Two executives at the Neuberger Berman Group have prepared a paper on what they call the “overall case for a recovery in emerging market debts” in the months to come.
Investors will want to “be around” for such a rebound, they say.
There are obviously now, and there will continue to be, risks in the emerging markets. Russian issuers may find themselves subject to international sanctions, for example. Turkey as a sovereign seems in danger of default and may be open to recovery only if it can tighten monetary policy further. There is uncertainty about whether its central bank is willing to do that. Meanwhile, the Fed tightening may strengthen the US dollar and that could hurt EM debt. Finally, on a brief representative list of troubles, “October brings difficult elections in Brazil.”
On Sept. 6, Jair Bolsonaro, one of the contenders for the office of President of Brazil, was savagely stabbed by an apparent “lone nut” at a campaign event. This has attracted sympathy for him on the one hand but could keep Bolsonaro himself off the campaign trail all the way to election day on the other. The only certain net impact is to increase uncertainty.
The Neuberger executives—Rob Drijkoningen and Leonardo Bernardini—suggest, though, that these risks are already reflected, perhaps more than reflected, in asset prices; that is, that “the sell-off would not have been so steep in the first place” without them.
Pausing over Turkey
Let’s pause for a moment on the example of Turkey. The price charts on its Lira against the USD look a lot like the analogous charts for Thailand’s baht in 1997. And the baht crisis led to a wave of currency crises around east Asia. It is at least on the surface reasonable to ask whether Turkey’s crisis, too, is contagious.
The key to Turkey’s vulnerability is its very high level of external debt. The external debt is not denominated in Lira, of course, it is denominated in the currency of the creditor institutions, US dollars or in euros, and it can’t be devalued away. And this characteristic of Turkey’s situation may also be key to the issue of containment-versus-contagion. Seven tenths of Turkey’s debt is denominated in dollars or euros, whereas the corresponding figure for the average emerging markets nation is just 35%.
The Wall Street Journal editorialized on Sept. 14, that “markets are culling the herd to attack the weakest instead of spreading currency contagion.”
A Brief History
But let us return to Drijkoningen, Bernardini, and their argument. Drijkoningen is the global co-head of emerging markets debt for Neuberger Berman. Bernardini is portfolio specialist in such debt. They offer a capsule history of the debt of emerging markets since 2013. A sell-off emanating from China, and weakness in oil prices, produced a sustained recovery in the EM world. That recovery coasted through the years 2016-17. Then came 2018 and a sharp correction. The EEM, a large emerging-markets tracking ETF, fell more than 11% from late January of this year to June.
The correction came about in part because of a slowing of global trade, and political currents further threatening such trade.
The key point, again, is that the correction has been in the view of these authors an over-correction and creates an opportunity for bargain hunting in this asset class, since the fundamentals are “still broadly supportive.”
July offered “some respite” from the correction, but it was “the calm before the August storm,” with notable troubles not only in Turkey but in Argentina, where it turns out the chauffeur of a government official kept notebooks. The chauffeur’s eight notebooks became public, telling a tale about trips taken to deliver bags of cash as bribes. This instigated a graft probe, and that spooked the markets. The Global X MSCI Argentina ETF saw its largest ever outflow since that fund’s creation in 2011.
The Good News
The good news, through all this, say the NB execs, is that a pattern of over-correction followed by strong returns is characteristic of the EM space, “with significant recoveries often occurring over a one to three-month horizon.”
The last eight times there have been drawdowns in the JPMorgan Government Bond Index Emerging Markets (GBI-EM) of a comparable scale to the drawdown of 2018, the index thereafter recovered close to half of its losses within three months.