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Emerging Market Spotlight Podcast Series: Challenges and Opportunities in the Current EM Investment Environment
14 Plays2 years ago
In this episode EM experts examine the challenges that have buffeted emerging markets over the last year, including geopolitical tensions, high commodity prices and inflationary shocks. How should investors approach this complex and somewhat tricky environment, and what are the bright spots? Dr. Murat Ulgen HSBC’s Global Head of Emerging Markets Research, and Celina Apostolo Merrill, Portfolio Manager of Emerging Market Corporate Debt at Blackrock, join host Cary Goodwin, Head of Institutional Sales, Americas & Head of Global Debt Market Sales at HSBC, for this conversation. Emerging Markets Spotlight is a podcast miniseries created and hosted by HSBC that seeks to explore and understand the complex and critically important issues facing the world’s emerging markets. For further insight and information around emerging markets, visit Accessing Emerging Markets | HSBC.
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Transcript
Podcast Introduction
00:00:02
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes.
00:00:16
Speaker
Thanks for listening.
00:00:17
Speaker
And now onto today's show.
00:00:32
Speaker
Welcome to the Emerging Markets Spotlight, a podcast series from HSBC.
Complexities in Emerging Markets
00:00:38
Speaker
The emerging markets landscape is more complex than ever at a time of divergent monetary policy, high commodity prices, supply chain disruptions, and geopolitical tensions.
00:00:52
Speaker
Join us as we speak with world's leading institutional investors, experts, policymakers, and thought leaders to explore the challenges and opportunities.
00:01:03
Speaker
Make sure you subscribe to HSBC Global Viewpoint and stay up to date with new episodes.
00:01:10
Speaker
Thanks for listening.
00:01:11
Speaker
And now on to today's show.
00:01:19
Speaker
Hello, and thank you for tuning in
Expert Guest Introductions
00:01:21
Speaker
today.
00:01:21
Speaker
My name is Kerry Goodwin, and I'm Head of Institutional Sales Americas and Head of Global Debt Market Sales.
00:01:27
Speaker
Today, I'm going to be talking with Selena Apostolo Merrill, Portfolio Manager of Emerging Market Corporate Debt at BlackRock, and Murat Olgin, HSBC's Global Head of Emerging Market Research.
00:01:39
Speaker
With over 20 years of experience in the industry, Selena Pastolo Merrill is the portfolio manager for EM Corporate Credit investments across BlackRock's active flagship portfolios.
00:01:50
Speaker
Prior to her role at BlackRock, Selena held roles as an executive director in LATAM Corporate Credit at JPMorgan Investment Management and head of Emerging Markets Corporate Credit at VanEck Global.
00:02:03
Speaker
Dr. Murat Olgin joined HSBC in April of 2006 as the chief economist for Turkey,
00:02:09
Speaker
Before joining HSBC, he held several sell-side economists and strategist positions in London and Istanbul, covering more than 15 emerging market countries in that time zone.
00:02:18
Speaker
In December of 2009, Dr. Olgen was appointed HSBC's chief economist for Central and Eastern Europe and Sub-Sahara Africa, and he became HSBC's global head of emerging markets research in 2014.
Selena's Insights on Emerging Markets
00:02:31
Speaker
Selena, what can you share with us that led you to a professional career in emerging markets that
00:02:39
Speaker
we might like to hear as we get to know you to start this podcast.
00:02:43
Speaker
Sure.
00:02:44
Speaker
Thank you so much, Carrie and the HSBC team for having me here.
00:02:47
Speaker
Well, first, I was born and raised in El Salvador.
00:02:50
Speaker
So I know emerging markets, true to my heart, which is why when I started working in the US, I wanted to do distressed investing, not in emerging markets.
00:03:00
Speaker
But then Argentina defaulted, and I've subsequently worked on two Argentina defaults in the various corporate restructurings that followed across EM since then.
00:03:10
Speaker
And one of the things that I've learned that I think is a good reminder of being an emerging markets investor is how quickly things can change.
00:03:17
Speaker
So I was maybe eight years ago now on a due diligence trip where we traveled two hours offshore via helicopter to a drill ship operator to look at the asset, to look at the ship.
00:03:28
Speaker
And that was our collateral for our bonds.
00:03:30
Speaker
We flew back after this day trip and then
00:03:32
Speaker
A couple of weeks later, the contract was terminated and the bonds ended up defaulting.
Murat's Perspective on Asset Evolution
00:03:37
Speaker
So how quickly does your collateral actually turn into a liability is something that I think we always keep in mind in emerging markets.
00:03:45
Speaker
That's quite the baptism by fire story, but yeah, thank you.
00:03:49
Speaker
And then I guess over to you, Murat.
00:03:51
Speaker
Love to hear sort of what attracted you to the emerging market space and how you landed in the role that you are at, at least the beginning of the journey, please.
00:03:58
Speaker
Thank you, Kerry, and thank you, Selena, for giving us this opportunity.
00:04:02
Speaker
I think it's great and great pleasure for me to be in conversation.
00:04:06
Speaker
and talk about emerging markets in the podcast.
00:04:08
Speaker
I guess on my side, it's sort of this ever-changing dynamic and at times volatile backdrop that attracted me.
