EM Monthly: Technically Speaking

April 16, 2024

Portfolio managers Warren Hyland and Mel Siew discuss the key themes and topics in emerging markets and what investors should look out for in the month ahead.

The big story: EM technicals

To gauge the direction of asset prices, investors typically look at fundamentals, valuations and technicals. Technicals are defined by calendar seasonality, investor sentiment, supply, demand and investor positioning. The current technical backdrop for EM corporates warrants a closer look.

Based on historical analysis, April has proven a good month to invest in emerging-market (EM) corporates. Positive total returns were generated in 8 out of the past 10 years (Fig.1), with April offering the highest average monthly total return for EM high-yield bonds and bonds in the Europe, Middle East and Africa (EMEA) region. On a quarterly basis, Q2 has historically been one of the strongest for an allocation.

Figure 1: Spring has historically been a good time to invest in EM (2014-2024)

Past performance is not a reliable indicator of current or future results

Source: Bloomberg, ICE data platform,  from March 31, 2014, to March 31, 2024. Indices used represent best proxy for EM markets. Index performance is for illustrative purposes only. You cannot invest directly in the index.

Our proprietary risk index to assess investor sentiment is currently sitting on the low stress boundary line, indicating the environment for risk taking is positive. Reviewing the 25% weighted sentiment building block in the index, sentiment is in stimulative mode, scoring 17.8%, which is significantly inside the low stress region of the risk model (Figure 2). As a result, a positive risk-seeking environment, driven by strong sentiment, should be positive for EM asset prices.

Figure 2: Current risk sentiment at low stress

 

Source: Muzinich & Co, as of March 26, 2024. For illustrative purposes only.

Shrinking supply

JP Morgan estimates the EM corporate universe will shrink in by US$190 billion in 2024,¹ with all regions contracting. While this forecast may be pessimistic given the improved market sentiment, we believe it is difficult to build a scenario where gross supply exceeds US$434 billion for several reasons.

First, the largest contraction of supply is expected to come from Asia (-US$148 billion). This is understandable given the average policy rate in the region is just 3.34%,²  making it significantly cheaper for companies to fund themselves through domestic rather than international markets. This situation is likely to remain unchanged for the rest of the year.

Second, commodity prices are expected to remain elevated, allowing the commodity sector to fund organically through cashflows rather than issuing debt. Latin America, a commodity heavyweight, has not printed net positive supply for the last 5 years.

Finally, geopolitical risk is likely to prevent excessive supply from the other regions. As a result, prices are likely to be supportive, liquidity will be skewed towards sellers (i.e. it will be easier to sell than buy) and any primary issuance should be oversubscribed.

Figure 3: EM issuance (US$bn)

Forecasts mentioned are not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy.

Source: JP Morgan, as of February 2024. For illustrative purposes only.

While demand has been neutral year to date, over the last two years the asset class has seen outflows. This is understandable considering investor concerns around the impact of rising interest rates on fixed-income assets and the consequences of monetary policy tightening on EM. This has left positioning at the lowest levels in 5 years across dedicated EM investors and crossover investors.³  However, we believe such an underweight is no longer justified.

Globally, policy rates appear to have peaked, and some EM central banks have begun loosening policy ahead of developed market peers. Fundamentals appear strong and the universe has undergone a ‘cleaning’ exercise where companies expected to default have done so and the downgrade cycle is largely complete. In our view, the asset class also looks appealing on a relative-value basis versus Western credit as the hunt for yield has returned.

Figure 4: EM sovereign and corporate flows

Source: JP Morgan, as of February 26, 2024. For illustrative purposes only.

Figure 5: EM corporate holdings at lowest levels in 5 years across most investor types

Source: JP Morgan, as of February 26, 2024. For illustrative purposes only.

Our overall conclusion is that the technical backdrop appears strong for the second quarter. Seasonally and historically, it has been the best time to add exposure, global sentiment is supportive and the supply versus demand dynamic is also underpinning prices.

The month in credit: Risk on

EM corporates produced another positive month of returns while credit spreads continued to grind tighter. The spread compression theme has been a dominant feature of global credit markets for much of the year and EM corporates have been no exception as fundamentals remain strong and defaults have been contained.

In this risk-on environment, high yield outperformed investment grade at the corporate level, with the strongest returns coming from the lower-rated segments. By sector, the strongest performers came from areas such as energy and autos while financials were weaker. Long-duration bonds outperformed their short-duration counterparts while EM high yield overall outperformed both its US and European counterparts.

Looking at the broader EM complex, sovereigns were the main outperformers, benefiting from strong returns from the stressed lower-rated countries of Argentina and Ukraine.

