The capital group inc singapore: Improving fundamentals boost emerging market debt

 

Emerging market (EM) debt has seen a sharp sell-off since the US elections. What is your outlook for the asset class? EM debt needs growth, and in theory strong US growth (i.e. fiscal expansion) should be positive for the asset class. The uncertainties around a Donald Trump presidency are well known, especially on the global trade front, and this explains some of the sell-off that we’ve seen in EMs since the US elections. However, I think the markets may be overestimating the extent of trade protectionism by pricing in potential moves such as the North American Free Trade Agreement (NAFTA) being cancelled, but the important thing to note is the fact that EMs benefit from strong global growth and we should see this in 2017, especially with stabilising commodity prices.

 

This is particularly good news for local yields, which are around 6.5%-7%, and in some of the higher yielding dollar universe, for example Argentinian US dollar-denominated debt. EM debt is also less affected by rising bond yields than traditional fixed income. Another concern is that if US interest rates move significantly higher, then EM debt won’t look as attractive as an asset class. Finally, higher US interest rates will also directly increase borrowing costs for EM countries – although US dollar debt is becoming a smaller portion of overall EM borrowing and dollar debt levels are in general more manageable now.

 

Despite all this uncertainty, it is important to note that EM countries are actually in pretty good shape. Overall fundamentals for EM as an asset class are stabilising, and this is after a number of years when fundamentals were deteriorating. This has been driven by external factors, such as the dissipation of the commodity price shock and the improving global growth picture. It has also been driven by the improving credit stories of countries like Brazil, Argentina and Russia.

 

Overall, I am quite optimistic and I think 2017 will be a year where we can take more opportunities and less of a defensive stance, with the p

 

What could be the impact of fiscal expansion in the US?

 

President-elect Trump intends to give the US economy a shock of fiscal stimulus that I do not think it needs at its current point in the financial cycle. There could be a boost to growth, from around 2% to 2.5%-3%, but because of the tight labour market there is an inflation risk. However, the hope is there will be enough global spare capacity that prevents this from becoming an issue – if not, the US Federal Reserve (Fed) would have to raise rates faster than the markets anticipate.

 

How do you see current valuations in EM debt?

 

Local yields are, in absolute terms and relative to developed market yields, attractive. Inflation is coming down, which should also support EM bonds. This is because EM central banks can now ease monetary conditions; something they haven’t been able to do in a long time.

 

With hard currency bonds, we’re seeing more of a bifurcated market. You have the high-quality investment-grade countries, like Mexico and Brazil, where you get very little yield. If the US Treasury curve normalises further, these countries will have very little yield cushion to protect against a rise in US interest rates, which is not particularly attractive. However, in the dollar space, there are some higher yielding bonds, such as Argentina and some Sub-Saharan African countries, where yields are significantly higher. We see these as more attractive because you take a lot more credit risk, or spread risk, rather than underlying US interest rate duration risk.

 

What is your outlook on EM currencies?

 

If we look at our fundamental equilibrium value exchange rate (our internal fair value exchange rate model), overall, EM currencies still appear undervalued, and they have very attractive carries because of high inflation rates. Even those fair valued currencies like the Brazilian real have large carries, which provide lots of cushion, even if the currencies depreciate slightly. Whether or not we see EM currencies appreciate from here, however, will again depend on what a Trump presidency looks like. We may see the dollar move higher if we have meaningful fiscal expansion in the US, but I think it will be different from when the Fed was withdrawing quantitative easing or planning its first rate hike. At that time, this was done in an environment of disinflation and a lack of growth in the rest of the world. Now we have a recovery in Japan and Europe, with strong employment growth. I do believe that EM currencies are cheap enough to allow for some uncertainty.

 

What’s your view on commodity prices?

 

Based on the views of our commodity specialists, I would expect commodity prices to be well-supported and rangebound. There is still a lot of supply, but with a better growth picture, demand should not only stabilise but also increase somewhat.

 

Could you share your outlook for China?

 

There are several interesting things happening in China. Firstly, the government is working to depreciate the renminbi because it does not want the currency to appreciate any further against the Japanese yen, which the Japanese government is also trying to weaken. Plus, there is a slightly stronger US dollar outlook, at least for the next 6-12 months.

 

Secondly, Chinese growth received another artificial boost earlier in 2016 through fiscal stimulus, but this is now beginning to run out, meaning growth is coming down to its structural run rate of around 4%-5%.