00:04:16
Speaker
You really need to be on top of things, keep learning to understand various micro challenges.
Challenges in Emerging Markets Investment
00:04:21
Speaker
And also the rise of emerging markets as an artist class happened in earnest, like early 2000s, sort of when I started my own financial market career, because previously it was only hard currency, but now it's a full and rich spectrum of all financial assets.
00:04:37
Speaker
Actually, these days, I take even more joy of being an EM analyst because, you know, what's happening in the global landscape kind of resonates with inflation high pretty much all around the world.
00:04:49
Speaker
So I can apply my EM lens to understand the global macro backdrop and all the challenges.
00:04:55
Speaker
Thank you, Murat.
00:04:56
Speaker
And as an employee of HSBC, I've benefited from our approach in the space.
00:05:00
Speaker
We pride ourselves on being a market leader and getting to know people like yourself, Selena, and Murat over the years has been a lot of fun.
00:05:08
Speaker
So with that, I'm going to dive into some of these questions and hopefully we'll touch on some of the things that are on top of mind for our investors.
00:05:17
Speaker
So Selena, just starting with you, it's been a very challenging year with a lot of external factors affecting the markets.
00:05:26
Speaker
In fact, most of our recent respondents on the EM sentiment survey show that 41% of the investors have bearish expectations.
00:05:36
Speaker
This is the highest level since our survey started, a point that stood out when we were
00:05:42
Speaker
looking at this was the high cash balances.
00:05:44
Speaker
So we've highlighted this point on bearishness, which tends to correlate to high cash and
Investment Strategies in Emerging Markets
00:05:50
Speaker
low conviction.
00:05:50
Speaker
Just curious, Selena, sort of what can you share with us on that point?
00:05:54
Speaker
Sure.
00:05:55
Speaker
I mean, it's definitely been a tricky year and it continues to be tricky.
00:05:59
Speaker
The macro data keeps swinging back and forth.
00:06:02
Speaker
We're trying to, as Marat said, sort of anticipate where rates, quantitative tidying and inflation is going really in developed markets.
00:06:11
Speaker
I think one of the interesting things about EM is
00:06:13
Speaker
is that EM Central Bank started early because we've seen this story before in terms of how to react to certain inflationary shocks.
00:06:21
Speaker
But we have been relatively light on risk, and I don't think that's necessarily unique.
00:06:25
Speaker
We have had higher than usual cash balances.
00:06:29
Speaker
We have been looking at the more conservative parts of the capital structures, whether that's on the sovereign side or on the corporate side.
00:06:35
Speaker
And we have preferred the hard currency side of EM, given that we have seen and continue to expect to see a relatively strong dollar, which is generally bearish for EM.
00:06:46
Speaker
But I think that one of the things that we have been pretty negative about is valuations.
00:06:51
Speaker
And this is why we've been more cautious, is that a lot of the macro backdrop that's
00:06:55
Speaker
expected to continue to be negative in 2023 hadn't been reflected really in a lot of EM asset class valuations.
00:07:02
Speaker
But we do think that valuations are now starting to look more attractive in order to start to look at positioning our portfolios for 2023.
00:07:09
Speaker
And just a follow-up there on the positioning of the portfolios.
00:07:13
Speaker
Cash has become a much more valuable instrument in this environment.
00:07:17
Speaker
Curious if you see any particular part of the credit curve that's sticking out as more attractive
00:07:24
Speaker
Well, obviously, cash is now an alternate asset class, an alternate asset class with yield.
00:07:29
Speaker
And so I think we all need to take that into consideration as we manage our respective portfolios.
00:07:34
Speaker
But that also means that the shorter end of EM, both corporates and sovereigns, tend to be very attracted to us, especially if we look at things on a long-term horizon and as a whole to maturity horizon, how that all in yield really does look attracted to us now.
Global Macroeconomic Challenges
00:07:49
Speaker
and really acts as a ballast to the portfolio.
00:07:53
Speaker
That being said, we also think the long end of many curves on the hard currency side are very attractive.
00:07:58
Speaker
Very steep curves in high quality investment grade names, both on the corporate side and on the sovereign side, are across EM, and that's not replicated either in the US credit markets or in the European markets.
00:08:09
Speaker
So we think sort of a ballast and sort of back and forth part of a portfolio would be to combine short end investments with long and higher quality duration.
00:08:19
Speaker
Gotcha.
00:08:20
Speaker
Thank you.
00:08:21
Speaker
So, Marat, given what's going on in the world and knowing that investors are often faced with contradictory macro data, how should they approach emerging markets?
00:08:29
Speaker
This is a sort of catch-all question, but what do these broader challenges mean for emerging markets from your perspective, and what do they mean for asset prices in the current environment?
00:08:39
Speaker
Sure.
00:08:40
Speaker
Thanks, Gary.
00:08:41
Speaker
I think we have a basic macroeconomic challenge.
00:08:44
Speaker
It's the growth inflation mix.
00:08:46
Speaker
We have global economic activity decelerating emerging market economic activity, also losing altitude and momentum.
00:08:54
Speaker
And we have elevated inflation, in certain cases, the rising inflation.
