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Spring Forum - April 4, 2011

Spring Forum Speaker Cautious on 2011 Outlook for EM

Speakers at EMTA’s Spring Forum expressed cautious views on the outlook for EM debt performance in 2011.  The event, which was hosted by HSBC Securities USA (Inc.), drew a capacity crowd of 150 on Monday, April 4, 2011 in New York City.

Pablo Goldberg of HSBC Securities (USA) Inc. led the event’s panelists through a series of global economic and EM topics.  He commenced the session by contrasting the first quarter of 2011--with its weak returns and capital outflows-- to the more positive environment of last year, and asked panelists to discuss capital flows and the reasons why some investors have been taking funds out of EM.

Lazard Asset Management’s Denise Simon saw investor interest in the asset class as remaining strong, and stressed that institutional investors remain under-allocated in EM.  “The recent slowdown is probably a good reality check for the market; people have paused, based on valuation and concerns over inflation, although the market appears to be back now on investors’ radar screens.” 

Paul DeNoon (AllianceBernstein) acknowledged he had seen mixed flows.  DeNoon noted flows into EM dedicated funds had been flat, while high yield funds containing EM debt had seen new money.  DeNoon characterized the recent movement as a reallocation, with investors moving to income-generation.  Alberto Bernal (Bulltick Capital) added that local Latin pension funds were moving money into the US market, and that this was reducing a source of dedicated EM support.

Goldberg observed that the global backdrop has moved from concerns over oil pricing, following Middle East events, to deflationary pressures resulting from increased Japanese liquidity.  How would the global economy affect EM performance for the remainder of 2011 and what risks should investors consider?

Simon reasoned that the global backdrop would prove supportive of EM.  Key economic data in emerging countries continued to show strong growth, she stated.  However, for the asset class to tighten, the market would have to see a successful transition after the end of the US FOMC’s quantitative easing (QE2) operations

RBS’ Siobhan Morden agreed that the unwinding of QE2 posed the greatest risk to the market.  “The US has provided unprecedented liquidity, it has been an anchor for EM risk appetite,” she remarked.  The EuroZone and political upheaval in MENA countries also remain causes for concern according to Morden.

DeNoon advised investors to monitor the Bank of Japan for an end to its liquidity operations.  In addition, he also identified high commodity pricing as a concern.  Bernal rationalized that the best possible positive surprise for the market would be stable US job growth.

Speakers were also prompted to name which EM sovereign was most at risk at defaulting in the next two years.  “The only one I can think of is Ecuador,” replied Bernal, who continued, “how can a country not have a trade surplus with oil at $100 per barrel?”  While President Correa had recently given a relatively market-friendly speech, dollarization will remain a problem for Ecuador and paying back the ’15 bonds will be “complicated,” he commented.

DeNoon acknowledged his greatest concern was over-leverage in the corporate sector, “it’s not clear to me that enough analysis is being done,” he warned.  As for which sovereign was most likely to run into payment issues, he cited Venezuela.  “They are running out of reserves…and only rising oil prices will keep that system going,” he commented.

Floating-rate regimes and inflation-targeting make balance of payment crises a thing of the past, according to Morden.  While she didn’t expect a payment crisis in Caracas in the next two years, “the downside price risk is huge.”  She expressed concern that a large number of EM investors have been drawn to Venezuelan debt’s high yields, and remain vulnerable to a sell-off sparked by events such as the December 2012 elections.  The country is “a crisis waiting to happen, and eventually they will run through their balance sheet…but we don’t see a default in the next 24 months,” she concluded.  As for Belarus, which had also been a source of some market speculation, she believed that the sovereign would probably be bailed out by Russia.

Simon concurred that Venezuela was likely to muddle through “unless oil drops below $80 or if there is a G-3 crisis.”  She also seconded DeNoon’s corporate concerns.  “People are reaching for yield, and maybe not doing their homework….some of these issuers should not be borrowing from the market,” she argued.

Peru was also discussed, just a week before the country’s first-round Presidential elections.  Morden expressed concern that a victory by front-runner Ollanta Humala would upset Peru’s recent progress, while adding that, even if he won and subsequently proposed anti-market measures, there could still be potential institutional checks on his initiatives.  To go long Peruvian debt now, she suggested, one would have to be taking the bet of Humala losing or having any anti-market policies blocked.  Bernal agreed and cited the dramatic improvements in Peruvians’ standard of living in recent years.  While Bernal had previously advised clients to buy on weakness, “I am now getting seriously worried…and it is a tough question of where you should be buying.”

Most panelists agreed that EM currency appreciation would continue.  Bernal viewed this as part of the definition of economic development.  “Increased ratings and increased foreign direct investment lead to stronger currencies,” he stressed, adding “we will all have to learn to live with it, it will not be reversed unless there is a shock.”  DeNoon took a contrarian position, and argued that EM currencies could over-shoot, with future levels “not a one-way street.”

Speakers also viewed EM and DM converging more in the future, while generally concurring that EM would remain an asset class if only because most investors viewed it as distinct.  DeNoon argued EM should never really be seen as a unique asset.  (“Equity, real estate…those are separate asset classes.”)  Others noted that Euro-clearable countries or higher-rated countries could move onto DM desks, while some smaller countries would probably always remain in a distinct EM category.

The panel concluded with speaker predictions on returns.  Forecasts on EM external debt were hardly optimistic, ranging from flat (Bernal) to 6% (Simon), with local debt returns in dollar terms slightly more favorable at 6% to 9%.