EM Outlook
It’s complicated
The market consensus has turned overwhelmingly bullish recently, as a growth recovery plus ample liquidity presumably creates a rising tide that lifts all boats, including EM assets. But our EM analysts believe it’s more complicated than that. Identifying key drivers of asset markets and countries and differentiating based on fundamental and cyclical factors will be important to navigate markets in 2021.
The long-term bearish EM currency cycle is not over; it is just delayed. There should be sigificant disperion in 2021 and for aggregate EM FX the 2016-17 cycle (stable) is more likely than the template from 2009-11 (significant appreciation). A gradual growth recovery, a higher US 10y yield, EM easing cycles being mostly over, and fiscal risk premia in some countries mean higher rates and steeper curves. Sovereigns should follow corporate USD HY spreads wider in 1H and tighter in 2H, despite the search for yield that argues for continued tightening. In equities, a broadening of the earnings recovery to the South and cyclicals favours China, Korea, and Indonesia.
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This page contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale, at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for use by institutional and professional investors and is not intended for retail investors. Investors should consider this report as only a single factor in making their investment decision.
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This page contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale, at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for use by institutional and professional investors and is not intended for retail investors. Investors should consider this report as only a single factor in making their investment decision.
© Societe Generale 2020
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We see selective opportunities to monetise dollar-based carry due to central bank policy, protection against a EUR correction, or as yield play with a directional kicker
Monetising FX carry in Asia
A reversal of the COVID trade should cause excessively weak currencies with more vulnerable fundamentals to strengthen while other currencies that were safe havens to weaken. Asia and LATAM to underperform, and the EMEA dollar bloc and CEE to outperform
FX dispersion
6 Keys Calls
African FIC products offer high yields, low volatility and diversification qualities relative to traditional EM portfolios. Egypt and Ghana are attractive; Kenya and Nigeria are more challenging
Selective opportunities in Africa FIC
The earnings recovery should extend into laggard markets and sectors; major Asian economies pledge carbon neutrality, and in the technology sector we can expect greater dispersion of returns
EM Asia equities: rotation, transition, dispersion
(Click on each call to find out more)
Overview
Curve dynamics will likely not be consistent across regions and should be heavily influenced by local, external, policy and technical factors. In some markets, position for residual declines in front-end rates and flatter curves or construct a relative value strategy versus US yields
Idiosyncratic positions in rates
1
Long-end rates higher, steeper curves
Selective opportunities in Africa FIC
5
FX dispersion
3
Idiosyncratic positions in rates
2
Monetising FX carry in Asia
4
EM Asia equities: rotation, transition, dispersion
6
A vaccine-induced growth recovery, supply considerations and higher US 10y yields provide fertile ground to pay long-end rates and position for steeper curves in various EM countries
FX – Don't buy everything
The combination of the three themes mentionned in our overview is clearly bullish for risk assets, particularly in the credit and equities space. We prefer to reduce the rate sensitivity of our MAP ahead of the anticipated rise in bond yields in western economies (thus adding a bit more weight on equities) and increase our exposure to inflation expectations.
With the economy in recovery mode and
infrastructure spending gaining momentum, commodities should continue to do reasonably well, we therefore prefer Commodities to EM fixed income or EM currency exposure.
From the current V-shaped recovery, economic momentum should only start to moderate from the second quarter of 2021, after which rising credit spreads should signal the end of the risk rally.
Rates – higher and steeper
We like the growth theme, but we strongly dislike any heavy portfolio concentration on a very few well-advertised US names. As US technology is set to become more volatile, we recommend diversifying into other growth assets available elsewhere.
We find attractiveness in Asian equities where cyclical acceleration will be a key feature in 2021.
We also find attractiveness in the Australian currency (AUD); Europe, where the Green deal offers multiyear structural growth; and mega trend themes including Asia 5G. On the contrarian side, increasing exposure to cyclical sectors in the corporate space also makes sense after their heavy underperformance (laggards).
Sovereign credit – a follower
Published inflation will stay subdued for a while, a consequence of rising unemployment and keeping alive too many zombie companies. However, the most recent policy shifts from both the Fed and the ECB are clearly aimed at raising inflation expectation (more information on this can be found on the Global Economic Outlook)
Gold, US inflation-protected bonds and steepeners can deliver well in this context. US real yields should thus remain artificially low, sending the expensive USD further down after a potential pause – but the rising Euro could dampen Euro area inflation expectations.
