28 June 2011

Emerging Markets Strategist Better safe than sorry HSBC

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Emerging Markets Strategist
Better safe than sorry
 The global environment has deteriorated in recent weeks; we
turn tactically more defensive on EM assets
 EM balance sheets are robust, but there is still a threat from
reduced liquidity in the case of a risk-aversion shock
 We favor the front end of local curves and increase cash in our
external model debt portfolio; in FX, we prefer Asia



The global backdrop has deteriorated for EM and the market is at a crossroads. US
economic activity has weakened and fears that the Greek debt crisis may end in a default have
risen, unsettling financial markets.
Although we think EM balance sheets are strong enough to withstand even stronger
headwinds, we think liquidity could be squeezed if matters deteriorate further.
Market sentiment is likely to remain volatile, depending on the progress of the
negotiations on Greece and the political support for further adjustment.
We are not turning bearish on EM; but short term, we are taking a tactically more
cautious approach to the asset class in the context of asymmetrical risks. Past creditdriven sell-offs, notably Lehman and the first wave of eurozone worries, showed that
initially equities suffer the most, while the front ends of local curves appear quite solid.
Our call for a more cautious approach is also based on valuations; we have not
entered a risk-off mode in EM. EM equities have sold off, but in line with those of the
developed markets on the back of deteriorating growth prospects. EM fixed income and
FX have not seen significant pressure.
Economic activity continues softening in most of EM as shown by our new Growth
Tracker. However, it is still too early to know whether we are entering a soft patch or a
longer-lasting economic slowdown.
 Local markets: we favor the front end of curves where a reassessment of growth
expectations could mean that fewer-than-expected rate hikes lie ahead (Mexico, South
Africa, Czech Rep).
 External debt: we increase cash in our model portfolio; we trim overweights to highbeta credits (Argentina and Venezuela).
 FX: we prefer Asia to other regions due to the anchoring role of the RMB and less
commodity-dependant flows.
 Equity: outflows from dedicated funds are brought by diminishing growth expectations;
we prefer the strongest domestic cyclical stories (China and Brazil).



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