Emerging Asian assets significantly impacted by QE tapering
03 September 2013
News, Asia, Global, Emerging Markets
By Herve Lievore*
Between early 2009 and May 2013, emerging market (EM) assets outperformed their equivalents in developed markets (DMs). This was particularly true for bonds, but was only the case for equities till the end of 2010, before the onset of the second round of quantitative easing (QE) measures by the Federal Reserve that saw DM stocks catching up (in US dollar, total return terms).
Figure 1: EM assets relative performance (US dollar, total return)
As markets started to anticipate the tapering of the US QE programme in May, EM bonds started to underperfom and equities erased what remained of their 2009-2010 gains. Asia followed pretty much the same trend as the other emerging countries but with a more moderate decline since May.
Macro risks and a liquidity squeeze are the dominant forces
While fear of QE tapering acted as a trigger for the market downturn, its impact wouldn’t have been really significant if emerging countries had sound external financing positions. More generally, it is worth noting that countries experiencing current account deficits, fiscal deficits, strong growth in domestic credit relative to GDP and/or sticky inflation pressures saw the most severe correction in the value of their currency and their financial assets.
Growing imbalances, both external and internal, within the emerging space (including Asia) aren’t new. But contrary to the past, when the most important central banks committed to provide an unlimited amount of liquidity and, in doing so, probably distorted relative asset prices, macro risks have now come to the fore.
This combination of fear of slower liquidity injections in the US (QE tapering doesn’t mean the Fed will withdraw liquidity any time soon) and growing macro imbalances in emerging countries operates at two different levels, in the short term and the medium term.
In the medium term, ending the commitment to provide an unlimited amount of liquidity could lead to a better assessment of macro risks and eventually higher risk premiums. It is a structural issue given the ongoing rebalancing and deleveraging of DM economies. Most Asian countries, and by extension EM countries, reached high rates of growth before the financial crisis on the back of growing trade surpluses and expanding global trade. But for each trade surplus there is always a trade deficit elsewhere and most of these trade deficits were concentrated in a small number of countries, namely the US, UK, Spain, France, Greece and, more generally, advanced economies. By definition, trade deficits are the result of excess domestic demand and, indirectly, of an increasingly levered economy. As these countries maintain their efforts to reduce leverage (at least in the private sector), trade deficits tend to shrink. Exporting nations obviously suffer from this situation. Emerging countries as a whole have seen their external accounts deteriorate rapidly since the onset of the financial crisis. As these economies faced falling trade surpluses a surge in domestic leverage (credit as a percentage of GDP) in EM markets started to re-emerge in 2008.
Figure 2: EM ex China current account balance net of Foreign Direct Investments
In addition to likely higher country specific risk premiums over the medium term, QE tapering is also having a more short-term impact on markets. QE tapering is by definition an unusual policy move and its impact on the US recovery and asset prices is uncertain. In a context of high uncertainty, investors tend to favor liquid markets and assets deemed as “safe havens”. But this is a self correcting phenomenon as lower prices will eventually lure investors once they get better visibility on the consequences of QE tapering on the economy and financial markets.
Figure 3: Change in current account balances in EM Asia ex China between 2010 and 2012 (in % of GDP)
In the run up to the September Federal Open Market Committee (FOMC) meeting, market volatility is likely to stay high and the balance of risks for EM assets is tilting to the downside.
However, we believe that the recent underperformance of EM assets doesn’t reflect a deterioration in the underlying situation of EM economies but rather the result of transitory forces (expectations of a shift in US monetary policy) and a general re-pricing of macro risks after a period of relative complacency. It doesn’t modify the attractiveness of these asset classes from a long term, valuation based perspective. Though still ongoing, the current price correction will create investment opportunities.
However, the need to be selective will remain as macro risks will continue to be a concern. Countries running a current account surplus based on manufactured goods exports rather than commodities are likely to outperform in the event of a recovery in the US and a rebound in the eurozone.
From an Asian perspective, South Korea and Taiwan are well positioned to take advantage of such a scenario (expected outperformance of cyclicals, limited external financing constraints as well as benign inflation). There are also reasonable hopes that the process of economic stabilisation in a low export growth environment is reaching its end in China, allowing a gradual rebound in earnings. The situation seems less favorable in India in the short term as external imbalances remain problematic and the fiscal deficit reduction target will be hard to meet.
*Herve Lievore is Senior Macro & Investment Strategist at HSBC Global Asset Management
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