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Beyond the stock market: the attractiveness of emerging debt for all of 2023

Date: April 17, 2024 Time: 08:36:36

Some investors seem to be obsessed with the behavior of the stock market, ignoring another class of assets whose profitability has improved substantially. This is the case of fixed income, which has reached levels in the yield/risk binomial that have not been seen in a decade. Historic appeal could be building, not only in developed markets, but also in emerging countries.

A fundamental factor seems to have changed the schemes and moved the perspectives, for the better, through the air: the lifting of the Covid restrictions by China. That is why foreign and local currency denominated emerging sovereign debt rose in the fourth quarter of 2022.

Specifically, high-yield sovereign debt denominated in dollars was the one that increased the most, with a reduction in spreads of 175 basis points (bp). “Sub-Saharan African issuers were the biggest contributors to the market rally, despite growing concern from credit rating agencies that the external debt burden is reaching unsustainable levels in the various countries of the region. ”, describes Jeremy Cunningham, director of investments of Capital Group.

Would this backdrop suggest that the attractiveness will continue to grow? “Emerging fixed income markets are turning around,” says Luc D’hooge, head of emerging markets fixed income at Vontobel, who has seen a number of signs suggesting this year could be more positive for this asset class. “After a difficult year with high volatility, valuations are not in line with fundamentals, offering opportunities for active managers,” he adds.

Many investors considering that current valuations already discount the increasing risk of potential debt defaults or restructurings in these countries. “In our view, any factor that favors a weaker dollar, such as a pause in interest rate hikes or a rate cut, could benefit EM currencies in dollar terms,” says D’hooge. “These potentially favorable currency dynamics and attractive real and nominal yields, especially in certain Latin American countries, lead us to slightly favor investing in local currency-denominated debt,” she adds.

the big rally

Fixed income markets, and particularly emerging ones, have recently experienced a wave of optimism. Although the Federal Reserve has not finished raising rates yet, there will be fewer hawkish surprises from the monetary authority in 2023 as disinflation has been ongoing for several months. Or so would be expected, according to what the market consensus discounts.

The Fed’s new dot chart has confirmed what markets already knew: the central bank intends to raise rates to around 5-5.5% and then pause to see how the economy and inflation react after this aggressive hardening process. However, the rate of job creation in the labor market continues to be more than twice the rate of growth of the active population. As a result, we continue to expect a probable late – and not imminent – ​​recession in the United States. “This should allow the Fed to keep rates around 5% for longer than the market currently anticipates.

Overall, the combination of attractive valuations and yields across much of the asset class with good policy management in some of the largest issuers of local currency debt could provide a favorable environment for EM in 2023. However, the Continued economic and geopolitical uncertainty calls for a more prudent and diversified approach.

The perspectives

The experts considering that in the coming months we will continue to live with the same uncertainties: inflation and interest rates, geopolitics and a global recession. However, the 2022 correction in fixed income markets seems to be behind us. “The chances of a serious recession in Europe have further diminished after European gas prices have returned to their pre-war level,” says D’hooge.

Fixed income tends to present an asymmetry in its potential result. In the low yield environment, we had this asymmetry for years, which meant that bonds could fall more than they potentially could go up. This was an obstacle for fixed income and a support for equities.

The Vontobel manager points out that this asymmetry does not occur in the equity markets, which also faces an uncertain economic context, as the pricing power of companies is called into question as their costs increase. “We believe that many investors will rebalance their assets in favor of fixed income, especially in the United States, where pension funds are heavily invested in equities. With its high-yield potential, emerging market fixed income is probably a good alternative for them”, he elaborates.

Finally, the technical aspect will also continue to be positive for emerging market bonds. “Not only are emerging markets facing better prospects in 2023 than most investors would have thought in October, but the technical picture is quite positive,” D’hooge concludes.

* This website provides news content gathered from various internet sources. It is crucial to understand that we are not responsible for the accuracy, completeness, or reliability of the information presented Read More

Puck Henry
Puck Henry
Puck Henry is an editor for ePrimefeed covering all types of news.
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