EM vulnerabilities

EM vulnerabilities – separating the wheat from the chaff

Year-to-date, emerging market bonds are down by 5% (Figure 1). Among investors, the pullback in EM assets has rekindled memories of the ‘Taper Tantrum in 2013’.

 May pullback factsheet

What is the Taper Tantrum?
Since the financial crisis, central banks have slashed interest rates and purchased trillions of dollars-worth of bonds in order to stimulate the economy. While this has mitigated the worst effects of the recession, it has depressed the yields on developed market bonds.

Investors shifted their investments towards emerging market assets, which tend to offer a higher yield. Over time, some emerging market economies began to spend beyond their means, and they became overly reliant on inflows from foreign investors.

By mid-2013, the US economy had recovered enough for the Federal Reserve to discuss the possibility of tapering its bond purchases. This caused US bond yields to spike as markets began to anticipate the reversal of years of easy monetary policy. Global investors began to rethink their investment strategies as the potential returns on US assets increased.

Some re-allocated their investments away from emerging market assets back into the US, prompting a painful readjustment in the former.



  • US, Continental Europe and Emerging Asia remain our preferred regions
  • Banks, Industrials and Tech our preferred sectors
  • The cycle looks like it has room to run, suggesting profits growth will follow suit


  • Nominal yields in the high-quality government and corporate space make real returns difficult
  • Carefully selected and evaluated credit risk remains the order of the day
  • We recommend venturing further out into the credit risk spectrum


  • Oil marginally our favourite commodity
  • Base metals vulnerable to China old economy slowdown
  • Precious metals vulnerable to rising real interest rates in US

Lessons learned?
Countries whose markets suffered the most were also the ones that had the largest macroeconomic imbalances. In particular, investor focus fell on economies known as the ‘Fragile Five’ – Brazil, India, Indonesia, Turkey and South Africa.

These countries shared a common set of vulnerabilities that stood out during the Taper Tantrum. They had larger trade deficits (Figure 2), were more reliant on external funding from investors, and suffered from persistently higher inflation rates (Figure 3).

May factsheet - Fragile

may factsheet - high inflation

Emerging market economies have gradually reduced their trade deficits (Figure 4), accumulated larger foreign currency reserves to better cover their external funding needs, and taken a harder stance in curbing inflation. We think that emerging market economies are now  less vulnerable to a Taper Tantrum.

May factsheet - economies

Sifting through
The recent pullback demonstrates that not all emerging markets are immune to rising US yields. We used a scorecard to assess which ones are most vulnerable to a renewed spike in US yields, and used a number of metrics to help quantify external imbalances within these countries.

We included metrics such as the ability to attract foreign investment flows and the adequacy of foreign currency reserves. We then ranked each major emerging market based on these metrics, and obtained a set of relative rankings based on how vulnerable these economies appear.

Countries such as Argentina, Turkey, and South Africa appear the most vulnerable to rising US yields (Figure 5). Emerging Asian economies appear the least vulnerable. Many Asian countries have highly competitive export sectors, and tend to have trade surpluses rather than deficits so can accumulate more foreign currency reserves.

May factsheet - Asian

Investment conclusion
The Taper Tantrum was a blessing in disguise for emerging market economies because It alerted emerging market policymakers to the need to strengthen their economies.

With the US embarking on a faster pace of rate hikes compared to 2013, emerging market economies have broadly increased their resilience to rising yields. We believe emerging Asia is less exposed to volatile commodity price movements, and is better placed to benefit from the ongoing global demand and healthy trade. The region also seems less vulnerable to rising US yields.

Our Investment Themes 2018

The Fourth Industrial Revolution
New technologies are blurring the lines between the physical, digital and biological worlds.

Stocks to outperform bonds
Don’t worry about the economic cycle, relative valuations suggest stocks still have plenty of leeway over bonds.

US high yield – keep calm and carry on
Consider carefully calibrated credit risk while markets remain benign and the US economy grows.

Emerging Asia – tech tigers
The ongoing pick-up in global trade is set to continue to benefit emerging market Asian exporters.

European banks – economic tailwind
A eurozone growing in strength is providing a helpful backdrop for the region’s banks.

Impact investing
Protect and grow wealth while doing good.

What if we’re wrong?
Recessions can emerge from nowhere, so here are some suggested defensive approaches for the nervous.