In terms of credit ratings, upgrades outpaced downgrades 3 to 1 in March (57 vs. 19). In the high-yield segment, the upgrades were led by Turkish and Argentine companies while downgrades were mostly in the real estate and technology, media and telecommunications sectors. There were also two defaults and one debt exchange.

Primary issuance for March totalled US$23 billion, over half of which came from financials. This was significantly higher than year ago levels (US$17 billion), with the big difference being US$4.8 billion of issuance from Eastern Europe compared to 0 in the same month last year.⁴ By sub-asset class, 43% was issued by quasi-sovereigns, 46% by investment-grade issuers and 10% from high-yield names. Regionally, Asian corporates were the largest issuers with 45%, followed by Eastern Europe (23%), Latin America (11%) and Middle East and Africa (21%).

Rates trending downwards

Central bank interest-rate decisions dominated the month with 19 meetings happening globally in just one week.

In Mexico, Banxico made the first rate cut of its cycle on March 21, lowering rates by 25bps to 11% after being on hold for the last 12 months. The decision was not unanimous, however, with the bank’s deputy governor voting against the cut and the committee deeming inflation risks as skewed to the upside. Interest rate moves will be data dependent from here, but the path of least resistance points to a 25bps cut each quarter until rates reach a neutral level of around 8%. Other Latin America central banks to cut rates included Chile, Peru and Brazil, which made its sixth consecutive cut.

In South Africa, the central bank chose to keep rates on hold at 8.25%, which was anticipated given rising inflation expectations.

China continued to monitor its recent stimulus efforts and left the 1-year and 5-year loan prime rate unchanged, possibly due to a pick-up in industrial activity and strong retail sales data. Industrial production was up 7% year-over-year in the first two months, well ahead of the 5.2% forecasted, driven by strong capital spending. Retail sales also increased 5.5% over the same period.⁵ However, in its recent communication, the People’s Bank of China highlighted the abundance of tools at its disposal to stimulate the economy.

A surprising rate decision came on March 21 from Taiwan’s central bank, which tightened policy rates by 0.125% to 2% and raised its inflation forecast to 2.2% from 1.9%. This suggests the economy could overshoot its 2% target for the third year in a row.

Turkey’s monetary policy announcement on March 21 was also an outlier as the central bank raised rates 5% to 50% to cool inflation after populist policies from President Recep Tayyip Erdogan – including a 49% increase in the minimum wage - appeared to have stoked inflation. The bank sighted a deterioration in the inflation outlook and a determination to keep policy restrictive until it sees a sustained decline in the underlying trend of monthly inflation.

Oil firm aims for net zero

In Latin America, Argentina carried out a record bond swap and refinanced 77%, or cUS$50 billion, of its sovereign debt into instruments maturing between 2025 and 2028 as part of the government’s plans to wipe out the country’s fiscal deficit by year end.⁶  Elsewhere, Mexico’s state-owned oil company Pemex announced its plan to reach net zero emissions by 2050. This will require it to invest 10-14% of total capital expenditure each year through to 2030 to meet its net-zero target. Pemex also announced its intention to reduce methane emissions by 30% and Scope 1 emissions intensity by 54%.⁷

Fitch affirmed Romania’s credit rating at BBB- with a stable outlook.⁸ This removes near-term downgrade risk with Fitch, Moody’s and Standard & Poor’s now holding the sovereign on a stable outlook. The main uncertainty the sovereign faces this year is four rounds of elections: EU parliament, national parliament, presidential and local, which could slow fiscal reform.

In South Korea, the growth of semiconductor exports moderated but remained robust, falling from 66.7% to 35.8% year-on-year, although the value of exports rose to US$11.67bn from US$9.94bn in February, the highest level since September 2022. Meanwhile, display panel and computer exports registered double-digit growth and mobile phone export growth rebounded. We expect demand for AI-related chips will contribute to multi-year growth in Korea.⁹

Elections: Surprising and not so surprising results

The raft of EM elections continued in March with Russia’s re-election of Vladimir Putin for a new 6-year term. This will see him overtake Josef Stalin to become Russia’s longest-serving leader for more than 200 years.¹⁰

In Turkey, local elections went against President Erdogan’s Justice and Development (AKP) party, trailing the opposition party 35.5% to 37.7%; in 2019 the AKP won 44.3% of votes versus the Republican People’s Party (CHP) total of 30.1%. CHP candidates won 36 of 81 provinces, including Istanbul.  Nevertheless, President Erdogan vowed to continue with the current economic strategy to stabilise inflation.¹¹