 

Finally, the very positive news is that China has come out of its deflation trap – producer prices have been positive for the first time in three and a half years – which has increased its nominal GDP growth. So, yes, there is a structural slowdown, partially due to poor demographics, and we don’t expect any further stimulus, but the presiden

 

What about the problem of nonperforming loans in China?

 

There are lots of non-performing loans in China, which could be problematic, but because the country has a closed capital account and a banking system that is state-owned, then it should take a lot longer to become a problem, if at all. With time and money, you can defer those issues or just remove them through inflation; if your economy is growing well in nominal terms, these non-performing loans become a lot less of a problem.

 

What are your most compelling investment opportunities right now?

 

Brazil and Argentina are both examples of countries where, following a decade or so of economic mismanagement, we are finally seeing some change. Brazil has a strong technocratic caretaker government, with a president that is not planning to run for re-election.

 

This means that President Michel Temer can do the hard work and put the country on a much better footing, including cutting the budget deficit, which should also allow for lower interest rates. Hopefully, by the time of the next election in 2018, the economy should be doing better and the population might be in a better position to elect a government that will have a mandate to really improve the country’s economy

 

Argentina is in a similar position. After 12 years of Kirchner governments, the country finally has a conservative, orthodox centre-right government in place, which is looking to undo the distortions in the economy (although this will take time).

 

With Russia, while the political landscape has not changed much, the government has at least been very pragmatic in its economic approach by letting the rouble fall to compensate for declining oil prices. India is also delivering nicely on some reforms. Growth has been good and inflation is coming down.

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The capital group inc Singapore: Adding our voice to the indexing dialogue

In recent years, the idea that investment managers can’t beat the index has become something of a truism within investing circles. The latest to weigh in is legendary investor Warren Buffett. In his 2017 letter to Berkshire Hathaway shareholders, he effectively endorsed that view by advocating low-fee indexing as the best approach for most individual investors. Here, Tim Armour, chairman and chief executive officer of Capital Group, discusses Mr. Buffett’s views and offers his perspective on the indexing discussion.

 

What are your thoughts on Warren Buffett’s recent comments that seem to endorse index investing?

 

Mr. Buffett’s approach at Berkshire Hathaway has many similarities to how we invest at Capital Group — through bottom-up investing, rigorously analyzing companies and building durable portfolios. This research-driven, long term, buy-and-hold approach typically means less trading, lower expenses and with it better results. And we wholeheartedly agree with Mr. Buffett’s all important message that most people need to save more for retirement — and to get invested and stay invested.

 

Mr. Buffett is not the only indexing proponent. Why do you think this view is so prevalent?

 

It’s important to say that we don’t dispute the data that has led Mr. Buffett and others to form their views. Namely, we agree that the average investment manager does not outpace the market over meaningful time horizons. However, a fairly simple fact has gotten lost in the debate. Simply put, not all investment managers are average. As we like to say, “Just because the average person can’t dunk a basketball doesn’t mean that no one can dunk a basketball.”

Mr. Buffett and others acknowledge that there are exceptions. We are one of them. And selecting a manager whose track record suggests it has the potential to deliver better outcomes can make a very meaningful difference in an investor’s life. For example, investors in an index fund will generate market returns. On the other hand, by investing in certain select funds, investors had an opportunity to outpace the index. For today’s investors, the difference between the market average and even slightly better returns over the long term can mean a much larger nest egg for a retirement that could last decades.

 

Do funds from certain managers offer something beyond the possibility of higher returns?

 

Index funds allow the opportunity to benefit when the markets are going up. However, by investing in index funds, you are also locking in all the market’s losses. Index funds may have their place, but they provide no buffer against down markets. Despite the trillions of dollars that have flowed into them, only about half of investors we surveyed last year are aware that index funds expose them to 100% of the volatility and losses during market downturns. Perhaps that’s unsurprising given the historic length of the US bull market. But markets turn. And doing better than the crowd in bad times is critical for investors seeking to grow their nest egg over the long term. Actively managed investments can offer the potential to lose less than index-tracking investments during market declines.

 

What’s your view on the value of professional advice?

 

Capital Group has long believed in the value that good financial advice can bring to help investors pursue their long-term investment goals. We believe advisors help motivate people to save and, perhaps most importantly, they can serve as a steadying hand during volatile times when human nature often drives investors to make decisions that wind up being counterproductive. In most cases, investors need to save more and stay invested, and advisors play a pivotal role in helping people do both of those things.