Not surprisingly, sudden downturns in an asset tends to drag down the broad asset class – in this case EM – despite vast differences in terms of vulnerability and growth outlook across the complex.
It makes little sense, but to those who invest for the long term, broad indiscriminate sell-offs present interesting value opportunities.
EM is less on the cusp of a broad crisis than it is on the brink of significantly diverging outlooks – savers and reformers will see brighter growth outlooks where deficit spenders like Turkey and Argentina will continue to endure harsh economic adjustments.
EM is an increasingly disparate asset class not just across geographies but across industries where pockets of excess corporate leverage will still need to adjust.
China is aggressively deleveraging, which is positive for overall stability, but opportunities in consumption and technology are vastly different than industrial SOEs prone to excessive leverage.
Different than EM, the US has suffered only minor volatility, instead reaching new equity highs, mainly attributable to tax cuts and healthy growth. Stimulus may add a year or two to an already long cycle, but the effects of monetary tightening will be increasingly apparent – particularly given the high levels of debt and high Treasury issuance that will increasingly sap demand for credit.
Rising cost of debt service will crimp profit margins and limit share buybacks.
There are many high-quality names in the US equity space, but the broad market is increasingly priced to perfection, defying a broadly shared negative outlook for the rest of the world.
Simply put, US equities are expensive and have further to fall than global peers as conditions eventually weaken.
The Pavlovian preference for historically “safe assets” holds for now, but will need to be re-evaluated in the context of current valuations against asymmetric risks. US Treasuries, the typical go-to safe asset, offered little protection earlier this year when bonds and equities sold off together.
German Bunds and Japan JGBs may face similar shifts as asset purchases continue to decline.
Interestingly, China bonds have proven among the most defensive sovereigns this year.
As central banks remove stimulus, asymmetric risks are likely to redefine asset classes along fault lines of relative leverage and varying growth outlooks.
Investors will need to consider more deeply what constitutes quality growth and what is a safe asset as historical notions of safety may be mispriced and subject to adjustment.
Robert Samson is senior portfolio manager, multi-asset at Nikko Asset Management
