Expensive emerging markets assets may be vulnerable
Expensive emerging markets assets may be vulnerable
It is all making the asset class vulnerable to a pullback.
Once high-yielding bonds are offering less than they were and although emerging equities have performed less well than fixed income, some sectors within them are looking pricey.
Emerging sovereign debt, for example, has enjoyed returns of 16 percent this year, outstripping most of the developed world. As a result, yields have fallen dramatically.
"The market has rallied a lot, it's much less compelling to invest now, for a 4 percent yield," said Sergei Strigo, head of emerging debt management at Amundi.
"Since the beginning of the year, (yield) spreads have tightened by at least 180 basis points in places like Romania."
Data from Boston-based fund tracker EPFR continues to show net inflows into emerging bond funds, as has been the case for every month this year. Emerging equities have also enjoyed consistent inflows for the past few months.
But market participants are starting to get more cautious.
Morgan Stanley analysts, for example, cut their recommendation on emerging market assets to "hold" from "accumulate" ahead of the US election last week, for the first time since June, and maintained that position this week.
RISE AND FALL?
Investors have flocked to emerging market debt this year, attracted by lower debt levels in many of the sector's economies, a broad trend for rising ratings across the asset class and ultra-low rates in developed markets.
Emerging hard currency bond issuance has hit record levels, and analysts have revised up their borrowing forecasts for the year to well over $300 billion.
European Central Bank President Mario Draghi's pledge in July to do whatever it takes to preserve the euro, followed by the promise of the ECB's bond-buying program, also swelled appetite for riskier emerging markets.
But the tightening in emerging sovereign debt spreads, particularly since the summer, has triggered alarm bells.
Emerging sovereign debt spreads have narrowed around 150 basis points this year to 270-290 bps over US Treasuries.
That's still well above record low levels of 150 bps hit in mid-2007, before the global financial crisis. But US Treasuries offered higher yields then, giving average total yield for emerging market debt of more than 6 percent, compared with little more than 4 percent now.
Fair value for spreads is at levels tighter by only around another 20 basis point, Morgan Stanley analysts say, due to the renewed pessimism about the developed world.
"US and European concerns are likely to hold back significant risk-taking as we head into year-end," they wrote in a client note.
Emerging stocks have risen a more modest 8 percent this year, keeping pace with developed world bourses but also masking some huge gains in frontier markets, such as the 35 percent surge in African stocks.
Some equities sectors, though, are also starting to look pricey. Investors are well aware of the theme of the growing middle class in emerging markets, particularly in some of the newer markets, and this has made consumer stocks a favorite — maybe too much of a favorite.
"Over the last two years, a lot of investors have been focusing on consumer staples which has taken the sector up to quite aggressive valuations and given very limited scope," said Knut Harald Nilsson, portfolio manager at Skagen.
Forward price/earnings (PE) ratios stand at around 21 for the sector, compared with a 12-year average of about 15, according to Datastream.
This makes it more appealing to buy consumer stocks listed in developed markets but with emerging market exposure, Nilsson said.
So if emerging sovereign debt isn't great and neither are some emerging equities, where else is there to go?
Investors have already rotated this year into emerging corporate or frontier debt, and even into peripheral euro zone markets.
Oil prices fall as OPEC and Russia weigh output boost
- Russian Energy Minister Alexander Novak has had talks with Saudi Energy Minister Khalid Al-Falih on an easing of the terms of the global oil supply pact that has been in place for 17 months
- The energy ministers of Saudi Arabia, Russia and the United Arab Emirates are discussing an output increase of about 1 million barrels per day
LONDON: Oil prices fell below $78 a barrel on Friday as OPEC and Russia considered easing supply curbs to offset disruptions in Venezuela and an expected drop in Iranian exports.
Russian Energy Minister Alexander Novak has had talks with Saudi Energy Minister Khalid Al-Falih on an easing of the terms of the global oil supply pact that has been in place for 17 months, Novak said on Friday.
The energy ministers of Saudi Arabia, Russia and the United Arab Emirates are discussing an output increase of about 1 million barrels per day (bpd), sources told Reuters.
Speaking in St. Petersburg, Falih told Reuters that “all options are on the table” when asked about the targets on production cuts.
Brent crude futures were down 80 cents at $77.99 a barrel by 0914 GMT, having hit their highest since late 2014 at $80.50 this month.
US West Texas Intermediate (WTI) crude futures were at $70.18 a barrel, down 53 cents.
“The debate about a possible relaxation of the production restrictions should preclude any renewed price rise,” Commerzbank analysts said.
“The $80 mark is likely to pose an obstacle that is difficult to overcome because it would significantly raise the probability of a production increase.”
The Organization of the Petroleum Exporting Countries (OPEC) as well as a group of non-OPEC producers led by Russia started withholding output in 2017 to tighten the market and prop up prices.
Global crude supplies have tightened sharply over the past year because of the OPEC-led cuts, which were boosted by a dramatic drop in Venezuelan production.
The prospects of renewed sanctions on Iran after US President Donald Trump pulled out of an international nuclear deal with Tehran have also boosted prices in recent weeks.
As a result, compliance with the deal to reduce output by 1.8 million bpd by the end of 2018 has been at 152 percent, sources said.
Amrita Sen, chief oil analyst at consultancy Energy Aspects, said: “Addressing overcompliance was always likely to be on the agenda amid a tight market and low inventories, but the volume to bring back is still up for debate.”
HIGHER PRICES AT A COST
While Russia and OPEC benefit from higher oil prices, up almost 20 percent since the end of last year, their voluntary output cuts have opened the door to other producers to ramp up production and gain market share.
US crude oil production
Output from the likes of the United States, Canada and Brazil, which are not bound by the OPEC/Russian-led pact, is likely to rise further as crude prices rise.