Distancing vs Socialising – Cross-Asset Implications
In their Emerging Market Outlook for the second half of 2020, our cross-asset research experts look at the risks EM assets face and explore which assets to distance oneself from and which to socialise with.
Distancing vs socialising
Varying degrees of social distancing could persist for a long time, with certain types of behaviour deemed low risk (safe) or unacceptable (unsafe). A similar analogy can be applied to EM assets – there will be distancing from higher risk assets and socialising with lower risk assets. Furthermore, the tug of war between liquidity (safe) and growth (riskier) will continue to be a feature of relative asset market performance in 2H. Based on these themes, investors should prefer (socialising) sovereign credit over (distancing) local currency bonds and currencies. The three primary risks for EM assets are: (1) growth outlook, (2) US-China tensions, and (3) politics. In our EM Outlook we explore implications for FX, bonds, and sovereign credit and also trade ideas with favourable asymmetries based on central, downside, and upside growth scenarios from Societe Generale Economics.
Asset class outlook
Caution (distancing) on EM currencies is warranted considering a growth rebound that entails significant lost output versus the pre-pandemic trend and tepid capital flows amid selective “distancing” from EM domestic assets. Liquidity and policy support have started to help currencies, but not to the same degree as other risk assets, suggesting downside asymmetric outcomes in the future. Emerging Market bond yields are at all-time lows as central banks followed their developed market counterparts in delivering substantial policy easing. We are neutral on EM duration but there is selective residual value in some countries. However, vigilance is warranted given valuations, positioning, and expectations of slightly higher US yields. Sovereign credit should is well placed due to liquidity, fundamental, and technical factors. The carry in Africa FX markets is high, and the significant outperformance versus traditional EM currencies highlights their return and diversification benefits. However, investors need to be selective. Egypt and Ghana should perform well, whereas there are downside risks in Nigeria from low oil prices.
During the COVID19 induced sell-off in risk assets, local and hard currency bonds of countries with high governance scores outperformed. The reverse occurred in the central bank stimulus induced recovery phase. But over time there are three key conclusions regarding incorporating an ESG factor into EM bond portfolios: (1) the impact performance at the index level is small, but it means that ESG-conscious investors can incorporate governance without sacrificing returns, (2) there is a slight improvement in the credit rating profile, and (3) a marginally lower volatility of returns.
The report further develops:
- Trade recommendations.
- EM FX Rates forecasts.
- Outlook by asset calls: FX – buyer beware; FX volatility – selective exposure; EM rates – only selective value; Sovereign credit – stay bullish.
- Key EM country analyses.
About Societe Generale Cross-Asset Research
Societe Generale Cross-Asset Research is composed of more than 200 Analysts, Strategists, Economists and Quant, combining their expertise into ‘Research-based’ and innovative solutions suited to client’ needs: fundamental studies and expert views, investment ideas and long-term strategies, trade ideas and tactical baskets, thematic and systematic indices, quant solutions. On top of its established UK and Western European base, Societe Generale Cross-Asset Research benefits from a global coverage thanks to its presence in the US and in Asia (Hong Kong, Singapore, Tokyo and Bangalore) and Societe Generale local networks in Eastern Europe.
This editorial contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of Societe Generale. This interview is dedicated to institutional and professional investors and is not deemed to be seen and used by retail investors for investment purpose. The viewers shall consult their own financial advisers to make their own appraisal.