November was not kind to EMs among other asset classes. After a strong October, portfolio outflows in emerging markets reached their largest since the 2013 according to fund flow statistics recently published by the IIF. Non-resident portfolio outflows from EMs are estimated to have surpassed US$24bn in November, with EM debt making up the largest share of that figure.
EM equities saw outflows of US$8.1bn, whilst debt saw US$16.1bn in outflows. On the debt side, US$14bn of those outflows were seen after the election result on November 8.
There have only been four months with bigger outflows since 2005 – and three occurred at the height of the global financial crisis, according to the IIF. The other followed the 2013 ‘taper tantrum.’
This is part of what investors and observers are starting to call a bond market meltdown that has so far seen global bond losses top US$1.7tn, the worst monthly loss on record – and according to Bloomberg, nearly three times the gains in world equity markets since the US election result.
That the election result was so proximal to a potential rate hike from the US Federal Reserve exacerbated a short-lived rally in US Treasuries and a much more protracted sell-off in riskier assets like EM and high yield debt, sending liquidity largely into US equities.
The big liquidity and price shifts have left many EM fixed income investors cash-rich and looking for opportunities, with many having initially waited on the sidelines to see what kinds of policies we can expect from President-elect Donald Trump. He has so far reversed himself on a number of fiscally sensitive fronts including his campaign promise to build a wall along the US-Mexico border and his pledge to repeal the Affordable Care Act, and softened his rhetoric around the deportation of millions of undocumented migrants – which would have carried significant negative implications for remittances going to Mexico.
“The risks are certainly elevated so we are running the portfolios with high cash levels, and are waiting for selective opportunities to add risk when the markets look oversold,” said Sam Beavan, a credit analyst at Aberdeen Asset Management, which manages about US$405bn in assets.
“Going into the election, we had been reducing risk in general by reducing duration and paring back our Mexico overweight,” he said, a trade strategy many investors Bonds & Loans approached had deployed.
Trump’s rhetoric around Mexico, the North American Free Trade Agreement and trade in general has clearly had an impact on the country’s asset prices. Spreads on Mexico’s sovereign bonds have widened by almost 40bp since November 8; observes believe spreads will likely to continue to widen until the President-elect is sworn in.
“US rates remain the primary driver of returns in the EM bond markets, which will also focus on the likelihood of Trump softening his policy rhetoric, particularly with regards to trade – clearly the biggest driver for EM,” he added.
It remains difficult to get a strong sense of the policy nuances we could expect from Trump’s presidency, despite a softening of his campaign rhetoric. As a result, many EM investors seem to be sticking with their convictions and proceeding with caution.
“I am currently on the sidelines,” said Sergey Dergachev, who leads Union Investments’ emerging market corporate bond team.
“In the meantime, I like strong domestic stories in emerging markets that are less dependent on international flows or US and global trade, and where good momentum is visible. For instance, I favour Indian corporate debt; I also like corporate debt from Russia and Turkey. I am still cautious on Malaysian debt and Hong Kong debt where valuations are still relatively expensive.”
EM investors and analyst also point to the challenge of assessing how Trump’s policies on immigration and the economy could affect remittances to foreign countries, particularly those concentrated in Latin America. Mexico, El Salvador, Guatemala, Honduras, and the Dominican Republic are cumulatively estimated to receive over US$22bn in remittances from unauthorised immigrants according to M&G Investments. Any move to deport millions of these migrants from the US could have a dramatic effect on these markets (and the US).
Investors are working to develop trade strategies that help balance the likelihood of Trump’s policies on trade and immigration coming to fruition in search of relative value.
Thomas Christiansen, a PM on the emerging market debt team at Nordea Asset Management, said there are signs Trump’s policies on trade and protectionism, critical determinants of how exporters to the US – which have suffered disproportionately since the election victory – will perform going forward, are starting to crystallise.
“Trump won the election in large part due to his performance in the Rust Belt of the US – including wins in Indiana, Ohio, Pennsylvania, and Michigan. The jobs these people are clamouring for are higher value added jobs, within manufacturing or white goods, for example, and not textiles, chemicals or agriculture,” Christiansen explained.
The recent Carrier deal – which saw the air conditioning manufacturer agree to keep over 1,000 jobs in the US rather than sending them to Mexico, in exchange for so far unspecified concessions – is a good indication of the types of industries the President Elect will prioritise, he said.
Yet the market has so far done a poor job of discriminating between exporters that send manufactured and high-margin white goods and those that largely export textiles or other goods to the US.
“A country like El Salvador, where textiles comprise almost 80% of their exports, should not feel the same pain as Mexico, where more than 65% of exports come from machinery and transportation – mainly automotive, or Vietnam, where despite their producing a lot of textiles, machinery and manufactured goods still account for 20% of its US exports. Yet this is what has happened.”
Between November 7 and 22, spreads on Mexico, El Salvador and Vietnam’s sovereign debt have widened 20%, 16% and 8% more than the index average, respectively.
The smart bet, Christiansen explained, is to short countries like Mexico and Vietnam – where manufactured and high-value goods consist of large portions of their US exports – and go long on countries like Honduras, El Salvador and Guatemala, which mostly sends textiles and agricultural goods to the US.
“The premise of this investment theme working is centred on Trump moving on trade sooner than he could or would on illegal immigrants. It is a lot easier to repeal parts of trade acts or impose new tariffs than it is to find 11 million people, physically remove them from their homes, and get them transported back to their birthplaces. That said, we are already prepared with a “remittances theme” that we would be looking to implement down the road if it seemed like it could become a greater possibility.”
