The Rohatyn Group’s macro analysts convene each month with portfolio managers across our public markets strategies to dissect themes driving financial markets forward. A broad consensus is sometimes reached, but the 2-hour debate often leads to more questions, or divergent views. The iterative process is a part of our house’s approach to liquid markets.
At year-end, we argued further visibility on the outlook for inflation, China and the Ukraine conflict could bode well for certain assets within the emerging market (“EM”) complex. Dubbed “shifting sands,” these elements are now playing out on the global stage. We believe the impact of tectonic shifts in global themes will vary across the emerging market universe: put simply, we are not in an era of “buy risk” broadly across emerging market assets. We are in a period of differentiation.
While global themes exist, the pandemic bred idiosyncratic stories and abnormalities in data as each country emerges from a multi-year shutdown. The relative importance of global themes – ranging from inflation to growth – depends partly on an individual country’s stage in the business cycle. The position in the business cycle then provides cues on which asset classes may deliver relative out performance. One of the gauges we use at TRG is the so-called investment clock, which splits countries into four regimes based on the direction of growth and inflation relative to their recent trends and the business cycle.
Combining qualitative analysis with the framework outlined in the investment clock, our research team has observed:
Wide dispersion, supporting the case for selectivity. Most of Europe, which is facing an energy crunch and tighter financial conditions, is heading toward "stagflation” characterized by below trend growth and elevated inflation. Meanwhile India, the Philippinesand Vietnam are in a “recovery” phase defined by above-trend growth and subsiding inflation. This favors aggressive cyclicals and high-yield credit opportunities, for example.
The more compelling signals come when the investment implications from the clock are aligned with the global themes. For countries in the “overheat” quadrant such as Mexico and Malaysia, the framework suggests foreign-exchange positioning based on carry. Despite being in the same business cycle regime, Mexico offers double-digit carry in contrast to thelow-single digit for Malaysia, making the former more compelling. The Mexico carry opportunity is reinforced by our cautious view on the U.S. dollar.
Stepping away from the clock momentarily, let’s update you on where we stand with regards to the global narrative.
Returning to the clock, we overlay our take on the global narrative with the investment clock to pinpoint where we stand on a country-by-country basis. We then drill into the optimal asset class. The investment clock is not static, and its results require a nuanced interpretation. Cycles vary in terms of intensity and length. The policy reaction – the willingness and ability to add stimulus or tighten – plays an important role when thinking about positioning, too. For example, the U.S. is heading into a “reflation” regime of both below-trend inflation and growth. This typically calls for an allocation to Treasuries and defensive stocks. However, the positioning will vary depending on whether the U.S. achieves a soft landing or dips into recession. If the downturn coincides with sticky inflation, the Fed may find itself in a bind, unwilling to cut rates (and thus limit the traditional benefit from holding Treasuries during a contraction).
Combining the implications from our themes, the investment clock, valuations, policy considerations and other drivers, we have higher conviction on the following investment narratives:
- China reopening
Authorities delivered a policy U-turn, principally scrapping the zero-Covid strategy and by delivering comprehensive support to the property sector. Despite reports of overwhelmed health care facilities and excess mortality, the reopening remains on track. Meanwhile forced deleveraging among developers has been replaced by mounting liquidity support. The investment clock indicates China is in the “stagflation” quadrant and favors defensive positioning. But we contend the pro-growth policy shift is the dominant investment narrative. Valuations for Chinese stocks, which have rebounded, remain below long-term averages. But Thai equity valuations still trade at a discount compared to the10-year average measured by price-to-book. At the sector level, the return of Chinese tourists to Thailand, Vietnam and Philippines may benefit large tourism industries with large exposure to China. This should boost the airport and hospitality sectors, along with secondary service providers such as health care and insurance.
- High carry and dollar weakness
The U.S. dollar is off nearly 10% from its multi-decade high hit in September and we believe this has more room to run. The perception that the Fed’s tightening cycle may be near it send, the shift in growth in favor of emerging markets and the compression in the geopolitical premium are likely to work against the greenback. The investment clock favors carry trades in countries that are in “overheat” and “recovery.” Our weaker dollar theme reinforces the signal from the clock supporting high-yielding currencies in select EM countries. The weaker dollar also decreases the likelihood of currency mismatches within the balance sheets of EM corporates.
- Cautious on trades linked to the monetary policy cycle
Emerging market central banks tightened policy earlier and more aggressively than many of their developed market peers. We prefer to exploit this positive real-rate cushion via foreign exchange and remain cautious around rates based on monetary policy. Looking at the investment clock, rate cuts tend to materialize in the “reflation” phase of below-trend growth and inflation, thus favoring countries like the U.S. and Brazil. In the former, the risk of stubbornly high services costs linked to tight labor markets may limit the ability for the Fed to cut rates in a downturn. In Brazil, concerns over the fiscal path suggest that it may be a while until the Banco Central do Brasil (“BCB”) can credibly lower rates.
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