A Bright Spot in Higher-Yielding EM Corporate Debt
There has been no shortage of risks facing emerging markets (EM) over the last couple of years. 2018, in particular, was challenging, as we saw escalating trade tensions between the U.S. and China, higher oil prices, U.S. Federal Reserve rate hikes and U.S. sanctions against Russia—not to mention the presidential elections in Brazil and Mexico and political crises in Turkey and Argentina. Over the last year, many of these headwinds have dissipated, and some have actually turned into tailwinds—most notably the Fed pivoting to a more dovish policy.
As we think about 2020 in this context, the biggest risk revolves around the potential U.S.-China trade deal and, related to that, the possible knock-on effects of a divisive U.S. election year. With respect to the trajectory of the trade deal—at the peak of the tensions, the U.S. proposed about $120 billion in tariffs. When the dust settled, that number was down to about $67 billion, and the U.S. announced additional product exclusions worth about $7.5 billion. In aggregate, the U.S. essentially peeled back the tariffs to roughly 50% of what was threatened in late August 2019. Heading into the U.S. election, we may see a managed trade truce with China, whereby President Trump wants to focus more on growth and positivity. But depending on how it plays out, it could also have the opposite effect and cause renewed volatility in the markets.
Aside from that, we are also keeping an eye on the unintended consequences that could arise from global discontent. Several EM regions—Hong Kong, Ecuador, Bolivia, Chile, Peru, Indonesia and Lebanon—have been engulfed in waves of civil protests for weeks or months. These situations certainly represent risks for investors but we have also continued to find value opportunities in EM corporate issuers—often globally diversified companies—that have been unfairly punished by markets because of the country in which they’re domiciled.
Given the material amount of negative-yielding assets in developed markets, asset classes that offer decent positive yields, such as high yield and EM debt, will likely continue to look attractive over the next year, in our view. Looking at EM corporates, for example—corporate fundamentals have been stable, with many companies exhibiting attractive growth in revenues and EBITDA over the last few years. Balance sheets appear healthy, and defaults have remained low. When factoring in the 2018 headwinds—some of which turned into tailwinds in 2019 and look likely to remain supportive in 2020—coupled with expected supportive growth for emerging markets1—we think EM corporates will remain attractive.
Within the broader universe of EM corporates, we see a particular opportunity in short duration high yield debt. Given the various idiosyncratic risk flare-ups in several high yield countries over the last few years, spreads have widened relative to investment grade-rated EM corporates. While this has normalized somewhat in recent months, the spread differential is still wide relative to history, suggesting there is still value in high yield-rated EM corporates.
SHORT-DURATION, HIGH YIELD CORPORATES LOOK ATTRACTIVE
EM HIGH YIELD VS. EM IG SPREAD DIFFERENTIAL
Source: J.P. Morgan. As of November 2019.
While it’s difficult to make sweeping predictions, one prediction over the coming months is that we see stability in U.S. rates and global growth—particularly if the U.S. and China reach a managed truce over trade. In this type of environment, we would expect to see strong performance from the shorter-dated, higher-yielding portion of EM corporate debt.
1. IMF expectations are for Emerging Markets to grow roughly 4.5% in 2020. This compares to expectations for low single digit growth for developed market economies.
This commentary is provided for informational purposes only and should not be construed as investment advice. The opinions or forecasts contained herein reflect the subjective judgments and assumptions of the investment professional and do not necessarily reflect the views of Barings, LLC, or any portfolio manager. Investment recommendations may be inconsistent with these opinions. There can be no assurance that developments will transpire as forecasted and actual results will be different. We believe the information, including that obtained from outside sources, to be correct, but we cannot guarantee its accuracy. The information is subject to change at any time without notice.