In a webinar on Tuesday, DoubleLine Funds offered its outlook on emerging markets and provided an in-depth look at risks in China and Brazil specifically.
DoubleLine identified several country-specific risks for investors in emerging markets: what it called the “terrible three” of Argentina, Venezuela and Ukraine; countries in transition like Brazil and Russia; and, of course, Greece. (MSCI downgraded Greece from developed to emerging market status in late 2013.)
Rising Treasury yields, the global slowdown in growth and falling commodity prices are also risk factors, according to Luz Padilla, director of emerging markets fixed income for DoubleLine.
Padilla said it looks like the Federal Reserve will not increase rates this year, but if it does, the increase will happen slowly enough that it won’t have a significant impact on emerging market debt.
Both developed and emerging markets’ growth have shown a “ratcheting down,” Padilla said. The International Monetary Fund recently released its growth expectations for 2016, predicting emerging markets will grow 4.5%, down from 4.7%. Globally, growth is expected to be down to 3.6%, and in developed markets it’s 2.2%.
DoubleLine is also watching elections in Argentina, Venezuela and Turkey in 2015, and in the Dominican Republic, Peru, the Philippines and the U.S. in 2016, Padilla said.
Venezuela continues to have issues with oil pricing, Padilla said, and Nigeria has struggled with energy prices as well.
“No doubt we have seen a deterioration in the growth market for emerging market debt, but a lot of these economies are coming from a pretty robust base, so I think they can manage the slowdown,” she said.
DoubleLine funds were down 2.5% to 2.8% in September, Padilla said. “Part of that differential has been attributable to the Ukraine restructuring, but also, Russia has had a very sharp rebound and we have been out of Russian bonds this year,” she noted.
“We’re mostly watching the situation in China and growth expectations, and specifically how those correlate to commodity prices,” Padilla said. “We’re also monitoring the situation in Brazil very carefully because that has had implication in terms of sentiment for the rest of the region.”
Bill Campbell, an analyst for DoubleLine, said that the situation in China has caused “major indigestion in world markets, especially in this past quarter.”
The equity rally that began last year was promoted by the government, he said, and was expected to offset the weakness in the housing market.
“This crescendoed on June 10,” he said, when it was expected that MSCI was going to include China A-shares in its emerging market indexes. That didn’t happen, which “was pretty much the marker of when this equity market rally had gotten ahead of itself” and started to unwind.
As investors began to unwind equities, the government pushed a stability fund, required purchases from state-owned companies of their own equities, then sold securities held less than six months, “all in an attempt to stabilize the market,” which they did, according to Campbell.
“Unfortunately, these interventions caused a distortion in the market,” he added. “People had been looking at the equity market as an indication of underlying strength or weakness of the Chinese economy, but now the government intervention stabilizing the equity market has clouded that as an indicator for market participants.”
In August, the People’s Bank of China devalued their currency 2%, Campbell said. “That seems like a very small amount, but we can see is that basically erased the gains that their currency had seen over the past two years.”
He added that “there is no doubt that China’s growth has been slowing since their stimulus following the global financial crisis.” The country is changing its growth model from an export and investment-led model to a more services- and consumption-based model of a developed economy and are still in that transition, he said. Slower growth is typical during those types of transitions, according to Campbell.
China has a “very strong balance sheet,” Campbell said, with reserves of $3.6 trillion, net foreign assets of $4.4 trillion and a trade surplus of an average $45 billion a month. “They have a lot of reserves in order to help implement policy levers that can support growth,” he said.