00:08:58
Speaker
I think this very mixed combination of growth and inflation is quite unpleasant and unfavorable.
00:09:03
Speaker
And in the past, we used to have China lifting up all the boats by big credit impulse and strong recovery and rebound.
00:09:10
Speaker
At the moment, we're not seeing that.
00:09:12
Speaker
If anything, markets and ourselves will revise China growth down.
00:09:16
Speaker
We do expect a steady recovery next year.
00:09:18
Speaker
But in the immediate term, China is not lifting up global trading commodities as it used to in the past.
00:09:24
Speaker
And finally, we have this twin tightening coming through the Fed.
00:09:29
Speaker
We know one angle investors are very much focused and understandably so.
00:09:32
Speaker
It's the cost of funding.
00:09:33
Speaker
It's the Fed funds rate.
00:09:35
Speaker
We've recently revised them up.
00:09:36
Speaker
But there's another angle where I think there is relatively
Market Dynamics and Valuations
00:09:39
Speaker
little discussion and it's not explored well.
00:09:41
Speaker
It's the quantity of funding.
00:09:43
Speaker
It's all these balance sheet reduction and quantitative tightening, which is actually withdrawing liquidity from the markets.
00:09:50
Speaker
And this gives a very challenging backdrop for emerging markets.
00:09:53
Speaker
For one thing, it is causing dollar strength and it's a major headwind.
00:09:57
Speaker
And the other thing, as Selina very rightly mentioned, you have a new financial instrument that has arisen from zero yield over the past two years, year and a half, to relatively attractive yield, that's US dollar cash, and it is becoming a major alternative.
00:10:15
Speaker
So this is a pretty challenging backdrop.
00:10:17
Speaker
But at the same time,
00:10:18
Speaker
I do agree with Selina on valuations as well.
00:10:20
Speaker
They are looking attractive now.
00:10:22
Speaker
Emerging markets, I mentioned about this slow growth, high inflation, sort of pseudo-stackflation backdrop, but emerging markets have been pricing this in for a very long time.
00:10:32
Speaker
I mean, when I look at the individual asset classes, hard currency credit, for instance, you have to go years back to find similar returns.
00:10:41
Speaker
I do believe certain parts of emerging market assets are looking quite attractive, in particular hard currency returns.
00:10:47
Speaker
I mean, you really have to go back.
00:10:48
Speaker
perhaps a few decades to find similar returns when you exclude this blip at the onset of the pandemic.
00:10:55
Speaker
Positioning is quite light, many parts of emerging market universe and cash level, cash balances are very high.
00:11:01
Speaker
So in a way, you are in this sort of conundrum where the fundamental backdrop is really challenging.
00:11:07
Speaker
from a growth and inflation perspective.
00:11:09
Speaker
And this twin tightening by the Fed in the background is really causing massive headwinds in terms of financial conditions for emerging market for the downside
Liquidity Issues and Strategies
00:11:19
Speaker
growth risk.
00:11:19
Speaker
But on the other hand, you have the technical picture in terms of valuations, in terms of cash positions, cash balances, and actual positioning in the market that are quite attractive.
00:11:29
Speaker
I mean, to me, it's still the fundamentals that overcome the technicals, but we shouldn't lose the second aspect and try to understand where actually emerging markets are paying back and paying off to hold that risk.
00:11:41
Speaker
Yeah, I mean, the cash balances comes up often in a lot of the client dialogue.
00:11:46
Speaker
And I guess it begs a couple of questions, but the one for you, Selena, is liquidity has been a challenge for everybody.
00:11:52
Speaker
And as I said, when I was with Murat in London at an EM dinner that we hosted just a few weeks back,
00:11:59
Speaker
It was evident that people had cash to put to work, but they were struggling to find the liquidity necessary to really sort of build positions.
00:12:07
Speaker
Love to hear any comments there.
00:12:08
Speaker
And then I'll have a follow on question specifically as it relates to the primary markets.
00:12:13
Speaker
A lot of folks had said as we entered into the fall, they were hoping to see some supply where they could redeploy some cash.
00:12:19
Speaker
I'm not sure that that's necessarily played out.
00:12:21
Speaker
Last couple of days, I've opened markets up a little bit.
00:12:23
Speaker
I'm curious just on liquidity and how you're finding sort of getting things that you need in the door in this environment.
Outlook for EM Corporates
00:12:30
Speaker
Love to hear your views.
00:12:32
Speaker
Well, I think liquidity has been particularly challenging.
00:12:34
Speaker
And so all our sell-side partners have unfortunately been very limited in terms of the kind of risk that they've been able to recycle, as we've had outflows in the asset class that are the largest we've seen in 20 years, right?
00:12:45
Speaker
So that risk has to go somewhere, and it's been really difficult to find at home for it.
00:12:50
Speaker
When looking at BlackRock's portfolios, so given the size of the portfolios that we're trying to manage and given the difficulty in the liquidity side,
00:12:56
Speaker
We try to be good partners and also try to be a little bit contrarian in terms of where we can find pockets of liquidity and be adding risk, sometimes when the market feels the most uncomfortable.
00:13:06
Speaker
But as Murat mentioned, when we find pockets of value, that's when we try to position our portfolios.
