Spectre of 1994 still lurking in shadows
Like many ‘riskier’ markets, emerging markets, both equity and debt, have had a good run over the last 18 months. Like the majority of other ‘risky’ asset classes, and indeed some of the safer ones, they too have suffered a bit of a sharp set back in recent weeks. Though chairman of the Federal Reserve, Alan Greenspan, has yet to pull the trigger, the chances of US interest rates being raised in the near future are pretty well 100%, and historically all markets sell off when interest rates rise, and of course the riskier ones tend to suffer rather more. At the risk of boring everyone by mentioning it again, the spectre of 1994 does feel as though it just might be lurking in the shadows.
“Don’t panic this time,” urge the managers at Ashmore Investment Management (AIM), who run a variety of emerging market bond (and equity) funds. AIM argues that the emerging market debt rally is predominantly a function of ‘push’ factors away from developed markets rather than of ‘pull’ factors of improving emerging market fundamentals or especially high spreads. They point out that institutional investor liquidity is high and that the search for a diversifying asset class is a major objective and argue that emerging debt remains one of the few asset classes offering real economic diversification and, very importantly, high yield.
As for the argument that there is too much ‘hot’ money roaming the emerging markets, AIM contends that the main allocations to emerging debt are from pension funds from their fixed income allocations and are strategic rather than the tactical (or flighty?) hedge fund moves. Starting from a zero base, the reversal of flows is unlikely.
Fundamentally, emerging markets look strong says AIM, pointing out that upgrades are currently outnumbering downgrades by 2 to 1. Economics both global and local are set fair too, and emerging debt may one of the few beneficiaries of a high oil price.
There is no doubt that short-term correlation with US Treasuries is high; as risk aversion rises all risky assets get sold, including emerging debt. However, unlike in the mid 1990’s when the leveraged money was the dominant player in this asset class, it is not the case today and those ominous times of financial contagion spreading across these markets are a thing of the past. AIM reminds us that Argentina’s default in 1998, the largest in history, was followed by an emerging debt rally.
In fact, they state that the substitution effect out of US Teasuries now translates into a negative correlation in all but the short-term. There was that unusual year of 1994 where everything was correlated to US Treasuries (as prices plummeted), but that ghost is apparently not due to make a return.
AIM funds have been experiencing far more buyers than sellers as the market has sold off in recent weeks and say that it is institutional clients who have been the main buyers. They do not believe that this dip will last for more than three months but admit that it is somewhat unpredictable, but they are sure that 2004 will still turn out to be a stronger than average year for emerging debt.