Why I’m going long US and EM equities
The final few weeks of last year were full of drama, the markets’ wild movements scaring and wounding many investors as over 90% of all the investable financial assets around the world ended up in the red.
Thankfully the big equity markets like the US, Europe and Japan were only negative in the single digits. Others were not so lucky, emerging markets suffering the most with China leading the losses with a 20% plus plunge.
Commodities fared little better, oil (the second most traded asset in the world after the US dollar) ended up down 24.8% for the year and metals and soft commodities also had a rough 2018.
The only asset that made money were long-term Treasuries, mainly on their yield rise that hit a 2018 high of 3.25% in October and fell back down to 2.69% by year end. Short-term Treasuries had a meager positive return, but after adjusting for inflation you ended up losing money.
The good news is that some elements of the rally are already happening now. We even think, while taking some precautions, this might not be a bad moment to put some money to work.
There are two clear places that are consensus calls amongst the big wirehouses, the US and emerging markets equities. We happen to agree with that consensus as valuations in the US are very attractive, more so if you believe that there is no recession on the horizon.
The Federal Reserve is giving the market a free pass for at least one quarter by not raising rates, maybe two if the data is negative, and this window should be enough for the market to take off. Most strategists agree that at the moment the market is discounting an outright recession of earnings, no one sees this happening so the market is cheap. I agree with that view.
In my view though, emerging markets are more interesting. Clearly they suffered the most in 2018 with some serious double-digit losses, but that was then and this is now.
With a break in rate rises emerging markets get a two-fold benefit: the cost of funding its hard currency obligations stabilizes; when rates stop going up the dollar tends to be soft and this help the price of commodities – the principal export product of most emerging markets.
Some investment houses in Wall Street started recommending allocating to emerging market equities as early as October, maybe that was too early but more groups soon followed and made similar recommendations.
If you look at the final weeks of last year, when most markets were in serious turmoil, emerging markets (equities for the most part) held up pretty well and even went up. There was an underlying demand that highlighted early on a very good technical picture.
The change in government in Brazil with Jair Bolsonaro’s win was a welcome surprise that the market had not fully discounted. During his victory speech not only did he speak about more privatizations and diminishing the role of the government in the economy but, more importantly, he highlighted the importance of fiscal discipline and the need for structural reforms, mostly for the social security and pension systems.
The markets welcomed this and its commercial partner Argentina, which had a very difficult 2018 that included the International Monetary Fund rescue package, also got a boost from the news.
We are positioning accordingly, going long US and emerging markets equities. As for rates we feel that extending duration in the portfolios is not a bad idea.
Using soccer terms, we know that we are in the second half of the game of economic growth but we do not know whether we are at the 60 minute mark, where still a lot could happen, or at the 80 minute mark and nearing the end.
However, we do not see long rates going up much more than 3%-3.2%. In this environment we like long bonds and also long emerging markets bonds to pick up some more yield.