On the bond side, hard currency sovereigns returned more than 5% in the first quarter, while local currency was up more than 11%.
Moreover, while news out of the developed world was light last week, news out of the emerging world bordered on the historic.
It started with the lower house of Congress in Brazil voting to impeach President Dilma Rousseff. This was the high watermark to-date of a wide-ranging scandal that is testing the country’s political and judicial institutions.
A few days later, Argentina returned to the international bond markets after 15 years. And what a return it was. The government sold $16.5bn worth of bonds and could have put out four times that. Buyers got a 7.5% yield on the 10-year issue and the “holdouts” in Argentina’s defaulted debt were paid, ending one of the longest-running sovereign-debt disputes.
Both events underline the theme of electorates turning toward more market-friendly leadership in the region, but also two of our longstanding emerging markets themes: at the company level, businesses that benefit from the rise of the domestic consumer; and at country level, economies that benefit from structural reforms. Orthodox economics tend to see the two things as intimately linked, and that may explain why Brazilian assets have rebounded so strongly despite such political turmoil.
Cautious but optimistic
And yet, while we have generally been in favour of increasing emerging markets exposures after the precipitous drop early in the year, our preference has been for shifts that are both cautious and tactical, seeking to exploit short-term moves that may or may not consolidate into something more fundamentally driven.
And we don’t think the fundamentals are there quite yet, which is why more broadly we favour emerging markets debt over equity, and hard currency bonds over those issued in local currency. As long as investors are being well compensated for taking credit and duration risk, our overall caution would weigh against adding high-volatility local currency risk at this stage. We also expect the Federal Reserve to raise rates one or two more times this year, which could give the dollar short-term support and take the wind out of emerging market sails, especially in local currencies.
That means we missed some of the upside despite timing our recent increase in exposure well. But it fits with our overall view that these past two months have seen a “relief rally” in riskier assets rather than a genuine return of confidence, and that the fundamentals have not changed much since the start of the year.