Equities – European banks

Value or value trap?
Value shoppers have long eyed up the continental European banking sector, which has languished in comparison to the US. However, as the economy has sprung back to life, so have European banks.

The darling buds of May...
Even as growth in the continental European economy plateaus, there is evidence of increased demand across corporate lending, mortgages and consumer credit.

It may be some time before the central bankers help with higher interest rates, but maybe not as long as the market currently expects. Loan growth will help profitability, and loan loss provisions will continue to tick lower.

Take out
There is a distant possibility of renewed M&A. Over the last decade, the cumulative deal value among European banks has amounted to up to about a fifth of the value in the previous eight years. The reasons for this include regulatory and supervisory hurdles, the low growth environment and the lingering stock of nonperforming loans (Figure 1).

The highly fragmented regulatory framework in Europe remains a formidable barrier to cross-border deals. Some within- border M&A deals are possible and indeed necessary to reduce the considerable excess capacity in the region. However, this carrot is probably something for the more patient among you.

All in all, the sector is attractively priced (Figure 2) but risky. Steel nerves and patience are required, but likely to be rewarded in our view.

May factsheet - non-perm loan

May factsheet - European banks

Investment grade credit – signs of late cycle?

Who’s been swimming without trunks?
After the worst start to the year from investment grade credit since 2008, many are wondering whether we are seeing cracks appear in credit markets. A decade or so of extremely low interest rates and round after round of quantitative easing will have created excesses in the system.

These excesses will be difficult to spot until prices start to reverse. In keeping with the adage that we only see who has been swimming without their trunks when the tide goes out, rising US Treasury yields (Figure 1) represent the ebbing tide and certain corporate borrowers could prove to be the embarrassed swimmers.

Rising Treasury yields

Rising leverage
Consumers in the US have spent much of the decade de-leveraging, many governments have been trying to, and banks are more or less unrecognisable from their pre-crisis guises. However, non-financial companies have been piling on debt at the invitation of capital markets. A combination of strong earnings growth and high interest coverage ratios has kept the situation manageable, but quality in the sector has been declining.

In 2008, the investment grade credit index had some $700bn of BBB-rated debt. It’s now around $2.5trn – from under 40% of the sector to around half (Figure 2). BBB issuance was 42% of total investment grade supply in 2017, a record for as far back as the data goes.

IG issuer quality

Investment conclusion
We remain wary of the investment grade credit market, but not because we see a raft of defaults coming from structurally challenged and over-leveraged sectors such as telecoms and retail. It is more associated with the meagre yield on offer from an asset class that is not without risk. There is still a place for investment grade credit in portfolios, just as there is for government bonds; however, much like other areas of credit, as we enter the last phase of the economic cycle, extra due diligence should be rewarded.

Not all bad credits will be missed by the active management community, but for investors looking for a degree of safety with a slightly higher yield, it is important to be aware of the growing risks within the benchmark.

Summary asset class views

  • Nominal yields in the high-quality government and corporate space make real returns difficult#
  • Carefully selected and evaluated credit risk remains the order of the day
  • We recommend venturing further out into the credit risk spectrum

Doctor Copper – 2017 was a big year...

The LME cash price for copper at the end of 2017 was $7,207/t, representing a 31% gain for the year (Figure 1). Strikes and strong demand driven by China boosted the price. According to International Copper Study Group, data mine supply utilisation averaged 81% last year. It has only ever been this low once in the last 20 years.

2017 was a hot year for copper

A chief cause was the 44-day strike at the Escondida mine, Chile’s longest strike in at least a decade. Speculative positioning might have helped the copper price as well. Fund managers amassed a record long holding on the CME’s COMEX copper market last August (Figure 2).

Managers held record long positions on copper last year

...but now copper is at a crossroads
While demand conditions globally are strong and projected to remain so, consumption growth in the world’s largest copper market, China, looks set to slow further in 2018.

The most recent Chinese macroeconomic data shows an economy growing fast and beating expectations of a slowdown. However, demand growth shows that this market is entering a new phase of slower growth despite good headline GDP numbers.

Moreover, the market is ignoring weakness in one critical sector of Chinese copper consumption: real estate. The rebound in the Chinese property market (brought about by a credit expansion in 2016) is showing signs of fading. A decline in mining production in 2017 is likely to reverse in 2018, with copper supply expected to return to low single-digit growth.

Overall, the copper concentrate market may be balanced in 2018, depending on the level of supply disruptions. While the number of labour negotiations at mines will be above norm, concentrated primarily in Chile and Peru, there are reasons to assume only historically-tested disruption rates until proven otherwise.