00:13:11
Speaker
And similarly, when there's rallies that we don't think are fundamentally driven or valuations seem to be too tight, that's when we're also contrarian and also limiting some of our risk as well.
00:13:22
Speaker
And Kerry, if I may add something more sort of, you know, macro top-down view in terms of what global liquidity is doing.
00:13:28
Speaker
So we have developed a very simple framework.
00:13:31
Speaker
We look at some of the balance sheet size of large global center banks in trillions of US dollars.
00:13:36
Speaker
which has peaked about $25 trillion earlier in the year.
00:13:40
Speaker
And with the Fed starting its quantitative tightening in earnest in June, now that is coming down in small clips.
00:13:46
Speaker
But to us, for emerging market flows, the year-on-year change of that global liquidity is a lot more relevant.
00:13:52
Speaker
So the pace, the first derivative.
00:13:54
Speaker
So when I correlate financial flows to E&B bonds and equity with that year-on-year change in liquidity, it's a very clear downward trend in both.
00:14:02
Speaker
Year-to-date, we've seen $66 billion of outflows from emerging market institution investors in fixed income.
00:14:09
Speaker
Equities saved the day a little bit, but on equities, it was mostly passive ETF investments.
00:14:14
Speaker
And that's the secondary market.
00:14:15
Speaker
And in the primary market, the issuances, which both you and Selena mentioned before, it's the same downtrend.
00:14:23
Speaker
And actually, the legs are much shorter.
00:14:25
Speaker
When I look at the sovereign issuances over the rolling four quarters, it's only 70, 75 billion dollars, which is one third of what we had late 2019.
00:14:37
Speaker
So this liquidity or its pace of liquidity, the year on year change is actually impacting both the secondary market and the primary market flows for emerging markets.
00:14:46
Speaker
For sure.
00:14:47
Speaker
To that point that you've both made, I have a question.
00:14:49
Speaker
Today, we have Philippines in the market with a multi-tranche dollar deal, the public investment fund.
00:14:55
Speaker
is also doing a significantly sized dollar deal.
00:14:58
Speaker
Just curious, we've seen sovereigns come, we know more have to come.
00:15:02
Speaker
But in terms of the deployment of cash and separately sort of to you, Selena, what's your view on the corporate space and EM corporates ultimately reaching a point where they can come into the market
00:15:12
Speaker
If there were to be a catalyst besides just flat out rate moves, what would you point to?
00:15:18
Speaker
Because from my perspective, from a leverage and interest coverage stance, EM credit looks pretty good.
Impact of Global Liquidity on EM Markets
00:15:24
Speaker
It's been a positive few years leading up to this point, but we've broken down clearly.
00:15:28
Speaker
Curious what you're thinking as it relates to supply in the corporate space.
00:15:32
Speaker
Yeah, absolutely.
00:15:33
Speaker
And this is where we wish we could see more, both on the IG side and on the high-yield side.
00:15:38
Speaker
But let me put that into a slightly bigger framework.
00:15:40
Speaker
So EM corporates are now much larger than the U.S. high-yield, for example, in terms of an asset class.
00:15:46
Speaker
And most CFOs worth their salt in the last two years have been turning out their capital structures and reducing their leverage.
00:15:53
Speaker
So when you look at corporate balance sheets as a whole, as you mentioned, leverage is at an all-time low since 2007, and interest coverage is also at an all-time high versus 2007, and looks significantly better than U.S. high yield and European high yield credit.
00:16:06
Speaker
So EM corporates have that luxury of not necessarily being able to issue because unfortunately, there's no M&A of size, and there's not really a lot of CapEx investment going on at the corporate level.
00:16:17
Speaker
Hopefully, we'll start to see that.
00:16:18
Speaker
But to your point about rates, some of the IRRs for some of these projects may or may not be as attractive anymore, given where rates have come.
00:16:25
Speaker
That being said, we are actively looking for paper.
00:16:28
Speaker
You know, a handful of issuers that have come with a new issue concession.
00:16:33
Speaker
we've been buying throughout the course of 2022.
00:16:36
Speaker
And we hope to see more of those.
00:16:37
Speaker
We hope to help companies also pre-fund some of the maturities that are coming in 2024, even if it may imply a little bit of a negative carry for a company.
00:16:45
Speaker
But the other point that I wanted to highlight is EM corporates, even on the high yield side, have two things going for them.
00:16:52
Speaker
Local markets are that much more sizable now than they were even three or four years ago.
00:16:56
Speaker
So there's depth and breadth, both to the local capital markets and to local banking systems so that they can refinance a lot of their debt.
00:17:03
Speaker
And in the high-yield side, unlike many sovereigns, there are pockets of capital offshore distressed, local, like I mentioned, investors like myself, that are willing to underwrite credits in the public or the private markets.
00:17:15
Speaker
I think when you compare and contrast that with some of the lower quality or lower rated high-yield sovereigns, when they lose access to the capital markets,
00:17:23
Speaker
then there's a little bit more difficulty and a little bit more concern in terms of where you go to for that rollover risk that you have on the fiscal side.
00:17:31
Speaker
Even though sovereigns, as Murat will probably mention more elegantly than I, have not committed the original sin, right?
