This year will have exceeded most investor expectations (certainly ours). A total return in the EMBIGD of 14.2% YTD (to close 13 December) looks beyond anything we could have imagined in the depths of late 2018, with gains boosted last week by the US-China trade agreement.
Yet 2019 was still a year of two halves, as most of the gains were made in H1 – cheaper valuations to start with, after the market collapsed in Q4 18, may have made it easier to generate such strong performance. It has become more challenging in H2, notwithstanding the surprise reverse in the Fed tightening cycle, as markets have focused on the slowing global economy and the intensification of the US-China trade war, as well as country-specific risks in Argentina, Ecuador and Lebanon, and spread of public protests across the world against failing incumbent leaders.
And the market seems to have bifurcated into a barbell, with low-yielding (<8%) hard currency sovereigns and a small group of high-yield or distressed countries, with not much in between. We estimate the total outstanding amount of ‘distressed’ sovereign bonds is US$154bn (nominal), across eight countries that are either in default or with yields over 10%, slightly down from a year ago. However, just four countries account for most of this (Argentina, Ecuador, Lebanon and Venezuela).
Nominal EM yields (EMBI spread plus the US 10-year yield) have fallen by 217bps this year to 4.9%, and are now at a 6½-year low. They are only c50bps off their all-time low of 4.37% on 3 January 2013. Meanwhile, our measure of the frontier yield is 9% excluding Argentina, and 7.8% excluding Lebanon too.
We think it will be harder to generate such strong returns in 2020 as, despite a benign rate outlook (Fed on hold in 2020 and the ECB keeping monetary policy loose), spreads are already tight and the market not so dislocated. This might mean low-single-digit returns are the best we can hope for next year, although we think Argentina could make or break the year for investors. We’re not ready to pull the trigger just yet though.
We think there are four global themes that will shape the outlook for 2020 and the impact on EM, with some from this year repeating themselves (global growth, US-China trade war, global interest rate cycle) and some new ones (US presidential election).
We make three changes to our Top 5 picks. We include Buys on a couple of high-yield sovereigns (Ecuador and Tajikistan, where we think policy commitment – Ecuador – and fundamentals – Tajikistan – are mispriced). We have Buys on two corporate re-rating stories (Petropavlovsk and JBS). And we have a Sell on Kaltex.
We also highlight 12 other trades/assets to watch, or particular themes, during 2020. Some will be familiar, others are relatively new to our coverage. They include potential sovereign default/restructuring candidates (Argentina, Lebanon, Zambia), countries with elections next year (Bolivia, Ghana, Cote d’Ivoire), the diverging performance between Ukraine’s sovereign and corporates, and four corporate trade ideas (three from LatAm, plus Nostrum). We also include two special features: on Mexico and CEEMEA banks.