On the lookout: What to watch out for in April

• Indian elections are due to start on April 19 and run until June 1, consisting of seven phases of voting. Prime Minster Narendra Modi is expected to be returned for a third successive term.
• The International Monetary Fund and World Bank Spring Meetings take place in the week commencing April 15. This is a critical arena for central bankers, politicians and investors to engage, provide progress updates and adjust future outlooks.
• A heavy schedule of Asian central bank meetings are due in April, including South Korea, India, Indonesia, Philippines and Thailand. All are expected to leave policy rates on hold.
• In Eastern Europe, Hungary’s central bank is expected to reduce its speed of monetary loosening, having already reduced rates by 975bps since May 2023, while Poland, Romania and Turkey are expected to leave rates on hold.
• In Latin America, central banks are expected to continue with their loosening stance in Chile, Colombia and Peru.

Source: Muzinich & co as of April 2024. For illustrative purposes only.

Credit

Past performance is not a reliable indicator of current or future results

Source: ICE data platform. as of 31st March 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, ADOL - ICE BofA Asian Dollar Index, ADIG - ICE BofA Asian Dollar High Grade Index, ADHY - ICE BofA Asian Dollar High Yield Index, EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,. Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only.

Past performance is not a reliable indicator of current or future results

Source: ICE data platform. as of 31st March 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, ADOL - ICE BofA Asian Dollar Index, ADIG - ICE BofA Asian Dollar High Grade Index, ADHY - ICE BofA Asian Dollar High Yield Index, EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,.Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only.

References to specific companies is for illustrative purposes only and does not reflect the holdings of any specific past or current portfolio or account.

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of April 2024 and may change without notice.

References:

1.JP Morgan Global Data Watch, as of 28th March 2024.
2.JP Morgan ‘EM Corporate Supply Technicals’ published February 2nd, 2024.
3.JP Morgan Global Data Watch, as of 28th March 2024.
4.JP Morgan, as of March 28, 2024
5.JP Morgan, as of March 31, 2024
6.Bloomberg UK, Milei notches win as Argentina swaps US$50bn of debt, as of 13th March 2024.
7.Bloomberg UK, Pemex ESG plan promises to reach net zero emissions by 2050, as of 14th March 2024.
8.Fitch Ratings, Fitch affirms Romania at BBB-; outlook stable, as of 1st March 2024.
9.Bloomberg UK, South Korea’s tech-led exports continue growth, boosting economy, as of 1st April 2024.
10.Reuters, Putin wins Russia election in landslide with no serious competition, as of 18th March 2024.
11.Washington Post, Opposition victories in Turkey’s local elections deal Erdogan rare defeat, as of 1st April 2024.

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Index Descriptions

EMGB - ICE BofA Emerging Markets External Sovereign Index tracks the performance of US dollar and euro denominated emerging markets sovereign debt publicly issued in the major domestic and eurobond markets.  Qualifying securities must have risk exposure to countries other than members of the FX-G10, all Western European countries and territories of the US and Western European countries.

EMCB - ICE BofA Emerging Markets Corporate Plus Index tracks the performance of the US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets. Qualifying issuers must have risk exposure to countries other than members of the FX G10, all Western European countries, and territories of the US and Western European countries.

EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated AAA through BBB3, inclusive.

EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated BB1 or lower.

Q690 - ICE BofA Custom Emerging Markets Short Duration Index tracks the performance of short-term US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

ADOL - ICE BofA Asian Dollar Index tracks the performance of U.S. dollar denominated sovereign, quasi-government, corporate, securitized and collateralized debt publicly issued in the U.S. domestic and eurobond markets by Asian issuers.

ADIG - ICE BofA Asian Dollar High Grade Index tracks the performance of investment grade U.S. dollar denominated sovereign, quasi-government, corporate, securitized and collateralized debt publicly issued in the U.S. domestic and eurobond markets by Asian issuers. Qualifying securities have a country of risk classified as an Emerging Markets country that is part of the Asia/Pacific Region.

ADHY - ICE BofA Asian Dollar High Yield Index tracks the performance of sub-investment grade U.S. dollar denominated sovereign, quasi-government, corporate, securitized and collateralized debt publicly issued in the U.S. domestic and eurobond markets by Asian issuers.

EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Latin America.

EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Latin America region.

EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated sub-investment grade based on the average of Moody's, S&P and Fitch, and with a country of risk associated with the geographical region of Latin America.

EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Europe, the Middle East and Africa including Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan.

EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

The MSCI EM Index is a free-float weighted equity index that captures large and mid cap representation across emerging market countries. The index covers approximately 85% of the free float-adjusted market capitalisation in each country.

Index performance is for illustrative purposes only. You cannot invest directly in the index.

Important Information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.

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