Do they present buying opportunities for fixed income investors?
There are certain macro-economic events that have put downward pressure on emerging markets and frontier-debt markets over the last five years. If we analyze some of these events, we find that they have a few things in common for emerging-market fixed income investors. They have presented strong buying opportunities for those willing to buck the trend and buy into weakness. Returns for those investors buying into weakness in frontier bonds have seen an average annualized return of 8.01% over the last five years.
Some of those global macroeconomic events include:
- Higher U.S. interest rates
- A decline in oil prices
- A drop in commodity prices
- A strengthening U.S. dollar
Higher U.S. interest rates
On May 22, 2013, then U.S. Federal Reserve (Fed) Chairman Ben Bernanke stated in a testimony before Congress that the Fed may taper or reduce the size of the bond-buying program. This sent shockwaves throughout the financial markets as investors feared that the long period of easy money fueling the appetite for “risk assets” was coming to an end. U.S. interest rates moved up sharply, with 10-year U.S. Treasuries surging by 100 basis points (bps) from 2% to 3% over the following months. It caused a sharp negative move in emerging-market debt in both hard currency and local currency bond markets.
10 year U.S. Treasury yields and performance across emerging-market sectors
Oil prices peaked in June 2014 at more than $105/barrel (WTI) then went into a bear market, losing over 70% of its value over the next 1.5 years as the laws of supply and demand kicked in. Lower demand from Europe and China, increased supply from the Organization of the Petroleum Exporting Countries (OPEC) and the new threat of increased production from the U.S. as “fracking” technology became the new buzzword all contributed to global supply concerns. During this downturn in energy prices, one of the more severe periods that caused emerging markets to suffer the most was the post OPEC meeting period in late October of 2014 when OPEC couldn’t agree on what action to take to halt the slide of energy prices. Over the next two months, oil prices suffered its most severe shock of the period and lost over 40% of its value in two months. During this period, emerging-market debt investors once again suffered under the weight of rising yields, wider credit spreads and weaker local currency markets.
Oil prices and performance across various emerging-market sectors
During the June 2014 to January 2016 period, the commodity markets were also facing downward pressure. Raw industrial prices suffered from a combination of oversupply and weak demand from China and other emerging economies such as Brazil. There was also reduced demand on natural resources such as steel, iron ore and crude oil. Cheaper borrowing costs and too much optimism about the demand side led to an oversupply from producers. Raw industrial prices lost over 25% during this bear market for commodities but also saw over two-thirds of the down move in the second half of 2015 before bottoming in late 2015. During this bear market in commodity prices, local emerging-market debt prices came under severe downward pressure as economies with exports tied to raw industrial prices and metal prices fell substantially relative to hard currency bonds.
Commodity prices and performance across various emerging-market sectors
Sustained Commodities Sell-off
Trump’s U.S. presidential win
On November 8, 2016, Donald Trump’s surprise Presidential win caused a surge in U.S. interest rates. This was predicated on the belief that the Republican Party would control all three branches of government and therefore would be able to move quickly to implement the conservative agenda. The agenda consisted of low taxes, reduced regulation and a more business-friendly environment. This was perceived to lead to accelerated growth, an upward pressure on inflation and higher rates. This period once again put short-term downward pressure across the emerging-market debt space.
10-year US Treasury yields and performance across various emerging-market sectors
U.S. dollar strength 2018
The U.S. dollar has been strengthening, led by slightly higher interest rates but mainly coming from the improving economic backdrop. The U.S. dollar as measured by the USD Index-DXY up 8.5% from April 15 to August 15 has once again put downward pressure on the emerging-market debt sector.
Investors who took advantage of the aforementioned macroeconomic events by buying into frontier markets during weakness would have seen strong returns, as evidenced in the chart below. Following sharp sell-offs, Frontier bond markets have performed exceptionally well. What should investors do? The answer should be obvious….
Annualized returns since the month the selloff ended
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).