Greek bonds trading through US Treasuries, Italy’s order book for a 50-year bond 5.5 times oversubscribed and US$13tn in negative yielding bonds – the search for yield is back with a vengeance. Buoyed by expectations of global monetary easing, in the US and in Europe, and a more dovish ECB with the impending arrival of the IMF’s Lagarde, as well as the US-China trade truce agreed at the G20 (even if the trade war hasn’t gone away), markets have been able to dismiss the risk of slowing global growth, and other geopolitical or idiosyncratic stress points.
The credit boom may not end well, but that might not be for some time yet, assuming the global economy can finally escape from the liquidity trap it finds itself in. In the meantime, investors can just buy anything that moves. We prefer to be more discerning.
The compression in yields, amid surging capital flows to EM, make finding value harder and harder, without going down the credit curve, extending duration or accepting lower liquidity. But even some idiosyncratic risks (distressed sovereigns and special situations) need to be treated with care at this stage.
We make four changes to our Top 5 picks. We add Buys on Ghana, Petropavlovsk and DTEK. We keep our Buy on CSN. We add a Sell on Kaltex. Our picks reflect the compression of EM sovereign yields, with just one sovereign Buy, as we see more value in corporates/special sits.
We also identify nine other trades to watch for H2 and identify four global themes that we think will shape the outlook for H2:
- Global monetary easing, with the Fed expected to cut rates this month. In our Special Feature on page 25, we look at EM bond performance during previous periods of US Fed easing and conclude (tentatively), that EM bonds generally perform well if the easing is associated with a slowdown rather than a recession.
- Slower global growth. Policy accommodation could mitigate the impact, but slower growth can bring vulnerabilities to EM/frontiers.
- And related, another flaring up of the US-China trade war.
- Oil prices. Will softer demand outweigh supply factors, notwithstanding US-Iranian tensions?