If there is a stress on the economy of a country, it should help to promote exports – and certainly Canada has benefited from that. If you look at the rest of the world, everybody is trying to have a weaker currency.
From a macroeconomic perspective, falling currency is not such a bad thing. For the performance of fixed-income assets in emerging markets, clearly that hasn’t been that great. Local currency bonds have suffered, clearly because of that weakness – but for Canadian investors this fall in local bond valuations has been mitigated, as the Canadian dollar is moving in the same direction. When everything depreciates against the US dollar, Canadian investors are having better returns in Canadian dollars compared to the US.
What do you think is the appropriate spread between EM bonds, and their US and European peers?
Strigo: There are 400 basis points difference on an index spread between emerging market countries and the US treasury (JP Morgan EMBIGD). These levels of spread are rather high compared to historical levels; so we think that going forward there’s some room for these spreads to compress 100 basis points or even more – but that will depend on the overall supportive risk environment and stable interest rates.
Wang: Actually, I’d rather talk about equity market valuations, not bond market spreads.
The S&P 500 in the US is trading at about an 18-times trailing P/E, and the TSX Index on the other hand trades at around 20 times trailing P/E. Historically, the TSX has traded at a premium to the S&P 500, mostly because the TSX Index has many more cyclical types of companies, so sometimes the TSX P/E is distorted because of that.
When I look at the historical valuation spread between the two markets, two multiple points is in line with the average. I don’t think the relative valuation is arguing for one market over the other. However, the better fundamentals of the US economy and the US dollar favour investing in US stocks over Canadian stocks.
Emerging markets – which ones should investors avoid, and which show promise?
Strigo: I believe today, the majority of emerging countries are in a better position to withstand possible interest-rate hikes in the US comparing to past. The levels of foreign exchange reserves are close to the historical highs; the amount of foreign-currency debt is decreasing and total levels of public debt to GDP is significantly lower than in the developed countries; currencies are much more flexible than in the past.
The growth of emerging markets is actually a positive thing, as it adds liquidity and diversification. There are more countries issuing debt; there are countries in South America and Asia that have never issued debt before. So it’s making our universe more interesting and diversified.
The growth of debt has been more on the local currency side – it doesn’t have the same risks attached to it, as opposed to if these countries were issuing debt in US dollars.
On the corporate-debt side, there has been significant growth in emerging-market (EM) corporate debt, but if you look at the composition of that, a large part is from the government-owned enterprises, which arguably are safer compared to privately owned firms. And a lot of that is coming from China, which has the largest reserves in the world; more than $3.5 trillion US dollars. So we don’t think this increase of debt in EM countries is a big risk factor.
Murenbeeld: I’m partial to India. India is going in the right direction; I like the prime minister and I like the governor of the Bank of India – he is an ex-economist from the International Monetary Fund (IMF). I think generally speaking, they are a little more pro-business. Actually, they are one of the few countries the IMF believes will actually do better next year, and they continue to improve.
People tend to focus a lot on China, and they are missing the flowers beginning to grow in India. The population is just shy of China’s, and they are beginning to shift towards a more progressive, pro-business kind of climate. I have a small exposure to India.
Wang: When I look around the world, I still see the US as the best place to put money. And a lot of that is explained by my outlook for currencies, and I think the US dollar will continue to strengthen.
When you mention emerging markets and the more volatile ones, like Russia and Brazil, we have very little direct investment in these EM markets – China included. My preferred way of getting exposure to these volatile, less-mature markets would be to invest in companies that have businesses in those countries.
For example, by investing in Manulife, they have a fast-growing Asian business; so we can get exposure to Japan, Indonesia, China through their subsidiaries. Similarly, by investing in Scotiabank, we can get exposure indirectly to Latin America and to Asia, because the Bank of Nova Scotia is the most international of the Canadian banks. That is my preferred lower-risk way of investing in these emerging markets.