Over the month the fund gained 0.85%. Markets have been in a state of wind-against-tide for much of the summer. Unsettled, rangebound and volatile.
Much of this can be attributed to the increased uncertainty over the global growth narrative. This last month the divergent trajectory of US and Japanese rates has been the most notable, and triggered an aggressive unwind of the Yen carry-trade.
Recent US economic data has been soft, which is exactly how it should be at the top of an interest rate cycle, but compounded by weak loan demand, rising corporate defaults and a growing consensus that Chinese overcapacity is causing an intractable deflationary trend.
We now look to the long-heralded Fed rate cut, with the only debate being the size and more importantly the guidance. The ‘optimistic’ consensus has been for moderate global growth with limited rate cuts. Easing rates, combined with a weaker dollar and lower oil prices should probably be sufficient to avoid recession, all of which presents a decent backdrop for EM assets.
But over the summer there’s been growing nervousness that the Fed is already too late, and markets have been pricing-in much larger defensive rate cuts. The 2-year note says it all, now at 3.6% down from 5% in late May.
In sharp contrast there’s absolutely no evidence of credit stress in emerging corporates, in fact quite the opposite with defaults at a near all-time low. Whilst the deteriorating Chinese current account is used as evidence of weak output, it’s not corroborated by customs data which remains healthy and points to China’s increasing share of global exports. Unfortunately, there’s a lot of smoke and mirrors in the data these days.
There’s also a divergent trend in corporate profitability. More private sector companies are now loss making whilst the proportion of SOEs is actually improving. Entrepreneurialism is what’s really under pressure.
What we know is that rates are coming down and global growth is weakening, but not recessionary. Easing US rates will be particularly welcome to some EM central banks that will be able to follow suit, particularly those with high real interest rates (eg South Africa) or those pegged to the dollar such as Hong Kong, UAE and Singapore.
All of this tilts us further towards bond-like equity allocations, with high-quality, high-visibility earnings that will be paid-out to investors in cash, combined with a growing relevance on buybacks. As rates come down these yield spreads will become more attractive and in theory lead to capital appreciation.
Some of the portfolio manifestations of this has been to reduce Technology and to further increase Communications which are less cyclically vulnerable than utilities. They also benefit from factors such as stronger pricing power from consolidation, easing capex cycles and an increasing exposure to datacentre demand from AI. We also
continue to find attractive investments in the UAE and are drawn to Hong Kong where the pass-through of lower rates will be felt quite directly.
At the portfolio level we feel comfortable that we can maintain our forward yield at around the same level as our historic yield. The attraction of this real yield spread should increase further as yields on alternative asset classes continues to fall given this general easing rate environment.