The massive 2017 disruption to supply was caused by the duration and not the number of strikes. Many strikes are short enough to be resolved before even impacting production. As most contract negotiations are due in the second half, it is very likely we will see more early resolutions.

Investment conclusion
More concentrate production, combined with a slowdown in demand from China, should result in weaker copper prices. The risk of massive supply outages from strikes created a “fear premium” for copper, pushing it above and beyond what simply supply and demand fundamentals suggest. The effect of the strike at Escondida last year on the market was mitigated by a surge in new scrap supply.

This year, with China placing new restrictions on scrap imports, the likelihood is low that a wave of scrap mitigates the damage from a prolonged dispute. As a result, this is exposing the metal to a high degree of volatility in 2018. However, any significant rally in response to a disruption or other supply outage would likely be short-lived. With the potential for price spikes noted, we think copper is likely to descend throughout the course of the year. Overall, investors should prefer other commodity sectors like oil.

Summary asset class views

  • Oil marginally our favourite commodity
  • Base metals vulnerable to China old economy slowdown
  • Precious metals vulnerable to rising real interest rates in the US
  • How and where can I find properties to buy or rent abroad?


    If you’re trying to find a property to buy or rent abroad, there are two main options. Either track down an agent based in the country you want to move to or use a UK one that specialises in that market.

    Andy Bridge, Managing Director of APlaceInTheSun.com, says: “If you want to see the whole market, then there are several multi-country property portals, such as RightmoveOverseas.com, as well as ours. Alternatively, you can search on a country-specific portal, such as Kyero.com in Spain.

    “You’ll be put directly in contact with the in-country agent who will then send further details and coordinate a visit to the property.”

    More information on estate agents overseas

  • How does buying property abroad differ from the UK?


    Remember that the conveyancing process in most other countries is significantly different to the UK's. That’s why it’s important to have an expert to help you. For example, much of Europe uses the notarial system. A notary is a government official who processes the property sale, negotiations and ownership transfer. This is quite different from the UK, where each party has their own solicitor to handle the sale.

    Peter Esders from overseas property lawyers Judicare, says: “Many places don’t have leasehold other than for commercial property. So, if you buy an apartment – which is normally leasehold in the UK – you’ll buy part of the freehold instead. This means you’ll own a share in the common areas of the property – much like ‘commonhold’ in the UK.”

    More advice on buying property abroad

  • How do you choose a legal representative when buying property abroad?


    Make sure you find someone who is independent and not acting for or recommended by the seller, developer or estate agent. They should understand the law of the country you are buying in, as well as the law of your own. Peter Esders of Judicare, says: “For example, literal translations from the local language may not reflect the actual situation and could mislead you. Your legal representative also needs to be familiar with ‘foreign’ buyers. Expectations of a British person buying a property in Spain are very different from that of a Spaniard buying in Spain, for example.”

    More information on legal advice

  • What are the tax implications or renting out my UK home while I'm away?


    “There are several aspects to consider,” says Andrew Watters, a director of accountant Thomas Eggar LLP. “If you move abroad and rent your home out while you are away, then all or part of the available relief from Capital Gains Tax can be lost. This is because the property is no longer your main home during that period.

    “A careful decision needs to be made therefore as to what to do with the property if the absence from the UK will be long term and a return to the UK is unlikely.

    “Any income earned from letting a property out while you are abroad is subject to income tax in the UK and you have two options for dealing with this. The first is to get your letting agent to withhold the tax and pay it on your behalf to the HMRC. The other is register for the ‘Non-resident Landlord Scheme’, receive the rent gross, deduct certain expenses and pay tax on the balance.”

    More information on taxation

  • What about renting before buying property abroad?


    “Fixed-term renting doesn’t differ that much around the world; it’s the terms and conditions that are the variables,” says Wendy Perez, Department Head Residential Corporate Services at Knight Frank.

    “These include the differing levels of deposit, fees, contract terms, break-clauses and references. For example, you often have to pay your rent many months ahead in Dubai. And in Hong Kong you have to prove you’ve paid to have your curtains cleaned and that your air-conditioning contract is paid-up before you can move out.

    “In the UK, the landlord pays most of the agent fees, in Hong Kong they’re split between landlord and tenant, and in the US the tenant usually pays.”

