EMTA Winter Forum, March 5 2013 EMTA Winter Forum, March 5 2013
Winter Forum - March 5 2013

EMTA Winter Forum Speakers Suggest EM Could Reach Bubble-ish Stages

A number of speakers at EMTA’s London Winter Forum suggested that EM assets could be reaching “bubble-ish” stages, while reiterating that opportunities in EM remained relatively stronger than in other asset classes. The event, which was held on Tuesday, March 5, 2013, at JPMorgan’s Canary Wharf offices in London, drew over 150 market participants. Moderator Joyce Chang (JPMorgan) set the tone of the meeting by commenting that in recent years investors had gotten used to double-digit returns, despite earlier cautioning that such returns were not likely to be repeated. “But this year, you really will get lower returns,” she emphasized. Chang displayed a chart of key economic forecasts contributed by the panel, which revealed a wide range of forecasts on such variables as the JPY (from 85 to 105 per USD), the EMBIG (200 to 300 bps) and EM local currency returns (from 4.4% to 10%). Despite record issuances in the first eight weeks of the year, Chang observed that returns have thus far proven lackluster, “and less opportunities are apparent.”

Discussing global economic conditions, Luiz Gustavo Cherman of Itau commented that external risks to EM have declined, with improvement in the Eurozone and little reaction to both the Italian election results and US sequestration.  Rashique Rahman of Morgan Stanley added that with continued G-3 pump-priming, risk-taking and yield-searching were being encouraged.  However, reserve accumulation in EM Central Banks has “flatlined” and EM countries were losing competitiveness as real FX rates rise.  Thus, investors needed to “pick their spots” to find returns; and Rahman cautioned investors that the end of G-3 liquidity would have large repercussions.

Arnab Das of Roubini Global Economics was pushed to explain his firm’s 200 bp EMBIG forecast, notably the most bullish of panel speakers.  He assured his followers there would be no abandoning of his firm’s reputation for “doom and gloom,” instead explaining that, “we are suggesting a bubble, in an atmosphere of very easy monetary policy with the repression of --not the removal of--tail risks.”  For Das, EM cannot absorb the inflows from the three parts of the world with 3% GDP surpluses, which suggested a bubble could be forming.

“It’s ironic to see us as the panel’s bearish forecast at a 300 bp EMBI call,” noted Tim Ash of Standard Bank.  EM spreads have contracted too quickly, he argued, and were not justified by fundamentals; investors were all similarly positioned, and any sign of US growth could lead to potentially “brutal” outflows for EM.  “In my personal account, I would not buy EM fixed income assets at present, you are simply not being paid for the risk,” he declared.

One trend Ash noted was that increased search for yield has boosted his bank’s Africa business.  “Before, we couldn’t get more than a couple of investors on a research trip; now people are going just to make sure nothing is so bad in these economies that they shouldn’t buy.”  Ash expressed frustration that reforms in EM countries have stalled; some of this was because countries were now accessing the capital markets and no longer needed to go to the IMF for financing, he reasoned.

Cherman discussed Brazil’s lack of growth in recent years, a common topic at recent EMTA Forums.  For Cherman, SELIC rate hikes, macroprudential rules and tighter fiscal policy enacted when growth hit 7% in 2010 had dramatic effects because they had not been fully anticipated by the business community; then the Eurozone crisis further depressed growth.  On a longer-term basis, Cherman cited structural issues, such as the lack of reforms, declining productivity and high levels of bureaucracy as weighing down on Brazil’s growth potential.  Cherman saw less than stellar growth for coming years, and estimated Brazilian GDP would rise 3% or lower for the remainder of the decade.  While market consensus appeared to forecast a 100 bp hike at the April COPOM meeting, Itau’s own forecast was an outlier, predicting no hikes unless inflation rose above 6.5%.

On China, Das offered a forecast of only 5% in 2014, noting the “much-vaunted rebalancing to consumption from net trade and investment has not yet been achieved.”  Das followed up that the most important implications would be a de-emphasis on base metals and increased demand for agricultural products, with possible beneficial effects on Brazil while harming Chile.

Rahman’s view on EM reforms was relatively more optimistic than other speakers.  “I think we are starting to see the seeds of reforms in several countries, such as Mexico,” he stated, and continued that lack of current reform efforts did not augur a dearth of future reforms.  Rahman added that a weaker JPY, which now appeared likely, could translate into more investment abroad and increased JPY inflows into EM assets.  Rahman concurred with earlier suggestions that valuations were overstretched compared to fundamentals; “its bubble-ish, but not quite a bubble.”

