EM Debt 2Q 2014: Emerging Markets in Crisis?
EM in Crisis?
FRAN RODILOSSO: The prospect for emerging markets debt as we head into the second quarter of 2014 is mixed. There has been a lot of talk about a crisis in emerging markets. In our view, the emerging markets are not a single asset class, nor obviously a single country or region. There are pockets in the world that are in a period of crisis. Russia and Ukraine represent significant geopolitical crisis, and the financial markets in those countries and some surrounding countries have reacted very negatively. Venezuela has been in a political crisis for some time. Prices of Venezuela’s debt, however, have adjusted downward over the course of the last one to two years. There are other countries that have been thrown into the crisis category over the last year: Indonesia and Brazil, for instance. Those countries were undergoing significant economic challenges last year but their markets have adjusted in that interest rates moved higher and their currencies weakened. They still have challenges with current-account deficits, but the movement of their currencies and rates have allowed for some adjustments.
To put it into perspective, through March 18 of this year, the Market Vectors® Emerging Markets Aggregate Bond Index that one of our ETFs tracks is up about 0.87% year-to-date. Although 10-year treasuries are up by more than 2% on a total return basis, emerging markets are not far behind the S&P 500 Index's little more than 1% rise year-to-date. In other words, this positive performance does not tell the story of an entire market in crisis.
RODILOSSO: I would be remiss to talk about the emerging markets crisis or potential crisis without discussing China, which has grabbed so many headlines last year and this year. China is raising concerns on several levels. At the margin, China has been a huge source of demand for raw materials which impacts the economies of many other emerging markets. People are concerned about the rate of slowdown of the Chinese economy. More precisely, the talk has been around the excessive lending in China's economy and the beginning of corporate defaults. There has been one local bond and a loan by another issuer that have defaulted. Albeit small, China’s defaults have become newsworthy globally and people are concerned that these are signs of what's to come on a larger basis.
My view on China is that there are some rocky roads ahead. There are pockets of the economy where leverage is excessive, but China is a very large economy and more diversified than what may be reflected in its equity indices. Corporate defaults do not mean that all corporations in China are over-leveraged or are unable to pay their debts. China is a country that bears watching and brings certain risks and potential opportunities. That's our message on emerging markets: when there's bad news, emerging markets tend to re-price more quickly than we as investors would like to see. Those re-pricings may bring in compensation for some of the risks that are being taken.
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