Investment Strategy

Emerging markets to fire again

By Nader Naeimi
Head of Dynamic Markets and Portfolio Manager of Dynamic Markets Fund Sydney, Australia

While 2018 was a year of high expectations and disappointing outcomes, 2019 has the potential to be the polar-opposite.

Most discussion among investment professionals is about the slowdown in China, rising global interest rates, trade wars between the super powers and the US government shutdown.

But the concerns are overdone even if the next few months prove difficult for many investors.

The upside

Expectations are heavily depressed but that means there’s plenty of room for positive surprises, and a short, sharp retracement will trigger bearish commentary which, in turn, will present a huge buying opportunity.

Some of the most promising opportunities are in emerging markets, reflecting the recent downward adjustments in global equity and fixed income markets, and the devaluations of foreign currencies against the US dollar.

There are signs that the US dollar and global inflation have peaked and we are at the end of the central bank tightening cycle. Put all that together and it could be a good year for emerging markets investments.

Markets to consider

Our multi-asset portfolios and, in particular, our Dynamic Markets Fund (which I manage) have increased our allocation to emerging market equities to 15 per cent. That’s the highest level since 2016. In fixed income, we are moving back to emerging market debt for the first time in three years.

Commodities also present good buying opportunities: oil prices have fallen sharply since October – the benchmark crude oil price is down 40 per cent – reflecting higher output from some of the biggest oil producers including Russia and Saudi Arabia.

But there’s plenty of reasons to think oil prices will start rising again as US sanctions against Iran, Saudi Arabia’s need for higher, stable oil prices and little spare capacity within the Organisation of Petroleum Exporting Countries (OPEC) means the energy sector is exposed to supply disruption in other large producers, including Venezuela, Nigeria or Libya.

I expect more disruption across the commodity supply chain as nationalism grows, labour strikes become more prevalent and the push for clean air grows, especially in China.

What to avoid

I’m cautious about US-based technology stocks. The so-called FAANG stocks – Facebook, Apple, Amazon, Netflix and Google (owned by parent company Alphabet) – had a bumpy ride in the second half of 2018 on the back of privacy scandals, calls for greater regulation and the US-China trade war.

I’m not sure that has fully played out yet and won’t be rushing into that sector.

China and trade wars

The outlook for China is, as always, crucial for the global economy. While some experts are concerned about the China growth story – it expanded by just 6.6 per cent in 2018, the slowest rate in almost three decades – I’m more optimistic.

China - contributions to GDP Growth
Source: Reserve Bank of Australia

Chinese authorities are undertaking a sensible, multi-pronged approach to turning the economy around using both monetary and fiscal policy.

Chinese data is still very weak but liquidity is abundant. Furthermore, money supply growth is picking up momentum and that has historically led to a rebound in activity with a small lag. I believe we are past the worst of Chinese economic weakness.

The ongoing trade conflict between the US and China remains a concern, but it has moved from an acute risk to more of a chronic issue.

The problem is that the longer it goes on, the greater the long-term implications. Trade wars result in higher inflation globally and higher bond yields. That’s not being priced in by financial markets.

Some economies will benefit from the ongoing spat, including those with low labour costs. Countries able to replace China’s low value-add production, that are removed from the China-US crossfire, could benefit. Vietnam, Cambodia, the Philippines and Indonesia are all examples.

Global interest rates

Another critical factor for investors over the next 12 months will be the behaviour of central banks around the world. Will they continue lifting official interest rates or take a breather?

Fortunately, there has been a broad-based fall in inflation expectations. Inflation expectations are a critical ingredient of actual inflation, meaning a fall in expectations has taken pressure off central banks to tighten monetary policy. Stabilising inflation expectations is likely to be theme for 2019.

Policy Interest Rates
Main refinancing rate util the introduction of three-year LTROs in December 2011; deposit facility rate thereafter - Source: Reserve Bank of Australia
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Important notes

This document has been prepared by AMP Capital Investors Ltd (ABN 59 001 777 591, AFSL 232497) (“AMP Capital”). BetaShares Capital Ltd (ACN 139 566 868, AFSL 341181 ("BetaShares") is the responsible entity and the issuer of units in the AMP Capital Dynamic Markets (Hedge Fund) (“Fund”). AMP Capital is the investment manager of the Funds and has been appointed by the responsible entity to provide investment management and associated services in respect of the Funds. Investors should consider the Product Disclosure Statement (PDS) for the relevant Fund before making any decision regarding the Fund. The PDS contains important information about investing in each Fund and it is important investors read the PDS before making a decision about whether to acquire, continue to hold or dispose of units in the Funds. Neither BetaShares, AMP Capital, nor any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this information.
While every care has been taken in the preparation of this document, AMP Capital makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This information has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of this information, and seek professional advice, having regard to their objectives, financial situation and needs.
This document is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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