8th September 2015
Quantitative easing has exerted a gravitational pull on developed market assets but it means they are sitting on an interest rate timebomb argues Jan Dehn, head of research at fund manager Ashmore.
Dehn says fundamentals are still much stronger in emerging markets, and investors in developed markets are in effect sitting on a time bomb ahead of monetary tightening.
“The markets know it, hence the recent volatility. The ECB knows it, hence its preparation last week to further ease policy. Even members of the FOMC know it, hence their inability to clearly signal the direction of travel” he says.
In note issued this week, Dehn says EM economies are coping with a raft of external headwinds at the moment, including capital outflows, lower commodity prices and negative risk sentiment which, inevitably, lead investors to view EM with caution.
“These factors matter at the margin, but they are not enough to create a crisis for the asset class. Nor do we expect this to be the case. As we argued last week, this is a ‘non-crisis crisis’, a case of asset prices weakening far more than justified by fundamentals within the asset class.
“It is no wonder why this is happening – the gravitational pull of the QE sponsored developed markets is sucking capital from EM. The bubble valuations in developed markets are therefore a mirror image of the excessively cheap valuations in EM. Asset prices have long ago lost touch with reality and could continue to do so for some time. However, investors must always bear in mind that the key to returns over the full cycle is not how EM is priced relative to developed markets, but how each and every asset is priced relative to the underlying fundamentals of its specific issuer. On that metric, EM offers value, while investors in developed markets are sitting on an overvalued ‘time bomb’.”
The note then looks at various EM market positions.
Ratings agency, Moody’s, stated last week that Brazil’s economy did not justify junk status. This is a minor palliative in what was otherwise a fairly horrendous week for the government. Rumours continue to swirl that finance minister, Joaquim Levy, will leave, though the government went out of its way to give him its backing last week. Levy’s departure would be a serious blow to President Dilma Rousseff and would bring her one step closer to impeachment. Moreover, it is unlikely that a stronger finance minister would want the job, so confidence in the recovery would weaken further. That would not go down so well after last week’s nasty data surprises.
The government has taken steps to eliminate a major uncertainty affecting foreign institutional investors in India by dropping a demand that such investors pay minimum alternative tax (MAT) on investments undertaken prior to 1 April 2015.
There was further confirmation this week that the next administration will seek a speedy resolution to the holdout issue, when an advisor to Daniel Scioli – who leads the presidential election race – said Scioli was willing to talk to holdouts. The change in tack for Scioli was made possible some weeks ago, when serving Economy Minister, Alex Kicillof, in effect said the same thing. In related news, local news sources reported that the government has put a proposal to a US court that both holdouts and the government present their demands in order to begin the process of finding an agreement. Our view is that the next government will want a speedy resolution to the holdout issue in order to be able to undertake a relatively gentle macroeconomic adjustment supported by renewed external borrowing.