that rising interest rates have not damaged the emerging markets and attributes this to a range of factors. The number of upgrades to downgrades in emerging markets has been running at a ratio of 5:1. The debt management skills of the big issuers have become increasingly targeted and sophisticated.
He cautions that one possible risk is that of 'crowding out'. With big issuers waiting for the most propitious moment to issue, there could be a glut of issuance that could damage pricing. Fitch expects a total of $52 billion in issuance for 2004 - the best volume since the mid-1990s.
Arturo Porzecanski, chief economist, emerging markets at ABN Amro in New York, predicts that yields will go back up but not reach the peaks witnessed earlier in the year.
A dangerous cocktail of macroeconomic imbalances does pose a substantial risk to this rosy picture.