Authored by Ritesh Jain via World Out Of Whack blog,
Indian media and Portfolio managers always like to spin a bullish story and the current bullishness stems from the collapse in oil price.
After all, rising oil prices for a country which imports almost all of its oil requirement is bad for discretionary consumption and its currency . Conversely, lower oil prices are good for the Indian economy as trade deficit comes down giving stability to the currency,retail oil prices come down giving breathing space to household budgets.
But Nedbank breaks this myth and their strategists, Mehul Daya and Neels Heyneke, write…
“Many market commentators are indicating that it is time to look for a bottom in the relative performance between EMs and DMs.”
History, as a guide, suggests that EM vs DM performance is still way above the 1988 and 1998 lows ( in short the bottom is far off)
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EMs underperformed in 2011-15, followed by a risk-on period in 2016-17 after the G20 meeting in February 2016 in Shanghai. Hence the interest in the upcoming G20 meeting to see whether the US and China can come to an agreement on global trade and re-engineer another risk on phase. We believe it will be difficult amid the number of headwinds facing the global economy.
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The underperformance started in 2011, long before the Trump victory; it is not just about trade, but also about $-Liquidity. As long-time readers know, we believe investors are underestimating the role that $-Liquidity (money supply) plays in risk assets.
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An agreement between the US and China should boost failing global trade, helping dollar creation and increasing $-Liquidity. This would trigger a setback in the value of the dollar (EURUSD targeting 1.18), providing relief for EM assets in the near term. However, we still believe structural dollar shortages will continue to plague the market in 2019; hence, in the longer term, we remain bearish on EMs. We also remain concerned about China and its dollar debt burden, as Chinese corporates are heavily indebted with cross-border dollar debt. Hence, China cannot afford a stronger dollar or an escalation in the trade war with the US.
My two cents
Before you hop on to the boat of EM outperformance vs DM rotation, look at the chart below.
When dollar liquidity is ample, capital moves to higher yielding EM in search of returns and when the dollar liquidity contracts, the same capital is forced to sell EM assets as dollar rises.
So pray for a G-20 deal between US and china.
It might just give you one last bounce in EM assets to get out because after that the door will be shut.
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