jueves, 27 de agosto de 2015

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Markets Insight

August 26, 2015 5:32 am

Currency storms create investment opportunities

Mohamed El-Erian

In the market washouts, good names get flushed out with the bad

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The currency storm that has engulfed the emerging world has blown into other markets around the globe. It has put pressure on valuations, produced patches of illiquidity and, in some cases, is starting to spill over into the economic and policy spheres.
 
While these dislocations have caused investor pain and risk some accidents, they are also creating a few investment opportunities today and a lot more down the road.

On the economic front, many emerging economies are being buffeted by that unpleasant mix of lower global demand and less favourable international prices. They are operating in an environment characterised by slowing growth, with China’s deceleration compounding sluggishness in Europe and Japan; and, in the case of commodity producers, a sharp drop in export earnings.

Policy options facing these emerging economies are a lot less attractive now they have used up some of the impressive international reserves they had built up in recent years. Their ability to navigate the global downturn using just financing tools is now more limited. Yet, and especially for systemically important countries with heavy influence in market indices (such as Brazil, Russia and Turkey), timely policy adjustments — a mix of fiscal adjustment and pro-growth structural reforms — are inhibited by unsettled political conditions.

The withdrawal of foreign portfolio capital accentuates the challenges. “Crossover investors” — those who have invested in markets outside their comfort zone, now feel an urgency to retrench to their home markets in advanced economies. In addition to placing greater pressures on international reserves and asset prices, this robs emerging markets of operational liquidity, making dysfunctional occurrences more common.

The carnage has been particularly acute in the foreign exchange arena. The most tradeable emerging market currencies are at lows that are worse than those experienced in the darkest days of the global financial crisis.

Companies face mounting losses on account of a mismatch between their high foreign exchange liabilities and their lower foreign exchange earnings. Inflexible foreign exchange pegs, most recently those of Kazakhstan and Vietnam, are biting the dust. And all this is fuelling the classic overshoot whereby currencies depreciate well beyond what is warranted by fundamentals.
 
The deeper the disruptions and the longer they persist, the more likely they are to contaminate other asset classes. And that is exactly what has happened. Having undermined emerging market credit and local currency bond markets, the instability stretched to corporate bonds in the advanced economies, and even to the better-anchored equity markets, such as in the US.

The resulting volatility risks lasting for a while. Despite recent developments, some market prices are still quite decoupled from fundamentals, particularly when it comes to those that have relied on the largesse of central banks. Meanwhile, policy circuit breakers are less effective these days, given how long these institutions have been operating exceptional policy regimes

In the short run, this calls for caution in portfolio positioning, but not universally so. The combination of overshoots and contagion creates interesting individual investment opportunities. In the market washouts, good names get flushed out with the bad, especially as volatility-driven trading algorithms force certain investors to sell wherever they can. Fearing client redemptions, even asset managers with long-term orientations scramble to accumulate cash, often in any way they can.

Most of the resulting trade opportunities are concentrated in “relative trades”, that is, investors using generally disrupted markets to buy the fundamentally well-anchored names and selling those whose weak fundamentals are likely to get weaker. And the most important distinguishing characteristics here are large balance sheet cushions, significant operational flexibility and a record of sound management.

Over the longer term, the opportunities will migrate to the asset class level as long-term investors find outright asset class exposure available at relatively cheap levels. This is particularly likely to be the case in emerging markets currencies, local bonds and external debt, where patience is likely to be handsomely rewarded.


Mohamed El-Erian is chief economic adviser to Allianz and chair of President Barack Obama’s Global Development Council

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