A stealth bull run has been under way in recent months amid EM assets, especially Asian equities, currencies and bonds, which should blossom in the year ahead. A major equity call will be when to adapt an overweight emerging market (EM) position after favouring developed markets in the past few years, especially the US
Pessimism towards all things EM seemed to peak earlier this year. Heightened geopolitical tensions have since kept most investors cautious. However, the Chinese economy has shown modest improvement and global export growth has firmed. Importantly for global investors, downside economic and financial risks in China have dissipated.
As a result, the contrarian call this spring was to bet on emerging Asian asset markets, which have experienced a period of ‘stealth’ outperformance since April. It could take an extended period before the majority of investors warm up to these markets but the valuation and economic fundamentals are supportive and we expect sustained outperformance in the year ahead.
Our absolute return portfolio has included several pair trades that benefit from better EM Asian equity, bond and currency performance. We recently added additional positions, encouraged by better relative value and the improving global trade cycle. Positions include:
Overweight China relative to the EM equity benchmark;
Long China/short Australia risk assets. Although both of these equity markets are pro-cyclical, this pair trade targets our relatively upbeat view on the Chinese economy (and asset markets) and negative view on commodity related plays. We also recommend the China/Australia currency cross;
Long emerging Asia/short EM commodity producer stocks. This equity pair trade is broader than the trade above and focuses solely on emerging markets, meaning it reduces one’s overall EM exposure;
Long emerging Asia/short US equities. Emerging Asian stocks have massively underperformed their US counterparts in recent years and now offer healthy growth prospects at a relatively attractive price. This does not mean we are negative on the cyclical prospects for the US market, only that EM Asia should outperform; and
Long EM debt. We continue to favour a long position in emerging Asian local currency debt, funded in yen. The yield pickup remains appealing, given the solid underlying public finances in these economies. We also have recommended a long position in EM US dollar-denominated debt versus 10-year US Treasuries.
Investors may wish not to implement all of these recommendations to avoid holding concentrated risk to the region. Our favoured picks among these would be Chinese equities versus their Australian counterparts, emerging Asian versus US stocks and emerging Asian local currency debt. All three positions also contain the currency exposures.
Phillip Colmar is a partner at MRB - The Macro Research Board