First investors had to get their heads around “quantitative easing” – the huge injection of liquidity by central banks into western economies.
Now they are having to grapple with “quantitative tightening” – an attempt, especially prevalent in Latin America – to cool down overheating emerging market economies by mopping up some of that excess liquidity at home.
Investors seem unimpressed by this new jargon. Many have taken a rise in inflation – following higher food and oil prices – as a sign that emerging market central bankers are behind the curve.
Developed economies are also rebounding faster than expected. Middle East unrest has further reduced investor risk appetite. As a result, the allure of emerging markets and the “Brics” (Brazil, Russia, India and China) has dimmed.
“The Bric trade is coming to a close,” warns Walter Molano, head of research at BCP Securities. “Fund managers should reduce their exposure to risky assets and duration before they get clunked on the head by a falling Bric.”
Certainly, the idea it might be time-up for the “Bric” trade seems borne out by recent equity performance, especially in Latin America.
This year, the FTSE All-World stocks index has risen by 4 per cent whereas emerging equities have fallen the same amount. Latin American stocks have dropped 4.5 per cent and Chilean stocks twice as far.
However, extrapolating a global view about capital flows from equities alone can be misleading.
For one, a long run-up had left Latin American stock markets ripe for profit-taking. Even now, Chilean price to earnings ratios remain around their five-year average, HSBC estimates. Brazilian stocks are about 6 per cent above, and Colombia and Mexico almost 20 per cent higher.
“Equity investment is just one component of portfolio flows, which in turn are part of overall capital flows,” notes Neil Shearing, emerging markets economist at Capital Economics. “In Brazil, foreign direct investment remains particularly strong.”
That capital is sticking to emerging markets, at least in Latin America, is borne out by other assets. Globally, bonds have sold off this year as growth expectations have risen. But the spread of Latin American hard currency debt over US Treasuries in JPMorgan’s EMBI+ benchmark index has barely widened.
Credit default swaps, a measure of default risk, tell a similar story: five-year sovereign Peruvian CDS spreads have risen by 1 basis point to 114 bps — hardly evidence of a “risk-off” trade.
Local currency bonds have had a harder time because of rising inflation. Last month, foreign investors pulled $500m out of Brazilian government bonds. But that is not true across the board. “Last week, we saw inflows into emerging bond funds,” says Maarten-Jan Bakkum, fund manager at ING Investment Management. “The powerful long-term shift into emerging markets still seems to hold.”
Currencies tell a similar story. Latin American central banks have intervened heavily since Brazil’s finance minister, Guido Mantega, warned last September that so-called “currency wars” were hurting the competitiveness of local manufacturers.
Yet the Brazilian real has since gained a further 3 per cent against the dollar; so too the Mexican and Chilean pesos. Although Latin currencies have weakened slightly this year, the trade-weighted and inflation-adjusted Brazilian real remains 25 per cent above its five-year average; the Chilean and Peruvian currencies up about 5 per cent.
However, if the challenge for investors is to find value, the task for Latin American policymakers is to engineer an economic soft-landing. Dominique Strauss-Kahn, head of the International Monetary Fund, warned as much this week while in the region.
Brazil, Colombia, Chile and Peru have raised interest rates over the past year, and Brazil is expected to increase rates by a further half a percentage point to 11.75 per cent.
But the need to cool economies that are bumping against their limits and sucking in more imports suggests rates need to rise further to cool demand faster. Despite this, central bankers appear reluctant to increase aggressively as it could attract more capital, and drive currencies higher.
This perception of hesitation explains investor worries about rising inflation and overheating. Nonetheless, in Latin America inflation remains in single digits and inside central bank targets, with the exception of Venezuela and Argentina where prices are rising at about 30 per cent annually.
“If Latin America is showing signs of macroeconomic stress, it is mostly the stresses of success,” says John Lomax, head of emerging equities at HSBC.
Even a prolonged oil price shock could play to Latin America’s commodity strengths. Apart from Chile and Central America, most countries are oil producers.
Mr Lomax says: “Investors have lately made a big play on a cyclical improvement in the US economy and cyclical strains in the emerging world. But that story has been pushed pretty far. Take a 12-month view, and those positions could be reversed.”