May’s guest interview

Ariel Bezalel (Head of Strategy, Fixed Income at Jupiter, and Lead Portfolio Manager of the Jupiter Dynamic Bond Fund) talks to Ian Aylward (Head of Manager Selection at Barclays) about global bond markets and how he is positioning the Fund accordingly.

IA: The market environment in 2018 is very different to what we have been used to over the last few years.

AB: The challenging and volatile conditions so far in 2018 will, I believe, continue throughout the second half of the year and beyond. We see several signs that point to the risk of a potential synchronised slowdown and numerous symptoms that we are in the latter stages of the economic cycle.

After a decade of gently rising equity markets and broadly low volatility in bond markets, it is understandable for investors to feel rattled by recent volatility. For the last decade, central banks have used low interest rates and bond-buying through quantitative easing programmes to support financial markets and aid the recovery after the financial crisis.

Now that central banks are withdrawing this support, led by the Federal Reserve in the US, more frequent bouts of volatility are not surprising.

IA: What are your main concerns about reversing QE?

AB: We believe that the Federal Reserve will encounter difficulties trying to tighten policy this year. US corporate leverage is at record highs, and the US consumer is under pressure, with rising delinquencies on credit card debt and auto loans. The sharp rise in the US dollar LIBOR rate and risk of higher gasoline prices will also add further strain to the US consumer.

Given the weak underlying economy, we believe that the long end of the yield curve will compress lower to reflect weaker growth and inflation expectations. Considering the underlying weaknesses, we believe two or three rate rises could be the end of this hiking cycle, after which we could expect to see a return to unconventional policy measures as the US economy takes a step backwards over the next year or two.

IA: Does this lead you to taking a defensive approach within the fund?

AB: I’d call it a more ‘prudent’ approach. There are still opportunities out there to invest in, but we have to be mindful of the risks. So, we run a ‘barbell’ strategy, which involves balancing medium and long-term US and Australian government bond positions with selected opportunities in credit markets, high yield, and emerging market debt.

In our view, the global synchronised growth of last year is at risk of giving way to a synchronised slowdown, which we believe would lead to a rally in the medium- to long-term part of the Treasury curve. We raised overall duration gradually over the last year or so to around 5.9 years.

IA: Can you talk us through the government bond exposure?

AB: Government bonds exposure has weighed on the fund’s performance recently as yields have risen, but we believe this should reverse as we enter a period of increasing volatility in the second half of the year. Despite the volatility in US Treasuries, we believe that the market feels well-supported from a technical standpoint. Speculators are currently running record shorts on most points of the US Treasury curve. In light of this, we have been using the opportunity of rising yields to gradually increase the duration of the US Treasury portfolio.

IA: So, if that’s your ‘defensive’ part of the portfolio, what sorts of opportunities are you finding?

AB: While emerging markets are volatile, we see opportunities in selected emerging market corporates with strong balance sheets and a long-term positive economic outlook. European banks are another area we like, especially the legacy tier-one debt. These bonds provide less yield than CoCos, but are less volatile. A bonus is that banks frequently buy back these instruments and sometimes at a substantial premium due to increasing pressure from regulators.

IA: And you mentioned emerging markets earlier?

AB: Yes, we see a number of opportunities in emerging markets. We added to our Russian exposure, especially to Russian corporates with strong balance sheets. We continue to see India as a long-term opportunity and believe concerns over India’s inflation outlook are short term. Since the strategy’s exposure is mostly to the short end of the yield curve, it was minimally affected by the recent sell-off.

IA: And finally, over the years we have got to know the various ‘special opportunities’ that you and the team at Jupiter have played in the fund. Any interesting stories or themes today?

AB: Despite our more cautious approach, we are not held back from discovering special situations in high yield. An example could be a position we have added in Boparan, the UK chicken producer, which had been trading at distressed levels. Another interesting area in European high yield, in our view, is the seemingly unloved retail sector. While concerns over online competition and high levels of debt abound, bonds of companies such as Matalan and Shop Direct offer value. With high single-digit yields, we believe investors are being well compensated.

IA: It certainly sounds like fixed interest is an interesting place to be.

AB: Yes. We believe that problems in the US economy are yet to fully surface but that they should help to keep a lid on inflation and therefore bond yields, as consumers feel further strain from a weaker underlying economy. We believe that now is a time for caution, but also remaining alert to opportunities. We believe this is the right strategy as we enter a sustained period of uncertainty and volatility.