Wall Street veterans shun emerging markets after record rout
Investors are worried the coronavirus could devastate nations such as India, South Africa and Brazil.
While the advanced economies have gone into lockdown to contain the spread of Covid-19, triggering market turmoil of a kind unseen in generations, the world’s developing nations have yet to experience the full effects, both economic and humanitarian, of the pandemic. True, the global dollar squeeze, collapse in commodity prices and rising distressed-debt levels have prompted pre-emptive stimulus measures across many countries, but the success or failure of these is likely to remain unknown for a while yet.
Little wonder then that some of the world’s foremost investors and strategists, from Goldman Sachs Group to JPMorgan Chase & Co and Franklin Templeton, are telling clients to hold off on bargain hunting. They’re worried the coronavirus could devastate nations such as India, South Africa and Brazil, where infections are only now starting to gather pace.
“Markets are discounting a catastrophic recession accompanied by massive defaults,” said Ricardo Hausmann, an economist at Harvard University. “As horrific as this sounds, the situation in the advanced economies is likely to be much more benign than what developing countries are facing. Not only in terms of the disease burden, but also in terms of the economic devastation.”
Emerging markets are traditionally thought of as volatile, and perhaps it’s no surprise that their assets generally came off worse than their counterparts in the advanced economies of the US, Europe and Japan. But while banks such as JPMorgan and Morgan Stanley say developed-nation stocks have probably bottomed already, that’s not the case for their emerging-market counterparts.
Equity markets in the developing world just capped their worst quarter since the 2008 financial crisis. Currencies tumbled as demand for US dollars soared, led by a depreciation of more than 20% in the Brazilian real, South African rand and Russian ruble. A broad gauge of dollar bonds from emerging markets posted its sharpest sell-off since 1998.
Developing-nation assets kicked off the second quarter on a negative note on Wednesday as stocks from India, South Korea and Colombia slid, currencies declined and the risk premium on bonds rose.
With emerging economies reeling from a slump in demand for commodities such as oil and metals, supply-chain disruptions and dollar-debt burdens exacerbated by weakening currencies, outflows are likely to surge in the next few quarters, according to a JPMorgan model.
“It’s unlikely this crisis is over as it moves from an acute to a chronic phase,” Luis Oganes, a London-based strategist at JPMorgan, wrote in a report. “Focus will turn to emerging-market country vulnerabilities over the coming months as capital outflows could mutate into a sudden stop.”
Hausmann and Oganes may be gloomy, but they’re in good company. In fact, a “Who’s Who” of economists and investors, including Mohamed El-Erian, Michael Hasenstab and Carmen Reinhart, are also sounding the alarm.
El-Erian, the chief economic adviser at Allianz and a Bloomberg Opinion contributor, said the current situation has elements of both the Great Depression and the 2008 financial crisis. While fiscal stimulus in the developed world has helped for now, investors need to eschew risk, he said. El-Erian advised selling lower-rated bonds, adjusting stock portfolios to favor companies with strong balance sheets and keeping more cash on hand for distressed opportunities down the road.
Hasenstab, Templeton’s chief investment officer for global macro, agrees. He says it’s “too early” to try to cherry pick among distressed securities. His team favours so-called haven assets, while increasing allocations to cash and several higher-yielding emerging markets with more resilient economies.
The list of developing nations seeking debt relief has already swelled in the past few months. Fifteen nations with more than $100 billion of Eurobonds outstanding had average spreads of at least 1,000 basis points over US Treasuries as of March 19, according to data compiled by Bloomberg. Argentina is pursuing a restructuring, Ecuador is discussing a re-profiling and Zambia is seeking to reorganise its foreign bonds. Meantime, Lebanon defaulted in March on its first bond since independence in 1943.
Another challenge is that China, a lender of last resort for many developing nations, is experiencing its own slowdown. Reinhart, an economist at Harvard University, warns that the world’s second-largest economy may contract this year for the first time since 1976, reducing Beijing’s lending capacity. Even Chinese officials have cautioned the road back will be a long one.
The potential human misery as the coronavirus rips through developing nations even less equipped to cope with a pandemic than their advanced counterparts is what worries investors most. The stricter the rules to curb contagion, the more those countries will be forced to boost spending, in turn compelling them to borrow more. That chain of events will disproportionately hurt the weakest credits, many of them commodity producers already suffering from a collapse in exports as well as a drop off in remittances, according to Hausmann.
Nouriel Roubini, a professor at New York University who predicted hard times before the global financial crisis in 2008, says money printing will flourish, with Mexican pesos, Indonesian rupiahs and Turkish liras about to spill forth from central banks.
“How do you avoid a freefall of their currencies?” he asked.
The consequences could be even worse in countries with poor policy responses or local dynamics that make the virus harder to contain, according to Fabiana Fedeli, the global head of fundamental equities at Robeco in Rotterdam. She singled out Brazil and Mexico for their lacklustre efforts to fight the spread of the disease, and India because of its crowded slums.
The International Monetary Fund and World Bank have committed some $1 trillion in lending capacity to nations hamstrung by the pandemic, yet Roubini estimates the need may be three or four times that amount.
Kamakshya Trivedi, a strategist at Goldman in London, says developing-nation bonds look more vulnerable now than during the 2008 financial crisis.
“We see further downside risks across emerging-market assets as the global economic outlook remains fragile and is consistently shifting,” he wrote in a report.