Emerging market assets have broadly underperformed in the past week or so, underscoring the collapse in confidence in several emerging Asian economies.
There are a few explanations for the sudden drop-off, which include China’s economic weakness and possible credit squeeze concerns, the withdrawal of global liquidity as the Federal Reserve tapers its asset purchase programme and economic problems and political instability in countries such as Thailand.
These concerns have not only led to a selloff in Asian equity markets – with the Hang Seng Index losing 2.9% to close at 21,397.77 on Wednesday, its lowest level since July – but debt markets have also underperformed.
Asian high-yield cash spreads widened by 8bp last week, whereas in the investment grade space, the cash spreads widened by 6bp, according to Morgan Stanley.
While there are undoubtedly strains in some emerging markets, the outlook is actually more benign than the headlines suggest.
“While it’s not a surprise that Asian markets should be suffering given the current return of investor risk aversion within the global emerging markets universe, Asian economies and companies are in a relatively strong position to ride out the storm caused by the retreat of the tide of artificial global liquidity as the Fed’s tapering clicks in,” said John Ford, chief investment officer, Asia Pacific at Fidelity Worldwide Investment.
Hard lessons learnt from the Asian financial crisis of 1997 mean that – in large part – the structural economic problems laid bare by tapering are confined to countries outside the Asia-Pacific region, notes Ford.
Where this is not so obviously the case, China’s combination of a closed capital account and still huge financial muscle in the form of reserves at the central government’s disposal is likely to buy it the time necessary to allow an ongoing reform programme, added Ford.
Other fund managers agree.
“It would also be wrong to get too hung up on the current weak patch in the Chinese economy,” said Gary Dugan, chief investment officer, Asia & Middle East at Coutts. “There is a strong suspicion that data releases haven’t been adjusted properly due to the timing of Chinese New Year.”
“Hence the bias is for data to be under-reporting China’s economic reality,” he added. “We wouldn’t go so far as to suggest that the Chinese economy is vibrant but the doomsters are overdoing it.”
China’s official Purchasing Managers’ Index (PMI) dipped to 50.5 in January from December’s 51, highlighting slowing growth in manufacturing as well as services.
BoJ to pick up the slack
Although the US’ quantitative easing would significantly diminish the funds available for emerging markets, the Bank of Japan is likely to be increasing theirs, according to Coutts in an emerging markets report on February 3.
US QE is equivalent to about $1 trillion, while the BoJ’s current programme is approximately $600 billion.
“The two programmes only overlapped from April last year. So in a sense the US is handing the QE baton on to Japan,” said Coutts’ Dugan. “In all likelihood the BoJ will further expand its QE from April, when the sales tax increases.”
The Fed trimmed its monthly asset-purchase programme by $10 billion to $65 billion per month last week – the second consecutive cut following December’s. Policymakers will not meet again until March.
The withdrawal of US QE is not leading to a general rise in short-term interest rates. In fact, the US central bank is committed to keeping these rates near zero until end-2015.
The European Central Bank also looks likely to keep interest rates at near zero for some quarters to come and the BoJ can only dream of raising interest rates, says Coutts.
As a result, the fund house believes that investors will continue to seek yield and will look to buy back into EM debt given the now attractive yields. For example, dollar debt on yields of 6% and equity markets on single-digit price-to-earnings multiples offer good long-term value.
