BlackRock Commentary: Liftoff ? EM has already taken off

Wei Li, Global Chief Investment Strategist together with, Scott Thiel, Chief Fixed Income Strategist, Axel Christensen, Chief Investment Strategist LatAm & Iberia and Beata Harasim, Senior Investment Strategist, all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

As U.S. inflation is hitting three-decade highs, market talk has been all about “liftoff:” When will the Federal Reserve and others start raising their policy rates? This is old news in emerging markets (EMs), where many countries have already raised rates to try to tamp down inflation. Their approach has pressured growth already hurting from a delayed vaccine rollout. This makes us cautious on EM equities, but has made selected EM debt more attractive in a world starved for yield.

Article Image 1

Sources: BlackRock Investment Institute and Bloomberg, November 2021. Notes: The chart shows the current and 1-year forward central bank policy rates. 1-year forward rates based on futures market pricing. Emerging markets policy rates are weighted based on the JP Morgan GBI-EM global Diversified Index. .

 

Central banks across the emerging world have been raising interest rates to try to contain inflation and prevent their currencies from depreciating sharply. The rate increases have accelerated as inflation has picked up and the U.S. dollar strengthened. A wide variety of countries is now tightening policy, ranging from Brazil to Russia and South Korea. The result? The emerging world has a head start in normalizing policy. A weighted average of EM policy rates now stands at 3.2%, as the red part of the left bar in the chart shows, versus near zero or negative rates in the U.S. and euro area. Market pricing (the yellow parts of the bars) shows much of the work is done in EM, whereas developed markets (DMs) have yet to lift off. This ties in with the much more muted response to rising inflation seen in the developed world, thanks to unprecedented fiscal–monetary coordination in helping the economy bridge the virus shock and new central bank policies of letting inflation run a bit hot. EM central banks historically have had less credibility, while inflation and currency pressures have been much greater. But many are acting earlier and faster this time to prevent things from spinning out of control.

What does the EM head start in raising rates mean for investments? We believe it supports EM debt. The hiking cycle has started well ahead of the Fed’s tightening – which has often spelled trouble for EMs as investors start to demand more compensation for holding riskier assets. The Fed has just started to taper asset purchases, and we don’t see it raising rates until the middle of 2022. The EM approach has created a large interest rate buffer versus DM, lowered valuations and raised coupon income. This makes EM debt attractive versus DM credit in a world starved for yield, in our view.

Improved valuations and coupon income should help cushion any yield rises and prevent disorderly moves in EM bonds when the Fed lifts off, we believe. Indeed, we don’t see a repeat of 2013’s taper tantrum when the Fed’s decision to cut back asset purchases caused havoc for EM assets. Why? First, the trajectory of rates matters more than the timing of liftoff, in our view. We see a very shallow rates path in DM this time, given the historically muted response to inflation. Second, many EM countries are now better positioned to weather Fed tightening and a stronger U.S. dollar. Currencies have adjusted, foreign ownership has declined, and inflation-adjusted yields have risen. There are exceptions, including EMs with weakening balances sheets or loosening policy, as country-specific risks always loom large in the diverse EM investing universe.

What do we like within EM debt? The big picture is that we expect fixed income to be generally challenged amid persistent inflation, and underweight government bonds as a result. We see EM local-currency debt offering the most relative opportunities in this context. Current yields and currency valuations compensate for the risks, in our view. And we like local-currency EM debt for its relatively low duration, or sensitivity to rising rates, and diversification benefits. It gives exposure to regions that make up a small share of EM equity indexes, such as LatAm. We prefer local-currency bonds of higher-yielding countries with solid current account balances. We also overweight Chinese government bonds for their relative high yields and diversification properties. We remain neutral on hard-currency EM debt.

Bottomline: We generally prefer equities over bonds in an environment of solid growth, persistent inflation and low real yields. Many EM central banks have started raising rates well before DM counterparts in an effort to contain inflation. This has dampened EM growth and tightened financial conditions – and has turned us cautious on broad EM equities and favor DM stocks. Yet it also has opened up opportunities in EM debt, against a backdrop of higher yields in a world starved for income. We are modestly overweight EM local-currency debt as we see valuations compensating for the risks.

Article Image 2

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of Nov. 18, 2021. Notes: The two ends of the bars show the lowest and highest returns at any point this year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are, in descending order: spot Brent crude, MSCI USA Index, MSCI Europe Index, ICE U.S. Dollar Index (DXY), MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, spot gold, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index and Refinitiv Datastream U.S. 10-year benchmark government bond index.

