Being less negative on emerging markets isn’t the same thing as being bullish, even if the asset moves are encouraging.
The rally has cooled, but stocks are still near a six-month high, bearish bets on most emerging-market currencies are down this quarter and carry returns are around the highest since July.
Given the list of idiosyncratic risks plaguing emerging economies, the feel-good rally from a possible trade deal between the US and China could easily stumble. China’s request for a rollback of tariffs before agreeing to sign a deal with President Donald Trump has already stymied the market’s advance yesterday.
In South Africa, the government has three months to save its investment grade rating, a feat some analysts say is near impossible given the financial burden of keeping some of its largest companies from ruin. And hours after the yuan broke through 7 per dollar on Tuesday, the top forecaster, Commerzbank AG’s Zhou Hao, said the rally won’t last. A symbolic rate cut shows the central bank may be wary of a strong currency.
As for the trade truce, the prospective deal wouldn’t address most of the major structural complaints America has made, according to US Commerce Secretary Wilbur Ross.
“I would be cautious on these trade discussions,” Rainer Michael Preiss, executive director for client investments at Singapore-based Taurus Wealth Advisors Pte, which manages $1.7bn, said in a Bloomberg Television interview. It “reminds me of the discussions about the US and North Korea. There is a lot of talk, nothing has really happened. Like North Korea, the China dispute is, in my opinion, more of a cold war than just a trade issue.”
So while net long contracts on the Mexican peso, one of the most-traded emerging-market currencies, are at the highest since May, short contracts are at the highest since March. And even though the South Korean won has outperformed peers over the past month, rising more than 3%, the premiums that options traders pay to sell the currency using three-month risk reversals over the one-month contract has widened to the most since June, signalling that the currency’s advance may be short-lived.
Then there’s Turkey, whose real rate of about 5.5% may be as good as it gets for now. Inflation may have bottomed out and borrowing costs, which already plummeted 10 percentage points this year, will probably continue falling under central bank governor Murat Uysal’s watch. Since Trump sparked the trade dispute, investors have come to appreciate – and take advantage of – any lull in the war of words. During rallies like the current one, risks that include deteriorating credit quality and protests are overshadowed by a hunt for bargains.
It won’t take much to derail the rally, as recent history shows. An escalation in tension between the US and China, or a tightening in US financial conditions would do it, said Hemant Baijal, a New York-based senior portfolio manager at Invesco Ltd.
Until sentiment turns, there’s value to be had in emerging markets. Baijal says local-currency bonds “remain constructive” as easier financial conditions in the US provide room for developing-nation central banks to cut rates. Equities are starting to look cheap on absolute and relative valuations, according to Damien Loh, the chief investment officer of macro hedge fund Ensemble Capital in Singapore. They’re even more compelling because of the dollar’s strength, he said.
And Goldman Sachs Asset Management is overweight high-carry currencies, according to a note dated November 1. At the same time, the analysts injected an element of caution.
“These exposures are sensitive to risk-off sentiment around trade news-flow,” they said. “As such, we hedge our positions with overweight exposure to perceived safe-haven currencies such as the Swiss franc and Japanese yen and underweight positions in Asian currencies, including the New Taiwan dollar.”
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