Source: www.ft.com
Now they are having to grapple with “quantitative tightening” – an attempt, especially prevalent in Latin America – to cool down overheating emerging market economies by mopping up some of that excess liquidity at home.
Investors seem unimpressed by this new jargon. Many have taken a rise in inflation – following higher food and oil prices – as a sign that emerging market central bankers are behind the curve.
Developed economies are also rebounding faster than expected. Middle East unrest has further reduced investor risk appetite. As a result, the allure of emerging markets and the “Brics” (Brazil, Russia, India and China) has dimmed.
“The Bric trade is coming to a close,” warns Walter Molano, head of research at BCP Securities. “Fund managers should reduce their exposure to risky assets and duration before they get clunked on the head by a falling Bric.”
Certainly, the idea it might be time-up for the “Bric” trade seems borne out by recent equity performance, especially in Latin America.
This year, the FTSE All-World stocks index has risen by 4 per cent whereas emerging equities have fallen the same amount. Latin American stocks have dropped 4.5 per cent and Chilean stocks twice as far.
However, extrapolating a global view about capital flows from equities alone can be misleading.
For one, a long run-up had left Latin American stock markets ripe for profit-taking. Even now, Chilean price to earnings ratios remain around their five-year average, HSBC estimates. Brazilian stocks are about 6 per cent above, and Colombia and Mexico almost 20 per cent higher.
“Equity investment is just one component of portfolio flows, which in turn are part of overall capital flows,” notes Neil Shearing, emerging markets economist at Capital Economics. “In Brazil, foreign direct investment remains particularly strong.”
That capital is sticking to emerging markets, at least in Latin America, is borne out by other assets. Globally, bonds have sold off this year as growth expectations have risen. But the spread of Latin American hard currency debt over US Treasuries in JPMorgan’s EMBI+ benchmark index has barely widened.
Credit default swaps, a measure of default risk, tell a similar story: five-year sovereign Peruvian CDS spreads have risen by 1 basis point to 114 bps — hardly evidence of a “risk-off” trade.
Local currency bonds have had a harder time because of rising inflation. Last month, foreign investors pulled $500m out of Brazilian government bonds. But that is not true across the board. “Last week, we saw inflows into emerging bond funds,” says Maarten-Jan Bakkum, fund manager at ING Investment Management. “The powerful long-term shift into emerging markets still seems to hold.”
Currencies tell a similar story. Latin American central banks have intervened heavily since Brazil’s finance minister, Guido Mantega, warned last September that so-called “currency wars” were hurting the competitiveness of local manufacturers.
Yet the Brazilian real has since gained a further 3 per cent against the dollar; so too the Mexican and Chilean pesos. Although Latin currencies have weakened slightly this year, the trade-weighted and inflation-adjusted Brazilian real remains 25 per cent above its five-year average; the Chilean and Peruvian currencies up about 5 per cent.
However, if the challenge for investors is to find value, the task for Latin American policymakers is to engineer an economic soft-landing. Dominique Strauss-Kahn, head of the International Monetary Fund, warned as much this week while in the region.
Brazil, Colombia, Chile and Peru have raised interest rates over the past year, and Brazil is expected to increase rates by a further half a percentage point to 11.75 per cent.
But the need to cool economies that are bumping against their limits and sucking in more imports suggests rates need to rise further to cool demand faster. Despite this, central bankers appear reluctant to increase aggressively as it could attract more capital, and drive currencies higher.
This perception of hesitation explains investor worries about rising inflation and overheating. Nonetheless, in Latin America inflation remains in single digits and inside central bank targets, with the exception of Venezuela and Argentina where prices are rising at about 30 per cent annually.
“If Latin America is showing signs of macroeconomic stress, it is mostly the stresses of success,” says John Lomax, head of emerging equities at HSBC.
Even a prolonged oil price shock could play to Latin America’s commodity strengths. Apart from Chile and Central America, most countries are oil producers.
Mr Lomax says: “Investors have lately made a big play on a cyclical improvement in the US economy and cyclical strains in the emerging world. But that story has been pushed pretty far. Take a 12-month view, and those positions could be reversed.”
Source: www.ft.com
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