 

Market backdrop

A virtual meeting between U.S. President Joe Biden and Chinese leader Xi Jinping sought to prevent strategic competition from turning into outright conflict and created the atmosphere necessary for follow-up meetings. Equities have notched records while bond yields have edged up amid rising inflation. We see inflation dropping from current levels and settle at a higher pre-COVID level in 2022, while we expect a historically muted policy response to inflation.

Week Ahead

  • Nov 23: Purchasing Managers’ Indexes (PMIs) for the U.S., euro area and UK
  • Nov 24: U.S. PCE inflation, personal income and durable good data; Japan PMI

Investors will get a good read on U.S. inflation this week. Personal consumption expenditure (PCE) inflation, the Fed’s preferred gauge for price rises, will show the intensity of price pressures. U.S. personal income and spending data will shed light on the mix of spending between goods and services. Global PMI releases will show the momentum of the restart of economic activity, in particular ongoing disruptions to supply chains.


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of November 22nd, 2021 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what their professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Global equities closed roughly flat overall last week; however, there were some notable moves beneath the surface. The MSCI World closed the week down 0.12%, the S&P 500 Index was up 0.3%, the European Stoxx 600 Index was down 0.1%, whilst the MSCI Asia Pacific underperformed again, down 0.4%. The key theme for markets last week was the resurgence of COVID-19 in Europe and the threat to economies potential new lockdowns pose. This drove the risk-off theme through the week, as defensive plays were sought. Outside of the COVID headlines, the European Central Bank (ECB) remains dovish, with President Christine Lagarde reiterating that the conditions to be met for raising interest rates are unlikely to be met in 2022. In terms of data, the latest US and UK macroeconomic reports were strong. Meanwhile, inflation remains a hot topic for markets, as corporates continue to pass cost pressures onto consumers.

Lockdowns Reintroduced in Europe

Unfortunately, there is only one place to start when we consider market-moving themes last week. The threat of more lockdowns in Europe wasn’t particularly new, but it was the uncertainty around how far and wide restrictions would go that shook investor confidence. Also, markets were primed for a pullback, European equities became technically overbought midweek. The breadth of market rallies also turned negative last week, with more decliners than advancers, despite a small rally in markets through the start of the week. That lack of breadth behind a market rally is typically a signal that a bull run is growing tired.

Early on Friday, Austria announced a nationwide lockdown for a maximum of 20 days starting Monday. The restrictions are likely to be extended beyond the 20 days for the unvaccinated. Additionally, the Austrian government will impose compulsory vaccination from 1 February as the country scrambles to make up for lost ground on the vaccination front. With these announcements, investors began to look towards the larger neighbouring economies for an indication on whether lockdowns were likely to become more widespread.

In Germany, Health Minister Jens Spahn had said earlier last week that a lockdown cannot be ruled out there and advised that the country has not reached peak of its fourth COVID wave. However, on Friday afternoon last week, German Foreign Minister Heiko Maas reportedly ruled out a full nationwide lockdown. Nonetheless, the stage appears to be set for increased restrictions. Chancellor Angela Merkel was reported to have said earlier today that the current COVID situation in Germany is worse than anything it has seen before and that tighter restrictions are needed.

Note, Germany contributes 29.6% towards eurozone gross domestic product (GDP); hence, Germany is a clear focus for economists and investors.

Elsewhere, Belgium re-imposed a work-from-home requirement, whilst Spain brought back restrictions on large gatherings. The Netherlands, Sweden, Greece, the Czech Republic, Slovakia, Hungary and Poland all imposed stronger measures last week. There was significant civil unrest in a number of these countries, as demonstrators took to the streets in protest against the new restrictions.

We saw a clear shift in sentiment on lockdowns last week, as countries across Europe continue to hit new daily case records and death rates increase again. But it’s not just in Europe that we are seeing notable increases. COVID-19 cases in the United States hit just under 97,000 late last week, up nearly 30% from the start of November and the highest level since early October. Focus shifts back to vaccination rates as countries work to pick up the pace once again.

Some countries in continental Europe seem to be learning the merits of keeping vaccinations at the forefront. For example, Germany and Austria managed the pandemic’s initial surge relatively well, but by early October of this year, vaccination rates were far behind the eurozone average and we’ve seen a resurgence in cases.

