EMTA LONDON SUMMER FORUM SPEAKERS ATTRIBUTE CORRECTION TO LIQUIDITY CONTRACTION RATHER THAN FUNDAMENTALS
EMTA’s Ninth Annual Summer Forum in London was held on July 6, 2006. Merrill Lynch hosted the event, which drew 130 Emerging Markets professionals. Despite the market sell-off that had occurred in May and June, panelists were relatively confident about the long-term prospects for the Emerging Markets debt asset class.
Global Outlook Remains Positive
Ashmore Investment Management’s Jerome Booth led the event’s panel of sell-side analysts, opening the meeting with the “inevitable” discussion of US rates and the other risks to the market. Phil Poole (HSBC) noted that the market’s recent downturn had to be understood in the context of the strong performance of Emerging Markets in general since the 1998 Russian crisis. Poole attributed the market’s spring correction to global monetary tightening rather than deterioration in Emerging Market economic fundamentals, and other panelists generally concurred.
Arnab Das (Dresdner Kleinwort) predicted that the US Federal Reserve would raise rates one more time before pausing, and that the US economy would achieve a soft landing before the Fed entered a rate-easing cycle. Das expects volatility in the near-term until the market sees a clear end to the Fed’s rate-hiking mode, with investors discriminating between countries based on their external financing needs.
JP Morgan’s Will Oswald asserted that, as the EM debt asset class becomes further integrated with those in developed markets, there will continue to be vulnerability in local markets during times of generalized risk aversion. Francis Beddington (Standard Bank) observed that, not only were investors discriminating among markets, but in many cases stock markets were hit but not currencies. For Beddington, this proved that the market’s performance in mid-spring was a removal of excess liquidity. It would take unexpected news, such as a more aggressive Fed stance, for the situation to deteriorate.
Booth chimed in with his own bullish assessment, commenting, “I find it very difficult to believe that we are not going to be in a low-inflation world for a long time.” He added, “It is very hard to think bearish thoughts when we have the amount of technical support that we do—there’s so much money just desperate to get into the asset class.” Booth reiterated comments he had made at previous EMTA forums on the support that pension funds, which are just starting to get exposure to EM debt, will provide to the asset class.
African Emergence?
Turning to the African markets, Beddington noted that the post-HIPC environment offers new opportunities for investors. He pointed out that, while some African nations are considering external debt issues, many sovereigns are trying to develop their local debt markets and their domestic savings base. When Booth interjected to express concerns about liquidity in nascent African markets, Beddington countered that some might actually be more liquid than one would expect.
Booth also opined that a dialogue with the public sector was needed, as many in the official sector see African markets as inappropriate for private sector finance. “Africa has to be taken off welfare,” he stressed. Beddington argued that global portfolio managers are underweight Africa, and asserted that the economic situations in some African and Latin nations were not dissimilar. He added that headline risks about kidnappings in oil-exporting nations such as Nigeria often mask underlying improving economic fundamentals.
Sell-Siders Discuss Mexico, Turkey
with the Forum occurring just days after Mexico’s contested presidential election, Booth asked panelists for their reactions. Poole acknowledged that there might be downside if the election’s results lead to social instability in Mexico. “However, the issue here is that the reform process has been stalled under the Fox administration,” he declared, and the new government will have that challenge even if Rafael Calderon is certified as the eventual winner; Poole also suggested that the market might not be fully factoring in governability issues in a divided Congress.
Turkey also featured on the agenda. “The problem is that more than half of the current account is being financed by short-term capital flows,” stated Das, who did not rule out an eventual IMF loan package being offered to Ankara. The transfer of the governorship of the Central Bank was “an extremely noisy process that sent a signal that the Bank is not, in fact, independent,” he added, calling into question the credibility of the disinflation process. The EU process has become even more problematic than most analysts had forecast, with the risk of Ankara’s candidacy being suspended higher than it was in the past, according to Das.
Investors Agree Fundamentals Remain Strong
the Forum’s investor panel was moderated by Merrill Lynch’s Tulio Vera, who began the panel by asking speakers for their take on recent markets. Susanne Gahler (F&C Asset Management) expressed her opinion that actual market losses were moderate and had been expected, and called the sell-off a “small correction.” She does not expect substantial spread tightening for the rest of the year. On the other hand, Gahler maintained that local currency markets remain vulnerable to further corrections.
BlueBay Asset Management’s Simon Treacher underscored the market’s differentiation between credits during recent volatility. He strongly criticized European Central Bank President Jean-Claude Trichet, predicting that he would “lead Europe into another recession,” and pointed to Hungary and Slovakia as countries that would have difficulty in locating financing. Treacher alluded to his recommendation to avoid Turkey at EMTA’s Winter Forum in February and admitted its performance has been better than he had expected. “I’ve covered all my shorts, and I’m not going long, but their performance has been better than I had anticipated,” he acknowledged. He also expressed concern at some of the “disgraceful” new issues coming to market, and criticized dealers who, once having placed an initial offering, “two weeks later act as if they had never heard of the bond.”