Geographical Investment Preferences
00:17:38
Speaker
Offshore issuance is lower, domestic market financing is more balanced, and so the mismatch between offshore financing and local financing isn't as high for sovereigns either.
00:17:48
Speaker
Gotcha.
00:17:48
Speaker
Listen, just in terms of geography and sort of what works versus what is presenting more of a challenge, I'm curious, I guess we'll start with you, Selena.
00:17:57
Speaker
What geographies, parts of the world are you prioritizing versus deprioritizing?
00:18:03
Speaker
We can talk about this from the sector perspective, or we can talk about it from which parts of the emerging markets world you like versus not liking.
00:18:11
Speaker
Curious what your thoughts are there.
00:18:14
Speaker
Absolutely.
00:18:15
Speaker
And it's a little bit of both in terms of marrying our macro view and our sovereign view versus some of the corporate view.
00:18:21
Speaker
And some of the corporates are increasingly, like I mentioned, sort of large multinational companies that happen to be headquartered in certain places across the end.
00:18:28
Speaker
So it's a different type of investing that we're looking at today versus, you know, five, 10 or 20 years ago.
00:18:34
Speaker
But in terms of regions and types of companies that we're looking at, we really are looking for the commodity exporters with on the sovereign side with strong fiscal balance sheets that haven't necessarily overspent during the pandemic.
00:18:46
Speaker
time period and can withstand the macro slowdown that we think will be coming.
00:18:51
Speaker
And that applies still even with the commodity sell-off that we've seen most recently, because we still have supportive commodity pricing, both on oil and gas, on metals and mining, pulp and paper, sort of across the board in the commodity space that are supportive for both corporate and sovereign credits.
00:19:06
Speaker
So regionally, that puts us in the GCC, although valuations are a little bit tight, we think they continue to stay tight.
00:19:13
Speaker
But it is a relative safe haven from a fiscal perspective with high quality corporates and with a strong local market.
00:19:20
Speaker
It also puts us into Latin America where
00:19:22
Speaker
Valuations tend to be more attractive, but that is also because there's a fairly sizable political risk we're seeing across the board in terms of elections, possible changes to constitutions or proposed changes to various other sort of legal and institutional structures.
00:19:37
Speaker
So some of that additional risk premium is warranted.
00:19:40
Speaker
But we think there's a lot of opportunities, not only in the commodity space in that time, but also in a lot of regional utilities, as well as regional consumer companies that we think are strong enough to withstand, you know, these sort of slowdown that we're underwriting their cash flows to.
Investor Sentiment on Regions
00:19:55
Speaker
So, Murad, I know in our EM survey, you highlighted some of the preferred regions.
00:19:59
Speaker
And in my discussions with you and clients, you've referenced LATAM.
00:20:03
Speaker
Just curious what your views are on the same topic, if you could share.
00:20:08
Speaker
Absolutely.
00:20:09
Speaker
So the sentiment survey was out only last week, so it's relatively fresh.
00:20:13
Speaker
And two regions, actually three regions that stand out.
00:20:16
Speaker
First, it's Asia.
00:20:18
Speaker
And it's quite interesting, actually.
00:20:19
Speaker
We've done nine surveys so far, and whenever there is...
00:20:22
Speaker
high volatility uncertainty in the market, we kind of see investors going back to Asia, perhaps because of its relative stability or better macroeconomic balances.
00:20:32
Speaker
But what stands out in Asia is actually Indonesia and India as preferred markets.
00:20:36
Speaker
And then in Latin America, yes, that's the second most preferred market after Asia.
00:20:41
Speaker
And when I say this, we look at the inclinations of investors in terms of what they favor across all asset classes and Asia and Latin America stand out as sort of, you know, those regions with
00:20:53
Speaker
the largest number of net favorable position across asset classes.
00:20:56
Speaker
LATAM is the second, the one country that stands out across the board for all asset classes, Brazil, you know, currency, rates, credit, and equities.
00:21:06
Speaker
And then we have Middle East, which is preferred for equities.
00:21:09
Speaker
And on the flip side, there is Central Eastern Europe, which is the least preferred region, possibly because of its regional proximity to the war and also the potential of a eurozone recession that is cited even more in HBC's expectation that kind of keeps Central Eastern Europe relatively lower in the preference list.
00:21:30
Speaker
Yes.
00:21:31
Speaker
Latin America definitely stands out, but that was one particular country, especially when it comes to FX is quite interesting because the general mood towards EMFX is not that great, understandably so.
00:21:41
Speaker
I mean, given all the headwinds and strong dollar, and actually 58% of investors are looking for further weakness in emerging market currencies in the near term.
00:21:50
Speaker
But when it comes to Brazilian real, there is a universal expectation that this currency stands out as one that is preferred.
00:21:56
Speaker
And this was even before the first round of elections when we released the survey last week.
00:22:01
Speaker
Clearly, Brazil has been ahead of the curve in raising rates and has oftentimes been referred to as the darling, which you touched on earlier.
Brazil's Economic Outlook
00:22:09
Speaker
Given the recent outcome from the first round of elections between Lula and Bolsonaro, what do you expect will be the outcome going forward?