What did this mean for markets last week? Overall, the Goldman Sachs basket of reopening stocks closed the week down 4.5%, whilst the Stay-at Home basket closed up 2.2%. With that, travel and leisure stocks were the clear laggard last week as the lockdowns threaten international travel this winter. Bank stocks struggled last week as well for a few reasons: lockdown caution; 10-year Bund yield fell below both 100- and 200-daily moving averages on Friday as investors flocked to safety; and, as mentioned, Lagarde pushed back against tightening once again.

Meanwhile, real estate stocks were higher as yields came under pressure on Friday. Given the growth bid last week, technology stocks were also higher. In summary, the risk-off theme was clear as investors moved out of COVID-19 reopening plays.

Week in Review

Europe

European equities closed the week lower after giving up all their weekly gains on Friday amid headlines around the re-introduction of lockdowns in central Europe. Up until Friday, the weekly market move had been fairly insignificant, trading in its tightest weekly range in two months. Volumes at the start of the week were poor too, the lowest since the start of September. Volatility spiked on Friday, up 25% on the week at one point. Nonetheless, the pullback on Thursday and Friday snapped the recent steady grind higher for European equities. On Wednesday, European stocks closed up for the 13th time in 14 sessions, an occurrence which has only happened once before in 1999. Capital raises continue in Europe.

The country-specific indexes reflected sector moves more than anything. The Spanish IBEX lagged, down 3.6% last week given its significant exposure to travel and leisure stocks as well as banks. The UK FTSE Index was down 1.7% on the week for similar reasons. The German DAX Index outperformed despite worsening COVID headlines, up 0.4%, helped by its exposure to technology and food delivery stocks. Growth stocks fared better on the week, whilst value stocks in Europe finished the week down. Sector dispersion increased last week, with the latest COVID figures providing the catalyst.

United Kingdom: Out of favour with investors? Last week saw strong UK macro data that will add to the pressure on the Bank of England (BoE) to raise interest rates. October UK inflation data surprised to the upside, as the Consumer Price Index (CPI) grew 4.2% year-over-year (Y/Y) and RPI grew 6% Y/Y. In addition, Friday saw the release of stronger-than-expected UK retail sales and, more importantly, solid employment data (unemployment rate at 4.3% for the July-September period).

The BoE held off lifting rates in order to see the impact of the end of the furlough scheme (ended in September), so that stronger employment data should be reassuring. However, the market is wary of being wrong-footed by the BoE again and sees only a 52% chance of a rate hike in December (82% chance of a hike for the following Feb meeting). There are still a few key data points before the BoE policy meeting on 16 December, which promises to be an interesting one.

Thinking about UK assets more broadly, generally there does seem to be an overhang due to UK supply chain bottlenecks/the ongoing spat with the European Union (EU) over Article 16 and the loss of confidence in the BoE. Last week’s Bank of America “Flow Show” report and Fund Manager Survey showed the UK suffering outflows, and it is the region fund managers are most bearish on. Again, EU equities are favoured, with respondents most bullish on that region.

However, to balance out some negativity, other market participants have noted the discount UK equities hold to other regions, which could be pointing to a potential rally.

United States

Last week saw US equities grind higher, with the S&P 500 Index closing up 0.3%, close to fresh all-time highs. Looking beyond the headline move, there was a clear outperformance of growth names over value, with the tech-heavy Nasdaq 100 Index outperforming, up 2.3%, vs. the more value-biased small capitalisation Russell 2000 Index, which declined 2.8%. This divergence is also reflected in sector performance, with consumer discretionary and technology stocks outperforming. In contrast, the value sectors of energy and financials were the laggards.

Next Federal Reserve Chair Nomination: In terms of talking points, a key focus as we start this week is President Joe Biden’s reappointment of Jerome Powell as Fed chair. Lael Brainard (seen as more dovish) was named vice chair. Some progressives have criticised Powell, but markets seem to be embracing the status quo.

Over the weekend, the US House of Representatives passed President Biden’s US$1.7 5trillion “Build Back Better” social spending bill. The harder task of getting the bill through the Senate (50/50 split between Republicans and Democrats) lies ahead, as it would take just one Democrat to oppose the bill to block its passage. Democrats are targeting a Senate vote by Christmas.

Looking to Fedspeak, Fed Vice Chair Richard Clarida said that the Federal Open Market Committee could take action earlier than expected to tackle inflation. Given inflationary pressures, Clarida said “it may well be appropriate (at the December meeting) to have a discussion about increasing the pace at which we’re reducing our balance sheet.” Any acceleration of the Fed’s taper on its asset-purchasing program would most likely see a knee-jerk negative reaction from markets, with heightened volatility.

