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  • Market Insights

    Eyeing Emerging Markets and Commodities in 2018

    Jan van Eck ,CEO
    March 01, 2018
     

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    U.S. interest rates are continuing to rise, and Europe looks almost ready to follow suit. As interest rates start to "normalize", opportunities are opening up in emerging markets and commodities.

    With our one to two year outlook, we see the fixed income market at a big inflection point. Our prediction is an aggressive 3.5% on the 10-year rate, which is not that far from the current 2.7%, but a jump could still come as a surprise to the market.

    If faced with duration or interest rate changes as risk factors, emerging markets and high-yield bonds may present more opportunities than government or investment grade bonds for fixed income investors.

    Interest Rates on the Rise

    Interest rates globally are "normalizing", kickstarted by the U.S. about two years ago when it stopped quantitative easing and started increasing interest rates.

    U.S. Treasury Issuance and Fed QE

    Chart showing government bond issuance and ECB QE as of October 2017

    Source: IMF, Deutsche Bank Global Markets Research. Data as of October 2017. Not intended to be a forecast of future events, a guarantee of future results or investment advice.

    Europe is about two years behind the U.S. on this and is showing signs of tightening. The European Central Bank has started reducing its bond purchases, which is a sign that interest rates could turn positive, but it has a trickier market dynamic to navigate. The role of the central bank in Europe is much bigger relative to its market size than in the U.S., so its actions can potentially have a more significant effect on the market and market psychology.

    Government Bond Issuance and ECB QE

    Chart showing government bond issuance and ECB QE as of October 2017

    Source: IMF, Deutsche Bank Global Markets Research. Data as of October 2017. Not intended to be a forecast of future events, a guarantee of future results or investment advice.

    Central banks globally have learned to move slowly enough to be fairly predictable, so we think easing will be carried out in an orderly way. However, the possibility of a large impact means the European Central Bank’s activities will still need to be watched closely.

    Emerging Markets Attraction

    As interest rates in the U.S. and Europe normalize, emerging markets debt can provide investors with portfolio holdings that are not part of that interest rate dynamic. For investors, a key issue with local currency debt is their view on the U.S. dollar. We lean bearish, though if global growth continues, dollar strength would be less of a concern.

    On the emerging markets equities side, we think there is still room to run as cash flow for emerging markets stocks continues to grow. After several years of underperformance, investors may still be under allocated to emerging markets equities. As the turnaround in this asset class continues, we expect this to change.

    China Economic Health Remains Vital

    China holds an important role within the world economy. If China experiences a slowdown, virtually every asset class would be affected.

    An interesting development over the past year has been the emergence of "new China". Technology is becoming a major part of the economy, with the market capitalization of tech stocks now making up about a third of the overall market. That is a dramatic transformation from "old China", which was based on manufacturing and property. Balanced growth between consumer-oriented new China and old China would be positive not only for the country itself, but also for global growth.

    Commodities the 2018 MVP?

    With global growth kicking in and fueling demand, commodities are well positioned for a strong year. Beyond the macro trends, commodity companies have been undergoing a rationalization process over the past few years. This has provided added support for prices.

    Commodities are still in a bit of a grind cycle and have not received major attention yet, but significant opportunities are emerging within this space.

    Preparing for Bear Market Signals

    The world economy is growing, the U.S. economy is growing, and nothing seems radically out of balance in terms of government policy. This all creates a positive environment for equities, but investors have to start thinking about and preparing for a correction.

    A central question that one of our investing themes at VanEck looks to address is, "Do you have strategies in your portfolio that will actually adjust to bear market signals?" After 10 straight years of seeing the market going up, it may be hard to think about anything else, but the time may have come for investors to start positioning themselves for a correction.