00:22:18
Speaker
And how do you think that will impact markets?
00:22:21
Speaker
I mean, I can set the stage for sort of the macro backdrop and leave the investment implications to Selena.
00:22:27
Speaker
Our economists and strategists, they follow it very closely.
00:22:29
Speaker
They publish various reports.
00:22:30
Speaker
They publish the report just on the heels of the first round election.
00:22:35
Speaker
And their interpretation is this is kind of reducing the probability of some extreme fiscal scenarios that the markets were worried about.
00:22:44
Speaker
So it's more about checks and balances.
00:22:47
Speaker
And with that, perhaps the focus of investors is on the other stronger parts of the economy, like the first mainstream large emerging economy or large economy across the globe that is actually seeing a downward momentum on inflation.
00:23:02
Speaker
I think that's very important.
00:23:03
Speaker
And you have very sizable real interest rates, which will only grow possibly over time.
00:23:08
Speaker
You have a balance of payment positions pretty favorable, only small current account deficit, definitely big support from earlier run-up in commodity prices.
00:23:17
Speaker
But when you compare to the past, when
00:23:19
Speaker
Brazil had large current account deficit back in taper tantrum or 2018, et cetera.
00:23:24
Speaker
It looks a lot more favorable and the capital account is in good shape.
00:23:27
Speaker
And finally, the real surprise recently is coming through growth.
00:23:31
Speaker
There has been upward revision in growth forecast where actually despite
00:23:36
Speaker
the aggressive tightening of Santa Bank of Brazil, growth is holding up a lot better.
00:23:41
Speaker
That perhaps reflects domestic confidence and international confidence.
00:23:44
Speaker
So the macro picture looks quite favorable.
00:23:47
Speaker
And that's no wonder why a lot of investors in our survey looked at Brazil quite favorably.
00:23:54
Speaker
Well, it's nice to know that we're constructive on some parts of the world.
00:23:58
Speaker
Selena, anything to add there?
00:24:00
Speaker
Yeah, I mean, you know, to follow up on Murat's point, I mean, the macro backdrop and the congressional composition really are very supportive.
00:24:06
Speaker
And I think back to my theme on exporters, you know, even with the real, you know, slightly stronger on a relative basis versus other currencies, commodity exporters in Brazil are generating significant cash flow.
00:24:17
Speaker
So it's no surprise that that's sort of an area that we like and that we don't think are exposed to any changes or surprises on a regulatory perspective.
00:24:25
Speaker
But I also want to highlight some other domestic names that the market had been sort of selling off as concerns about consumer consumption on the beef names, for example, on the supermarket names or other consumer names domestically.
00:24:38
Speaker
There's a lot of domestic infrastructure names that we think are very strong credits on a standalone basis.
00:24:45
Speaker
And that we think that the market is sort of overestimating this potential downturn.
00:24:50
Speaker
And to Marat's point, there's actual growth to the upside that we think is going to come
00:24:53
Speaker
domestically in Brazil that could be supported for all of these credits.
China's Global Economic Role
00:24:57
Speaker
Thank you.
00:24:58
Speaker
So I'm going to shift gears a little bit.
00:25:00
Speaker
We recently had our global emerging markets forum and Sir John Sawyer, an executive chairman of New Bridge Advisory, spoke and shared some of his ideas, specifically on China and the U.S.,
00:25:13
Speaker
He said, this has been a very challenging year for China with slowing growth, problems in the real estate sector, ongoing pandemic restrictions, and long-term demographic challenges.
00:25:25
Speaker
I guess I'll start with you, Murat.
00:25:28
Speaker
Curious, given what role China has played in past recessions, the buyer of last resort in some cases, how do we view China?
00:25:38
Speaker
How do you see them transitioning out of this
00:25:41
Speaker
slower growth phase.
00:25:43
Speaker
Absolutely.
00:25:44
Speaker
Thank you, Kerry.
00:25:45
Speaker
Clearly, China is so important for the rest of the world economy, for emerging markets.
00:25:50
Speaker
Just to give you one simple stat to set the stage and put it into perspective, when China first became part of WTO in early 2000, only 4% of emerging market experts were ending up in there.
00:26:02
Speaker
Fast forward to now, it's 16%, 17%.
00:26:05
Speaker
Massive increase.
00:26:06
Speaker
It's not only a major export destination, but also capital provider.
00:26:10
Speaker
And through the sentiment, China is super important.
00:26:13
Speaker
Yes, you're absolutely right.
00:26:14
Speaker
I mean, there are challenges currently.
00:26:16
Speaker
That's why recently we revised our growth forecast for this year, looking for only 3.5%, which is a non-consensus.
00:26:23
Speaker
But then there are some other good parts of the Chinese economy, economic story, one of which is actually investments, especially when it comes to infrastructure investments, especially when it comes to manufacturing investments.
00:26:37
Speaker
And we think over time, they will cause some moderate recovery in economic activity.
00:26:42
Speaker
We actually expect Chinese growth to pick up to 5.2% next year in 2023 from our forecast of 3.5, and that is a sizable recovery.