While investors seem to be favouring US stocks of late, the CNN Fear & Greed investor sentiment index has been looking stretched, and we have now seen this fall in recent sessions. It fell from “Extreme Greed” territory last week, suggesting waning underlying conviction, despite the S&P 500 Index grinding higher last week.

Looking to US macro data last week, October retail sales were stronger than expected at +1.7% month-over-month, and the US Empire Manufacturing index came in much strong than expected at 30.9 as order growth and employment accelerated, while an index of selling prices increased to its highest level dating back to 2001.

Asia and Pacific

Asian equities were mixed week last week, with concerns about COVID curbs in Europe and Fed tapering having a negative impact, as well as headlines out from central banks and the semiconductor space.

Chinese markets ended mixed last week as the CSI 300 Index closed flat and the Shanghai Composite edged up 0.6%. Disappointing earnings from Alibaba (amongst others e.g., Baidu) topped off a week that saw more negative headlines on the economy amid a scramble from real estate firms to raise funds (as previously flagged). The People’s Bank of China (PBOC) continued to signal its support for the economy as it unveiled its latest targeted lending program, this time aimed at the domestic coal sector. Analysts have estimated that the central bank’s various programmes are slowly adding up to 1-2% of China’s GDP.

As we started this week, the PBOC left Loan Prime Rates (LPRs) unchanged as expected. The media so far have focused on language tweaks signalling a looser bias. The central bank said it would keep its prudent monetary policy “flexible and targeted” and strike a balance between economic growth and risk controls. It added that it would keep liquidity reasonably ample while it also saw risks in the property market generally under control.

Hong Kong’s Hang Seng Index closed last week down 1.1%, mainly due again to Alibaba and some of the other tech giants who come out with disappointing earnings numbers, as well as concerns around China’s continued regulatory (tech) crack down.

South Korea’s equity market closed the week pretty much flat, with the semiconductor space in focus once again. We saw strong November chip export data.

Japan’s equity market was muted over a week that saw the government announce a larger-than-expected stimulus package, with the Nikkei 225 Index closing up 0.5%. The Bank of Japan reaffirmed its dovish stance, which led the yen to weaken against the US dollar.

Meanwhile, India’s stock benchmark closed below its 50-day average on Friday for the first time in six months as profit taking hit the metals, banks and PSU sectors. Indian Prime Minister Narendra Modi announced that the government would be repealing his controversial farming laws (a major climbdown for the Modi administration).

Note, Japan will be closed Tuesday of this week and the US market will be closed Thursday.

Week Ahead

Holidays:

  • Tuesday 23 November: Japan
  • Thursday 25 November: US (Thanksgiving)
  • Friday 26 November: US (half day)

Calendar:

Monday 22 November:      

  • Spain Trade Balance
  • Eurozone Consumer Confidence
  • US Existing Home Sales

Tuesday 23 November:      

  • One of the most dovish MPC members on the BoE, Jonathan Haskel, speaks on “high inflation now and then”.
  • France Composite/Manufacturing/Services Purchasing Managers Index (PMI)
  • Germany Composite/Manufacturing/Services PMI
  • Eurozone Composite/Manufacturing/Services PMI
  • UK Composite/Manufacturing/Services Manufacturing PMI
  • US Manufacturing PMI

Wednesday 24 November:

  • BoE’s Silvana Tenreyro is due to speak at the Oxford Economics Society.
  • France Business Confidence
  • Germany IFO Business Climate
  • US GDP
  • US New home sales
  • US FOMC minutes
  • Japan Manufacturing PMI

Thursday 25 November:    

  • Riksbank Interest-Rate Decision
  • ECB Monetary Policy Accounts
  • Germany GDP
  • US Thanksgiving
  • US Jobless claims

Friday 26 November:

  • Italy Consumer Confidence Index

 


Franklin Templeton Key risks & Disclaimers:

What Are the Risks?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Past performance is not an indicator or guarantee of future performance.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 22nd November 2021, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. 

Issued by Franklin Templeton Investment Management Limited (FTIML) Registered office: Cannon Place, 78 Cannon Street, London EC4N 6HL. FTIML is authorised and regulated by the Financial Conduct Authority.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Login

We strive to ensure a streamlined account opening process, via a structured and clear set of requirements and personalised assistance during the initial communication stages. If you are interested in opening a corporate account with MeDirect, please complete an Account Opening Information Questionnaire and send it to corporate@medirect.com.mt.

For a comprehensive list of documentation required to open a corporate account please contact us by email at corporate@medirect.com.mt or by phone on (+356) 2557 4444.