The countries with the largest current account deficit are often the most vulnerable, and frequently classed as boom and bust economies. Yet yield-hungry investors should not overlook attractive opportunities to access the economic vibrancy of the emerging world.
Emerging market debt has become a key part of the fixed income portfolio at Carmignac over the past 12 months, supported by China’s macroeconomic stabilisation, a rebound in commodity prices, improving current account balances, and higher yields than in developed countries.
A case in point is Mexico, where the real yields are very high, even for the emerging market category. After being buffeted by the bellicose overtures of US president Donald Trump’s election agenda, the country’s economy seems to be recovering. The Mexican peso has appreciated 15 per cent against the dollar since the start of the year.
While the North American Free Trade Agreement stands a good chance of being tweaked, the kind of no-holds-barred fight that could do major damage to Mexico’s economy and exports appears to be a much less likely prospect with a more pragmatic White House.
On the economic front, Mexico’s first-quarter real GDP growth at 2.8 per cent year on year confirmed that economic expansion continued at a healthy pace, despite US policy-driven uncertainty and a significant spike in inflation. Indeed, Mexico’s central bank continues to be vigilant about inflation and has implemented nine rate hikes since late 2015, demonstrating its commitment to its central objective of anchoring inflation expectations.
Meanwhile, Brazil presents attractive disinflationary and deleveraging trends. The current account balance has improved significantly and structural fiscal reforms have boosted public finances.
Argentina is more of a special situation. The country is in a big transition initiated with the arrival of president Mauricio Macri, following 15 years under the Kirchners, with more reforms expected.
It could be said that these emerging economies are at the sweet spot of the current cyclical recovery that started in early 2016, so the risk of the recovery rolling over in the US and China has to be taken into account.
As the world’s second largest economy, China needs particular attention in this respect. The current tightening of credit in the Asian country is an important risk factor since it is a much more volatile economy than the US. The good news is that the reduction is controlled and managed by the government, which, as ever, wants to preserve stability in the country.
However, since the Chinese economy seems very dependent on credit, any reduction of credit growth will result in some economic slowdown. The difficulty is to correctly dose the withdrawal of the stimulus measures. In the longer term, the challenge is to retain the huge savings of the Chinese population within the country. The weakening dollar is a supporting factor in this respect, but also a key variable to monitor.
Investors should also keep a close eye on the development of president Trump’s vaunted neo-mercantilist trade agenda, which aims to reduce the US trade deficit. The emerging countries that are potentially most at risk are the ones which have a large trade surplus with the US, such as China, South Korea or Taiwan.
Last but not least, the risks posed by geopolitics should always be taken into account. Difficult as crises are to predict, the most volatile issue seems to be the standoff of the GCC countries with Qatar, which could further add to regional instability and unsettle energy markets.
Commodities-linked countries such as Brazil, Mexico and Russia, which have a balanced mix between real and nominal rates, as well as local and hard currency bonds, offer returns and/or yields worth noting.
In Brazil and Mexico, real rates denominated in local currencies are another area of interest, while in Russia long-dated, dollar-denominated bonds have piqued interest.
As ever, the opportunities presented by emerging markets must be balanced by the risks.
Didier Saint-Georges is managing director and investment committee member at Carmignac
