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Emerging Markets Strategist
Permafrost or permarisk?
The developed world may be entering a world of economic
“permafrost” but EM fundamentals remain robust
However, now is not the time to increase risk because
investors fear a bleaker scenario of “permarisk”
We have grown more cautious, favoring cash, reducing
duration in local debt, switching toward hard-currency
bonds, and becoming more conservative with EM FX
HSBC economists have talked about developed markets entering a “permafrost”
world characterized by anemic growth (see The new economic permafrost, by
Stephen King, 23 August). EM economies, by contrast, are cooling, not freezing.
While the economic team ha cut its forecasts of GDP growth in the developed world to
1.3% for 2011 and 1.6% for 2012, we expect only a modest impact on the emerging
world, with growth of 6.2% and 6.1% this year and next.
It is not time to abandon our defensive stance to EM assets. With the euro-zone
financial crisis unresolved, investors fear a gloomier “permarisk” scenario. While EM
risk-on is consistent with permafrost, that would not be the case under “permarisk.”
Geographical distance would not insulate EM from the type of financial distress of 2008.
We recommend reducing duration in local markets and being cautious on EM FX.
Permafrost should anchor the short end of local yield curves, as lower growth opens room
for monetary easing in some EM countries. On the other hand, permarisk fears are starting
to weigh on EM long-term bond yields and currencies.
Weakened inflows to EM funds conspire against further tightening in local yields after the
recent rally. In turn, lower carry weakens the support to EM FX, which remains highly
correlated with risk-on/risk-off trading patterns. EM equity valuations are cheap, but a
rebound of stock markets in the developed world is needed for EM equities to rally again.
Local markets: We recommend reducing duration. Receive 5yr TIIE in Mexico, we
continue to like receiving 5y IRS spread between South Africa and Poland.
External debt: EM EXD has cheapened, but vulnerabilities to a risk-off scenario
suggest a preference for high-grade credits over high-yield.
FX: We still have conviction on short USD-CNH. We like CZK, IDR, BRL, and MXN at
these levels. Our preferred defensive trades are to short PLN, RUB, VND, and ARS.
Equity: The 12-month forward PE now stands at 9.3%, compared with a post-2000
average of 11x. S&P stabilization is a necessary condition for cheap valuations to
get traction.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Emerging Markets Strategist
Permafrost or permarisk?
The developed world may be entering a world of economic
“permafrost” but EM fundamentals remain robust
However, now is not the time to increase risk because
investors fear a bleaker scenario of “permarisk”
We have grown more cautious, favoring cash, reducing
duration in local debt, switching toward hard-currency
bonds, and becoming more conservative with EM FX
HSBC economists have talked about developed markets entering a “permafrost”
world characterized by anemic growth (see The new economic permafrost, by
Stephen King, 23 August). EM economies, by contrast, are cooling, not freezing.
While the economic team ha cut its forecasts of GDP growth in the developed world to
1.3% for 2011 and 1.6% for 2012, we expect only a modest impact on the emerging
world, with growth of 6.2% and 6.1% this year and next.
It is not time to abandon our defensive stance to EM assets. With the euro-zone
financial crisis unresolved, investors fear a gloomier “permarisk” scenario. While EM
risk-on is consistent with permafrost, that would not be the case under “permarisk.”
Geographical distance would not insulate EM from the type of financial distress of 2008.
We recommend reducing duration in local markets and being cautious on EM FX.
Permafrost should anchor the short end of local yield curves, as lower growth opens room
for monetary easing in some EM countries. On the other hand, permarisk fears are starting
to weigh on EM long-term bond yields and currencies.
Weakened inflows to EM funds conspire against further tightening in local yields after the
recent rally. In turn, lower carry weakens the support to EM FX, which remains highly
correlated with risk-on/risk-off trading patterns. EM equity valuations are cheap, but a
rebound of stock markets in the developed world is needed for EM equities to rally again.
Local markets: We recommend reducing duration. Receive 5yr TIIE in Mexico, we
continue to like receiving 5y IRS spread between South Africa and Poland.
External debt: EM EXD has cheapened, but vulnerabilities to a risk-off scenario
suggest a preference for high-grade credits over high-yield.
FX: We still have conviction on short USD-CNH. We like CZK, IDR, BRL, and MXN at
these levels. Our preferred defensive trades are to short PLN, RUB, VND, and ARS.
Equity: The 12-month forward PE now stands at 9.3%, compared with a post-2000
average of 11x. S&P stabilization is a necessary condition for cheap valuations to
get traction.
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