Amer Bisat (Rubicon Fund Management) concurred that recent activity was “nothing more than an overdue correction from very stretched valuations and extremely crowded positions.” Risky assets have been over-owned and thus “ridiculously expensive,” he declared, and were vulnerable when the market was hit with a number of uncertainties including the future direction of US Fed interest rate policy. Bisat believes that “an enormous amount of value has been created by the sell-off; there are a number of assets that are now cheap,” while conceding that the EM asset class would be “toast” if his assumption that the global economy was heading towards a mid-cycle slowdown rather than a recession proves incorrect.
ING Investment Group’s Rob Drijkoningen stressed the recent growth of local pension funds, mutual funds and the insurance business in Central Europe and Latin America. “This will create an environment which is much more stable, and that is where Turkey will have to go—it will need to build a domestic client base to diversify its sources of funding,” he affirmed.
Vera polled panelists for their views on how portfolios might change in the next couple of years. Treacher voiced his enthusiasm for the many new types of instruments one could invest in, although he cautioned buyers to understand their products. “You need to get paid to take the extra risk of ‘special situations’ because of their illiquidity,” he added.
Gahler sees EM becoming increasingly integrated into the High Yield world, although she doesn’t anticipate a full integration of the local markets, which should remain a segment with specialist managers due to their higher risk. Gahler also believes that real money accounts which are benchmarked should be replaced by absolute-return targets, and called on EM research to focus on finding the most profitable instrument across the whole EM universe.
Panelists Divided on Prognosis for Turkey
bisat spoke positively on Turkey. “Despite an initial weakness of communication, the Central Bank has shown us with 400 bps in interest hikes and strong language that they are really inflation hawks,” he proclaimed. In contrast to Treacher, Bisat asserted he would be long Turkish debt rather than watch from the sidelines.
Gahler commented that the “virtuous cycle” in Turkey had come to a halt because of uncertainty over the government’s commitment to macroeconomic and political reforms. “The jury is still out whether the government is still committed to these, and I have my doubts,” she remarked.
Ratings agency attendees breathed a sigh of relief when, after lambasting them at previous events, Treacher praised recent downgrades of Hungary as proof of a move away from the time when “anything linked to the EU was investment grade, end of story.” Treacher viewed this as a sign that the agencies would emphasize economic fundamentals rather than political factors.
Mexican, Brazilian Economies and Presidential Races Debated
”chances that Calderon can get reforms through are dim given the political situation in Mexico,” Drijkoningen observed as the panel discussed the prospects for Mexico, although it remains a possibility. Thus for him, the outcome of the Mexican election is not a non-event, as under a Calderon presidency there is at least a distant hope of progress.
Bisat reminded the audience that AMLO has a known track record as mayor of Mexico City. “The record there is favorable, and AMLO’s advisors are impressive,” he remarked. Bisat argued that AMLO’s team would, if they were certified as the winners of the election, demonstrate fiscal responsibility and show respect for monetary policy and independence. Second-generation reforms that will take Mexico into higher growth rates and improved social welfare need a political buy-in, and the center right has failed to achieve this with the populace, according to Bisat. In contrast, AMLO might be able to deliver what the establishment has not, he stated, citing examples including President Lula in Brazil.
Gahler concurred that the ideal situation would have been for AMLO to have won and to have made strong statements about fiscal orthodoxy and his willingness to enact reforms. “Short-term, this is a non-event, but long-term, who will mobilize these votes?” she pondered.
Vera guided the panel to a discussion on Brazil, its presidential election and the potential for the country to achieve an investment-grade rating. Treacher attributed much of the speculation about the Brazilian presidential race to consultants and pollsters seeking to generate interest in their work, but after the election, “nothing is going to change.” He also offered his assessment that each departing official in the Brazilian debt management team has been replaced by a more competent team member, a good dynamic for the country.
Bisat expressed concern that Brazil would deal with the macro-economy but would be less capable with the micro-economy, a situation he termed “the Mexico syndrome” and defined as being far away from default but unable to achieve high growth, generate employment, raise the country’s middle class or train its human capital. Bisat cautioned that, although Brasilia is more sensitive to such needs than most other governments, this remains a potential concern.
Gahler emphasized that “there is too much obsession with Brazil getting an investment-grade rating.” She seconded Bisat’s view that Brazil has competent macro managers who might be less adept at addressing the micro front. In her opinion, a Lula victory is the most likely result and a non-event.
Drijkoningen highlighted the rigidities in the constitutional system which hinder reforms. He added that high taxes combined with a large amount of short-term sensitive domestic debt will also make an investment-grade rating a challenge.