Markets will likely continue to be driven by three key themes until 1Q21: the pursuit of economic recovery via the strongest stimulus seen in decades, with fiscal policy taking the lead (helping final demand), a clear commitment by governments not to trigger early austerity (even in Germany), and a heavy monetisation of new sovereign and corporate issuance by central banks that will strongly distort credit risk. In a world with $14tn of negative yielding debt, portfolio managers with a growing savings pile to be invested are faced with the prospect of further momentum on risk assets and a possible imminent vaccine breakthrough on the one hand, and a potential resumption of volatility and profit-taking on any change in the risk outlook, on the other.
In this context, we retain some momentum in our allocation and we look for the best leverage to rising inflation expectations, rotation within the growth theme and significant portfolio protection.
OVERVIEW
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This page contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale, at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for use by institutional and professional investors and is not intended for retail investors. Investors should consider this report as only a single factor in making their investment decision.
© Societe Generale 2020
Cookies Policy
Legal Information
By continuing to use our website, you are accepting our use of cookies. The cookies we use are "analytical" cookies. They allow us to recognise and count the number of visitors and to see how visitors move around the site when they are using it. To find out more or to change your cookie preferences, please refer to our cookies policy.
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FX – Don't buy everything
The long-term bearish EM currency cycle is not over, it is just delayed, as the vaccine news has improved the growth narrative and provided a shot in the arm for risk assets.
In a reversal of the COVID trade, excessively weak currencies with more vulnerable fundamentals should outperform those with more fundamental resilience. This rotation will mean that average EM currency performance should be roughly flat in 2021, but with the high degree of divergence seen in 2020 continuing into next year.
Our analysts expect Asia and LATAM to underperform and the EMEA dollar bloc and CEE to outperform.
Rates – higher and steeper
Argument for yields to move higher is based on a gradual growth recovery (more powerful if vaccines come online faster), a higher US 10y yield, monetary easing cycles being mostly completed, and in some countries fiscal risk premia.
On the other side, factors that could push yields lower are long-lasting super-accommodative policy in developed markets and structural disinflationary forces.
Sovereign credit – a follower
Sovereign spreads widened to start 2020, exploded higher in March, have tightened significantly since then, but have not recovered to pre-pandemic levels.
Our analysts turned bullish in April, but they are now shifting to a bearish view in 1H21 and a neutral view to end-2021. However, the outlook is complicated.
A large global stockpile of negative yielding debt, long term valuations not being expensive, and higher US 10y yields/lower VIX typically would cause spreads to narrow.
But overall sovereign credit should follow USD HY corporate spreads – widen slightly in H1 and tighten in H2 back to current levels.
Main Themes
Our analysts' base case is that the former factors will win out in a complicated cycle and that EM yields will rise, and the trend of steeper curves will remain intact. Exceptions to this trend could be China, Russia, and Turkey.
EM Asia equity – what worked in 2020 may not work in 2021
Our analysts expect the performance gap between defensive East and cyclical South to continue to narrow as we go into 2021, due to an earnings recovery broadening beyond the Technology sector.
In their opinion, three investment themes should dominate the investment outlook:
(1) Rotation into cyclicals (Korea, Consumer Discretionary sector) and laggards (Indonesia, Financials – selectively).
(2) Green transition, with major Asia economies, including China, pledging to carbon neutrality.
(3) Tech dispersion, a sector that represents more than 40% of the market and where higher valuation and tighter regulation could be the source of more dispersed returns.
EM Asia equity – what worked in 2020 may not work in 2021
Sovereign spreads widened to start 2020, exploded higher in March, have tightened significantly since then, but have not recovered to pre-pandemic levels.
We turned bullish in April, but we are now shifting to a bearish view in 1H21 and a neutral view to end-2021. However, the outlook is complicated.
A large global stockpile of negative yielding debt, long term valuations not being expensive, and higher US 10y yields/lower VIX typically would cause spreads to narrow.
But overall sovereign credit should follow USD HY corporate spreads – widen slightly in H1 and tighten in H2 back to current levels
Long-end rates higher, steeper curves
Risk: deteriorating sentiment triggering a flight to the safe-haven US equity market.
OVERVIEW