00:26:52
Speaker
So that actually eventually might set the stage for the world economy to benefit from China's
00:26:59
Speaker
I mean, there are lots of question marks, you know, whether this will cause perhaps a little bit higher inflation, you know, when China starts growing strongly through commodities and elsewhere.
00:27:09
Speaker
I think it really all depends on the supply side as well.
00:27:12
Speaker
And, you know, as we know, throughout COVID and after the war, there has been a big strain on global supply chains, which are improving over the past few months.
00:27:20
Speaker
But, you know, clearly China plays a key role.
00:27:23
Speaker
Selena, anything to add?
00:27:25
Speaker
Sure.
00:27:26
Speaker
And to add to Marat's point about the importance of China, back in the early 90s when we started talking about BRICS, it's a very different world then.
00:27:35
Speaker
But China was 2.5% of global GDP in the early 90s, and it's now about 18, 19%.
00:27:42
Speaker
for 2022.
00:27:44
Speaker
So even on the lower absolute GDP growth, obviously it's a bigger driver of global growth.
00:27:49
Speaker
And we expect that to continue to be a driver, as Murat said, sort of contributing to EM growth outside of China in 2023.
00:27:57
Speaker
But also I would like to add that not only in the investment in infrastructure domestically, but we expect the Chinese government to continue to invest outside of
Future Outlook for Emerging Markets
00:28:04
Speaker
China.
00:28:04
Speaker
which is something that they have done quite strategically in the last 10 to 15 years, and is very supportive for infrastructure projects around the world, which in turn drives not just demand for various commodities, but also growth in other countries around the world that are more directly linked to projects and investing in FDI.
00:28:21
Speaker
Thank you.
00:28:22
Speaker
I'm going to put another one out there for you.
00:28:23
Speaker
In a recent discussion, a client made the comment that
00:28:26
Speaker
it feels like a lost year in terms of returns.
00:28:29
Speaker
And the trade is more what to do over the next few months to set up the portfolio for a better 2023.
00:28:36
Speaker
While the dollar is strong and the Fed is tightening, the fundamentals are tough.
00:28:41
Speaker
EM is going to have a renaissance at some point in the next few years.
00:28:45
Speaker
But for now, we'd rather take US credit risks.
00:28:49
Speaker
And I guess
00:28:50
Speaker
It's a tough day today, but the last few days have been positive.
00:28:54
Speaker
We've had a few deals get through the market.
00:28:56
Speaker
I was just curious if you think in the current environment, given how volatile things have been over the last few weeks slash months, are we tilting towards a renaissance moment now?
00:29:08
Speaker
And if not, what would be the catalyst that gets us there?
00:29:12
Speaker
Loaded question, but Selena, maybe we start with you.
00:29:16
Speaker
Sure.
00:29:17
Speaker
Happy to take a stab at that.
00:29:19
Speaker
And I think EM hasn't been the place to deploy your risk this year.
00:29:23
Speaker
And that's been the CIO view over the course of these few months.
00:29:27
Speaker
And partly it's part of our trifecta.
00:29:29
Speaker
Are your valuations there?
00:29:30
Speaker
And as I mentioned before, they're not.
00:29:33
Speaker
Is your fundamentals there?
00:29:34
Speaker
And they haven't been.
00:29:35
Speaker
And so we think that they will potentially be there as we recover into the next couple of years, but they certainly aren't there in the near future.
00:29:42
Speaker
And then the technicals, which is we know, in theory, we could have cash to deploy, but that's really sort of the trickiest and the most difficult part to predict in terms of the market.
00:29:51
Speaker
So when we see the trifecta functioning, then we're ready to step in with a more aggressive view.
00:29:57
Speaker
But it hasn't been our view right now.
00:29:59
Speaker
And I think at some point, as valuations do get better, are more attractive versus
00:30:04
Speaker
some of the developed market credit and like I mentioned before, versus US treasuries on an absolute basis, we think we'll start to playing a little bit more capital there.
00:30:11
Speaker
But we have been deliberately cautious for the reasons I mentioned.
00:30:14
Speaker
and you're not alone there.
00:30:15
Speaker
Murat, what's going to be our renaissance moment in your opinion?
00:30:20
Speaker
No, I think Serena has summed it up very well.
00:30:22
Speaker
And if the renaissance means there is an inflection point and emerging markets will have steady flows and a big rebound in terms of financial market sentiment and returns, that's not our expectation currently.
00:30:35
Speaker
We've come out with a view earlier in the summer that every now and then we might see technical bounces
00:30:42
Speaker
um which you know probably will be tactical in nature we actually had one throughout the summer where actually there was pivot excitement from the large center banks the expectation that growth will be the priority and inflation will take a backstage um
00:30:59
Speaker
or going to the back burner.
00:31:01
Speaker
But clearly, that wasn't the communication from the big global center banks led by the Fed.
00:31:04
Speaker
They reaffirmed, they worry about inflation.
00:31:06
Speaker
And that pivot rally, quote unquote, has fizzled out and actually returns were quite depressed in the third quarter despite the summer rally.
Personal Reading Recommendations
00:31:14
Speaker
To us, this is like against the fundamental challenging backdrop.
00:31:19
Speaker
You have these tactical and technical bounces because the technical picture is very supportive.
