Investing For a New Decade
The next 10 years are sure to bring a different set of opportunities and obstacles than the past 10.
Emerging markets showed their resiliency in an uncertain environment last year, and with the support of a global economic landscape that appears relatively stable, EM debt remains generally well positioned as 2020 commences.
The recent “phase one” trade agreement between the U.S. and China eases some (but not all) of the uncertainty that was hanging over global markets. Factor in the residual effects from 2019’s broad easing in monetary policies, along with investors’ ongoing search for yield amid generally limited supply, and the outlook for EMD appears broadly positive.
“Our view is that the global economy is likely to provide a favorable backdrop for markets and risk-taking in the year ahead,” said Nathan Sheets, PGIM Fixed Income’s Chief Economist and Head of Global Macroeconomic Research. “That’s not because we expect global growth to be buoyant, but rather because growth is poised to plod along at a moderate pace.”
In this environment, we believe EM hard currency assets will continue to perform well in 2020 (it’s not uncommon to have successive years of strong performance in EMD assets). More specifically, we continue to believe a hard currency “barbell” position consisting of lower-quality, front-end sovereigns and higher-quality, back-end issues may capture the upside in a constructive backdrop (while limiting the downside in a volatile one).
At the front of the barbell trade, we continue to favor select B-rated sovereign issuers, including Ecuador, Ukraine, Egypt, the Ivory Coast and a mix of sub-Saharan issuers, that are implementing reforms with proven market access and/or support from the International Monetary Fund. There are also some CCC-rated issuers that are trading at distressed levels, including Argentina and Lebanon, where recent developments are already priced in. For instance, if a resolution to Argentina’s sovereign dollar bonds emerges that is more market friendly than indicated by current prices, then Argentina assets could perform well. In Lebanon, a political resolution, combined with international funding support, could contribute to higher bond prices.
At the other end of the barbell, we favor select Gulf Cooperation Council countries that trade wide of their credit ratings and quasi-sovereign names that trade wide of the sovereign, such as PEMEX, or feature improving credit quality, such as Petrobras.
In terms of the main risks to the current constructive backdrop, we see two: China and politics. Uncertainty surrounding the trade war is the principal risk for the global economy over the next year. While the recent “phase one” agreement has lifted some of the clouds on trade, we remain fully aware that less favorable outcomes remain on the table. Certainly, a re-escalation of the trade war could reverse the stabilization we are starting to see in global manufacturing.
A second risk lies in the U.S. presidential election, as markets could struggle to price in risks associated with the outcome and the outlook for 2021. If President Trump is re-elected, for instance, how might his priorities change now that he’d be unencumbered by another election? That could be a particularly poignant question on the trade front.
If a Democrat is elected, markets could grapple with a major shift in regulatory and administrative policies pertaining to consumer and labor rights, health care, energy, the financial sector, and the environment. Given the rhetoric regarding tax increases for certain entities, the tax cuts implemented in 2017 may also come into question.
For Professional Investors only. Past performance is not a guarantee or a reliable indicator of future results. All investments involve risk including the possible loss of capital. The information represents the views and opinions of PGIM Fixed Income as of 12/20/2019, is for informational purposes only, and is subject to change. The information does not constitute investment advice and should not be used as the basis for an investment decision.