Emerging market fundamentals are improving but risks still lurk, says the investment giant
The backdrop of improving emerging market fundamentals warrants a more optimistic approach to investing in emerging assets, according to investment giant PIMCO, with attractive opportunities available in both hard currency and local markets.
“To begin with, consider that EM fundamentals are showing tentative signs of improvement,” writes the global investment giant. It reckons USD strength has abated, commodities have stabilised and the outlook for China, while bumpy, is one of muddle-through, not hard-landing.
“EM currencies have depreciated sharply since 2013, and in some cases have overshot fair valuations, helping kick-start meaningful adjustments in macro fundamentals across EM economies. Growth is accelerating with high-frequency variables pointing to stabilisation and forward-looking indicators signaling a soft rebound in activity.”
PIMCO points out that for EMs as a whole, political and geopolitical tensions are receding. The impeachment of Brazilian President Rousseff has helped foster a more constructive tone in the country, Russia/Ukraine geopolitical tensions appear to have frozen while there are several business-friendly governments coming into power, including in Argentina, India, and Peru.
While they are positive across a range of EM sectors, they warn that there are still risks ahead.
“A renewed bout of global risk aversion would likely pose headwinds for the emerging asset class, which continues to trade with a heightened beta (a measure of volatility) to global markets. Further declines in commodities, an increase in volatility and uncertainty related to China, or an overly hawkish turn by the Fed could all easily shift the cyclical outlook for emerging markets.”
Market technics also a lot cleaner in emerging assets, according to the investment giant. It believes the tremors in EM since 2013 have cleared much of the hot retail money out of the asset class, which reduces the risk of panic selling during periods of market turmoil. At the same time, long-term strategic mandates remain invested and are opportunistically increasing allocations.
“Global flows into EM debt are just now turning moderately positive compared with historical flows, in spite of the strong rally in emerging debt so far this year. Add to this the decline in net issuance in EM hard currency space, and supply technical look better particularly relative to prior years when high net issuance in the corporate space was a headwind for spreads.”