Good and Bad in Emerging Market Debt

Text transcript

This is Richard Lawrence. I’m a senior vice-president on the portfolio management team at Brandywine Global in Philadelphia.

So, what’s the outlook for emerging market debt? Obviously, coming off of 2018, which was a challenging year for some emerging markets, clearly sentiment turned quite negative on emerging markets. We would look at the complex and say that that was really more driven by the strong dollar environment, perhaps dollar liquidity, and it was more of a run on sentiment than it was a deterioration of fundamentals in emerging markets.

Actually, when we look at the fundamentals in emerging markets, they look quite attractive to us. When you look at things like leading indicators, they have clearly turned higher now. Emerging market PMIs (purchasing manufacturing indices), better in emerging markets than they do in advanced economies. The emerging markets overall, from a current account point of view, they’ve cut their deficit in half in aggregate. So in summary, we still think it’s an attractive place to invest. Certainly, there’s a degree of political rift to consider, but then you could argue that’s also true in the U.S., that’s true in the U.K., it’s true in Europe and lots of developed markets, as well.

In terms of markets we favour right now, I would say that the market that we’re most constructive on is still Mexico. Think of Mexico as a high-beta play on the U.S. economy. We think the U.S. economy, while it’s slowing from the highs of mid-2018, are still looking in pretty good shape. We think the U.S. probably grossed somewhere around the 3% level this year. That should be good for Mexican assets. Mexican assets continue to be undervalued.

Mexico itself has gone through a change at the top, with a new president being elected last summer. So far, though, we haven’t seen anything significantly negative from him, although bond yields did back up there in the latter end of 2018. They’ve now rallied again.

Of course, we still need to sign the new version of NAFTA, the USMCA deal, and it’s possible that Democrats in Congress might give that deal a rough pass through Congress. But at the end of it we do think that Mexico and Canada will both benefit from the signing of that deal.

Other markets that we remain exposed to and we like would include Malaysia, Poland, Brazil, Indonesia, some exposure to Chile, South Africa, Colombia. So we really do have a global favourable outlook on emerging markets.

Now, there are certainly some problem children in emerging markets. There are emerging markets that are vulnerable to higher dollar funding costs, U.S. dollar funding costs, and that would include markets like Turkey and Argentina, and those are the ones that came under the most pressure last year. They’re also going through very unconventional monetary policy cycles right now. They have some inflation pressures that they’re dealing with. So those are two markets we’re less excited about, and then of course markets like Venezuela, where you’ve got hyperinflation, and markets that we have absolutely no interest in. Generally, we shy away from investing in frontier emerging markets, and we have a bias toward higher-quality emerging markets.

Looking at a market like Turkey, which is a market we did have some exposure to a couple of years ago, one of the things that we always look for when we’re investing in emerging markets is you want to see strong, independent institutions in the economy. So, for example, you want to see the central bank operate very independently from central government, and any time you see signs that it looks like the central bank may be coming under some political interference from the central government, you start to worry, because if the central bank can’t enact a traditional monetary policy cycle, that makes it very difficult to handicap the direction of assets in that particular market.

And we’ve seen a little bit of that in Turkey, with Erdogan’s administration. Despite pretty high inflation pressures, the central bank has not been aggressive enough in raising rates. The reason why they’re doing that is because obviously raising the rates high enough will cause the economy to slow down too much, and eventually you’ll have the economy go into a recession—and clearly Erdogan’s administration doesn’t want that to happen. So you’re seeing a little bit of interference with the policy cycle, and that’s an example of what might keep us away from investing in a particular market.