Last updated: 14:29 / Wednesday, 20 June 2018
interview with HSBC

"A Stronger Dollar Should Benefit the Emerging Markets Export Engine and Their Liquidity Should Be Less Vulnerable Than in the Past"

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"A Stronger Dollar Should Benefit the Emerging Markets Export Engine and Their Liquidity Should Be Less Vulnerable Than in the Past"

Despite the challenges in the form of monetary tightening in the United States or geopolitical factors, emerging market equities this year have everything to gain. The reason? Levers such as valuations, earnings growth expectations and the confidence of investors. This is what Nick Timberlake, responsible for Global Emerging Equities of HSBC Global Asset Management, states in this interview with Funds Society.

Is the global synchronized growth scenario in danger? If this is the case, how could this impact the emerging world?

Global growth remains strong, though there has been a slight loss in momentum recently. Emerging Markets continue to be the key driver of global growth, and we expect them to contribute about 70% to total GDP growth in 2018. Many Emerging Markets remain in a “Goldilocks” environment of strong growth and low inflation. Some countries have scope for monetary easing, while some countries are taking advantage of growth acceleration to implement long-term economic reforms. Different inflation levels across countries is leading to policy divergence. This can affect relative interest rates and currency strength, particularly resulting in higher US interest rates and a stronger USD.

What will be the impact in emerging markets of a higher inflation, a cycle of rate hikes in the developed world, and a potential greater strength of the dollar?

Inflation remains relatively low in most Emerging countries, despite cyclical inflation in the US. A stronger USD should benefit the Emerging Markets export engine. Emerging country liquidity should be less vulnerable to a stronger USD than in the past, given that governments have reduced the proportion of short-term USD debt and improved their current account deficits. This makes the country’s liquidity position less sensitive to foreign exchange movements. Many emerging countries have improved their fiscal positions, and increased macro credibility provides them a degree of monetary policy flexibility if needed.  Certainly countries with a twin deficit are likely to be more sensitive than others.

Nonetheless, many experts are positive regarding emerging countries fundamentals, do you agree and why?

We are also positive on the fundamentals of Emerging countries. Fiscal budgets are better managed. For example, Russia has reduced the “oil breakeven” of its budget to reduce its sensitivity to fluctuations in oil prices. Monetary policy is more credible. A lower inflation environment in Brazil has allowed its Central Bank to implement aggressive monetary easing. Government reforms continue to strengthen the foundations for long-term economic growth. For example, Brazil is reducing its fiscal deficit through economic and anti-corruption reforms, while Mexico has a broad, long-term reform programme including energy, labour, and education. China is reducing capacity at state-owned enterprises and deleveraging.

Do the stock markets of emerging countries have potential to grow in 2018? At what pace or at what levels?

It is difficult to specify how the equity market will move, but, from my experience, this is the type of environment that should be positive for Emerging Markets equities and for active managers specifically.

Earnings drive equity markets. What is important for investors is that strong economic growth is translating into corporate earnings growth. Earnings growth expectations remain in double digits for 2018 and 2019, across most sectors and a majority of countries, though earnings revisions have moderated from a high level.

Valuations look attractive relative to profitability, though valuations are not as cheap as they were at the beginning of last year given the strong equity market returns. Emerging Markets equities offer a similar return on equity compared to Developed Markets equities while trading at a lower price-to-book valuation.

Investor sentiment has been positive. We have seen strong flows into the asset class over the past two years, yet global equity investors remain underweight Emerging Markets.

What is the biggest strength of emerging markets equities this year? The attractive valuations, corporate results outlook ....?

The biggest strength for Emerging Markets equities this year is that all the drivers we just discussed are present at the same time. We believe this combination of factors creates a positive and attractive environment for Emerging Markets equities.

What could be the impact of Fed’s rate hikes on the equities of the emerging world?

Investors should expect cyclical inflation at this point in the economic cycle. The current pace of Fed rate hikes has been well-flagged and has been priced in by the market. We are monitoring how high capacity utilisation, potential trade tariffs, and deficit spending could lead to higher prices and could cause the Fed to raise rates faster than expected. A much faster pace of rate hikes could lead to more volatility in equity markets in general, not specifically to Emerging Markets.

Currently, the volatility is stronger... Is this going to be the case in the stock markets of emerging countries.  Which are the potential consequences?

Volatility in Emerging Market equities reached the lowest point in a decade in January 2018 and has been near pre-financial crisis levels, so a pick-up in volatility was expected and has not come as a surprise to us. There are any number of reasons why uncertainty increases or investors begin to have differing views of the future. Inflation, trade tariffs, and geopolitical tensions are the first examples that come to mind. As active managers, we need to monitor these issues and incorporate our perspective into our stock selection and portfolio construction. I should note that higher volatility can be advantageous, as it can create investment opportunities where we see our fundamental outlook has been mispriced by the market.

Which are the more attractive markets? (Africa, Latin America, Eastern Europe, Asia ...)

Our region and country positioning is driven by our stock selection. This allows our portfolio positioning to be guided towards the areas of the market with greater opportunity. On a regional basis, we are overweight Eastern Europe and underweight Asia and Latin America.

On a country basis, we are most overweight Russia, given a stable macroeconomic backdrop, accelerating growth, and attractive valuations.

Regarding Latin America: with which markets are you more positive and why?

We are less positive on Latin America relative to other parts of Emerging Markets. On a country basis, we are somewhat neutral in Brazil, and we are underweight Mexico, Chile, and Peru. Mexico valuations are high relative to other Emerging Markets, and there is election uncertainty. Chile has fundamentally attractive companies but valuations are again high. Peru has a limited universe, and valuations are not attractive.

The situation in Argentina is complex following the support requested to the IMF ... are you positive on that country?

Our Frontier Markets has exposure to Argentina. The country has been implementing structural reforms that we feel should support long-term growth. Any IMF support would help to reinforce that path. Our Global Emerging Markets fund currently does not have a position in Argentina.

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