As emerging markets continue to dominate world news, Barings’ Ricardo Adrogué weighs in on the trade frictions with China, Venezuela’s evolving status as a political hotspot, and why he has high conviction in Mexico.
China: Maintaining Cautious Optimism
When we consider the U.S.-China trade tensions, it is unclear if the U.S. administration’s goal is true political change or a trade rebalance. If it’s political change, we are facing protracted and difficult trade negotiations. However, if it’s a trade rebalance, it could potentially be solved in the near future—as China has indicated a desire to buy more U.S. commodities, which suggests a willingness to collaborate. In terms of economic growth prospects, there are two interpretations of the administration’s actions: Either it is pushing the economy to re-achieve historic growth levels, which may be unsustainable, or it is willingly supporting a slowdown. Our view leans more toward the latter—that the Chinese government does not want to push the economy past a sustainable level—and therefore does not raise concern. Additionally, it is important to put China’s growth in context. Any slowdown would be very gradual—and the economy is still growing at 6%–6.5%, which is positive by any emerging market standards.
Venezuela: Monitoring the Math
We tend to approach Venezuela as being a market very similar to Iran and Cuba, two regimes that defaulted 40-60 years ago on their debts and never repaid them—resulting in a bond recovery rate near zero. If Venezuela follows the same path, the recovery rate of its bonds will likely be close to zero as well. While we technically cannot buy local bonds today as a U.S. investor, and would not do so given the near-term opportunity—the situation continues to evolve rapidly. Currently, when calculating the recovery value, we’ve found that it is not much greater than the face value of the bonds—and therefore the existing opportunity is not compelling enough for us to buy them. However, down the road, it could pose an interesting investment opportunity. We continue to monitor the situation closely as it evolves, but for now it remains too risky. The math has to make sense in terms of the potential recovery rates.
Mexico: Taking a Contrarian Stance
Despite the prevailing investor sentiment, we currently have a positive view on Mexico’s sovereign debt. Whereas other investors have taken a negative stance on the country’s outlook, due to the leftist government in power, we’ve found Mexico’s new administration to be highly reliable. When President Obrador pledged to annul the Mexico City Airport contract, he followed through. When he vowed to respect monetary policy independence, he followed through. When he campaigned for the importance of Pemex—a highly indebted quasi sovereign entity in need of substantial support from the government—the government came through with a capital injection and some tax break support. So, in every case, we’ve watched the country’s president explicitly lay out his plans and remain steadfast in them—and we think the markets are missing that fact.
In Conclusion: Staying the Course
We expect the remainder of 2019 to be more favorable for EMD relative to 2018—but also anticipate a continued stream of headlines related to political elections, trade disputes and growth concerns throughout the year. While we’re generally optimistic about the backdrop, we would emphasize that we are not completely free from risks—and believe a strict focus on bottom-up fundamental analysis for each investment is critical to success as the year continues to unfold.