00:31:24
Speaker
depressed sentiment and low positioning so in that sense uh until the tightening in global financial conditions led by large center banks or in terms of cost of funding and quant of funding reach a level and starts reversing at least in terms of expectations i think will probably continue to remain in this challenging environment and that's why uh you know to selena's point and to your earlier called it doesn't look like the renaissance moment as yet
00:31:51
Speaker
Thank you.
00:31:51
Speaker
Now, just to bring it back to just a little bit more of a personal touch.
00:31:55
Speaker
Curious for those listening, are either of you listening to any podcasts or reading a book that you'd want to recommend to the audience?
00:32:04
Speaker
Murat, we'll start with you.
00:32:07
Speaker
I'm going to mention a book which actually was recommended by one of my business associates very recently.
00:32:13
Speaker
I've started reading it.
00:32:14
Speaker
Very interesting book.
00:32:15
Speaker
It's called The Three-Body Problem by Kaixin Liu.
00:32:19
Speaker
It's actually an astronomical concept.
00:32:22
Speaker
I have special interest in it.
00:32:23
Speaker
I started my education formation as an engineer and had lots of personal interest in astronomy.
00:32:30
Speaker
So this three-body problem is more for the celestial bodies.
00:32:33
Speaker
which essentially says when our two bodies, two celestial bodies, like the Earth and the Moon or the Earth and the Sun, they find the balance.
00:32:41
Speaker
Once a third body is introduced, you've got a problem.
00:32:44
Speaker
And the interesting thing about the book is actually you can take the concept and you can map it over to world affairs and to a lot of disciplines.
00:32:52
Speaker
So it's not astronomy.
00:32:54
Speaker
That is the origin, but it is quite relevant with what's happening around the world these days.
00:32:59
Speaker
So really, really very interesting book.
00:33:01
Speaker
Thank you.
00:33:02
Speaker
Thank you.
00:33:03
Speaker
Selena.
00:33:03
Speaker
So a book I read recently that is called Everybody Lies, and it's really about data, right?
00:33:10
Speaker
And how data is collected from various data sources and used, obviously, to track our behavior and to predict our behavior.
00:33:16
Speaker
And it is a little bit disheartening to see that all sort of consolidated into one book.
00:33:21
Speaker
But I mention it because we should all be more aware, I think, of how that data is being used.
00:33:25
Speaker
But also given all the things we've lived through in 2022 and what we see in emerging markets, I also like to mix up my reading with a few lighter notes.
00:33:34
Speaker
So one of the books I'm really looking forward to that's coming out in a couple of weeks, it's called Serendipity.
00:33:40
Speaker
It's the history of accidental culinary discoveries.
00:33:44
Speaker
It's written by the author of Italy here in New York
Closing Remarks on Emerging Markets
00:33:47
Speaker
City.
00:33:47
Speaker
And it's just about accidental discoveries and how serendipity sometimes allows you to create
00:33:53
Speaker
you know, delicious things in the kitchen.
00:33:55
Speaker
So sometimes you have to mix a little bit of negative concerning factual books that we all should read with something a little lighter.
00:34:02
Speaker
I love the combo.
00:34:03
Speaker
I'll follow on.
00:34:05
Speaker
I just finished up The Lost Boys of Montauk by Amanda Fairbanks, which is a factual story of a shipwreck that effectively, you know, the ship was never found and some good fishermen disappeared.
00:34:18
Speaker
1984, for anybody that spent time out at the beach in Montauk, it's topical.
00:34:23
Speaker
And I just started Grit by Angela Duckworth.
00:34:26
Speaker
It's been around for a while, but I've got four children and trying to figure out how to embed the grit piece with a few of them.
00:34:33
Speaker
They definitely have it, but I want to understand it better so that I can talk to them and have them actually listen to me sometimes.
00:34:40
Speaker
But both good books and two very different stories.
00:34:44
Speaker
But listen, both of you, thank you so much.
00:34:47
Speaker
Clearly,
00:34:49
Speaker
of a challenging time in the markets.
00:34:53
Speaker
We have some very good stories specifically around Brazil, China, I think infrastructure.
00:34:59
Speaker
This is an attractive technical backdrop.
00:35:02
Speaker
Valuations are starting to get really, really interesting.
00:35:05
Speaker
We, Selena, appreciate the partnership.
00:35:08
Speaker
Murat will have to keep getting on the road and telling our story.
00:35:11
Speaker
But I think from my many years of doing this, we're embarking on what will be a very, very interesting time to invest.
00:35:20
Speaker
And there will, without any doubt, in my mind, be a lot of opportunity.
00:35:23
Speaker
So hopefully, we all take advantage and really appreciate you, Selena, as a client, taking the time to do this podcast.
00:35:32
Speaker
And thank you for those that are listening
00:35:38
Speaker
Thank you for joining us for this episode of Emerging Market Spotlight.
00:35:43
Speaker
We hope you enjoy the discussion.
00:35:45
Speaker
HSBC is uniquely positioned to connect investors and corporates internationally.
00:35:52
Speaker
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00:36:01
Speaker
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00:36:07
Speaker
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00:36:31
Speaker
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00:36:34
Speaker
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00:36:37
Speaker
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