EM opportunities alive in 2019, says PIMCO

EM opportunities alive in 2019, says PIMCO

EM opportunities alive in 2019, says PIMCO

While uncertainties over economic growth going forward and dovish signals from the Fed suggest a circuitous path for emerging market countries, there are still opportunities for investors who can withstand the volatility that separates the strong from the weak

That’s the view of experts from PIMCO as shared in a recent commentary titled Emerging Markets Outlook: The Wealth of Nations. “PIMCO sees many opportunities within the asset class by focusing on alpha potential,” they said.

They noted that opportunities exist across all major EM asset classes. For external sovereign debt, they cited the strong combination of high yields and defensive characteristics, which can potentially benefit further from an end to tightening US monetary policy. Corporate bonds continue to improve in terms of credit quality, providing options for selective portfolio diversification. Finally, local currency bonds that suffered in 2018 because of US dollar strength are expected to benefit from a stable-to-weaker dollar, reflation in China, and greater scope for central bank accommodation.

The expectations for a weaker greenback stem from signs of slowing global growth and the mature interest-rate cycle in the US. “The recent dovish shift in the Fed’s outlook points to the lowest terminal real fed funds rate in any modern tightening cycle,” PIMCO’s experts said. An end to US dollar appreciation and a rising fed funds rate would ease concerns about tightening financial conditions, they said, adding that a clear turn toward weakness in the currency would be a basis for a more aggressive shift toward local rather than external EM debt.

“[W]e believe it is premature to call for a significant reversal of dollar strength,” they clarified, stating that they’re waiting for evidence of a sustained US growth slowdown. They also noted other risks to their constructive EM view, which include the potential for debt stagnation in China following its long credit boom. As the Fed hints at a likely end to its tightening cycle, they said, China should exercise flexibility, considering domestic stabilization efforts without resorting to a large currency depreciation.

Citing added risks from market volatility and geopolitical tensions, they emphasized the importance of bottom-up credit assessments that integrate material ESG risks and prioritize “idiosyncratic stories that are less correlated to the broader market.”

To examine the diversification properties of EM against the backdrop of 2018’s rise in volatility, they said, they analysed the performance of several EM asset classes against risks from oil prices, credit/equity markets, the US dollar, and duration/bonds. The analysis revealed declining EM asset-class betas to global risk factors, suggesting that EM is increasingly becoming an idiosyncratic investment. EM local bonds, they added, continue to be the least affected by the four major risk factors.

“[W]e would encourage investors to think of emerging markets as a longer-term investment that offers potentially high carry rather than as a shorter-term trade,” the PIMCO analysts said.

 

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