For trade recommendations, Ash favored Serbia, while seeing the zloty and forint as vulnerable.  Das expressed concern at the lack of structural reforms in the West and Japan and the “palliative” yet “sugar-high” quality of current G-3 policies; “if forced, I would hold my nose and buy high yield bonds.”  Rahman would buy structural reform stories, and Cherman would invest in Chile, Peru or Colombia.   Chang spoke constructively on EM corporates, noting the high percentage of quasi-sovereigns and high-grade debt in the asset class; while remaining positive on Venezuela.

The panel concluded with a discussion of possible market surprises.  For Das, a tail risk could be events in Italy leading to a resurgence of Eurozone instability.  Ash discussed the negative effects on EM of a decrease in commodity pricing.  Stronger-than-expected Chinese growth could lead to Chinese tightening, noted Rahman, while Cherman suggested any steps backward in Latin American reforms could cause great concern.

Kevin Daly (Aberdeen Asset Management) steered the event’s investor panel.  Investors first discussed their thoughts on a rotation from debt into equities and potential outflows from EM.  “It has been a good run, and all good things must come to an end,” observed John Carlson of Fidelity Investment Management, who believed investors would chase returns in equity markets.  Jan Dehn’s firm Ashmore Investment Management traded equities on a tactical basis, although, he stressed, its base allocation was in EM fixed income (and not in the HIDCs or “highly indebted developed countries”).  Greg Saichin of Pioneer Investments stated that some of his clients have increased their equity allocations, although “the big money is not there yet.”

The panel also discussed the US dollar and EM currencies.  Gene Frieda of Moore Capital Management expressed a generally constructive dollar view, believing that the greenback had reached a low point five years ago.  With apparent consensus that local currencies would outperform developed country FX, Frieda mused whether it was time to challenge conventional wisdom.

Carlson seconded Frieda’s positive dollar view.  “Look at the underlying fundamentals; it’s a tough sell to short the dollar long-term,” he affirmed.  Saichin continued to receive client requests for local currencies, driven by rates in EM countries.  Dehn discussed an “’ugly contest’ of money being slushed around in the dollar, euro and yen.”

Daly referred to recent EMTA seminars on the Argentina legal situation, and asked panellists for thoughts on the case, now that “the deck is stacked against Argentina since the February 27 2d Circuit oral arguments.”  Dehn stressed that Argentina was willing to pay exchange bondholders, while US court rulings might prevent the sovereign from servicing its debt.  As a result, Dehn predicted that this would eventually translate into an end of New York-law bond issuance, which he described as “archaic,” “a legacy of the Cold War” and a relic of the Brady bond era.  Dehn suggested that Argentina might offer to swap exchange bondholder debt into local-law debt in order to continue payments, although uncertainties remained.  One needed to trade the debt tactically as Argentina’s economic future was also in jeopardy, notwithstanding the legal issue.

Saichin, the panel’s native Argentine, agreed that Buenos Aires might seek to swap bonds into local-law instruments, triggering a potential technical default,“ but that might be the price they have to pay.”  He regretted his country’s “management--not resource-- problems.”  Carlson opined that corporate and provincial bond yields did not compensate investors adequately for the risks associated with a “mercurial” government.

The panel then reviewed additional EM sovereigns.  On Mexico, Frieda adopted a contrarian stance.  “The numbers don’t really justify the market’s sentiment on Mexico—there is not that much FDI, and growth is not that great,” he stated.  However, he did acknowledge that Mexico was one of the few countries where an optimistic view of reforms was justified.

Carlson addressed China’s critics, highlighting the country’s dramatic economic transition over the past 30 years.  Dehn spoke positively on the planned transition away from export-led growth.  Frieda expressed concern over the lack of transparency, a point he said was critical because of the economic linkages between China and so many other economies.

Speakers expressed continued interest in frontier markets, which Carlson reasoned could have been the correct term for all of EM several decades ago.  Dehn expected as many as 20 new countries in the EMBIG by the end of the decade.  For Carlson, the issue was knowing when investors have poured too much money into them.  Saichin concurred that frontier markets remained shallow,...”but you need to own a little of them.”  Moderator Daly viewed African USD bonds as generally expensive, although some of the local markets, in particular Nigeria, appealed to him with their double-digit nominal/positive real rates following the sharp decline in inflation

Finally, the panel discussed the future of local currency-denominated corporate bonds.  For Dehn, this was surely the next wave; “investment banks tell you they are not investable, but, in fact, these bonds do trade locally, with local counterparties.”  Saichin echoed Dehn’s positive comments, while stressing “one often needs to have smoke signals on the ground to know when new issues are coming; not every investor has those resources.”