Transcript

Chapter 1 - Introduction

Welcome, and thank you for watching Ashmore's "EM in 10". My name is Gustavo Medeiros and I'm the deputy head of research.

"EM in 10" is a short video designed to cover important events in Emerging Markets. This week, we will go through the performance of EM asset prices year-to-date, discuss the latest manufacturing PMI surveys and finally discuss recent events in China.

Chapter 2 – Performance review

EM assets are weathering a transition period where the world attempts to normalise mobility more than one year since the start of the Coronavirus pandemic. Countries that adopted mass vaccination earlier like the United States, the United Kingdom and Israel are already benefiting from a rebound in mobility and low COVID cases. On the other hand, most emerging market countries and most of Europe struggled to get vaccines approved and procured fast enough, leading to a slower vaccination phase in the first quarter of 2021.

Furthermore, the United States Congress approved a much larger than expected fiscal stimulus. The resulting strong economic rebound is leading to the most inflationary pressures in the US economy as commodity prices surged 72% from 12 months ago and shortages of important production components have emerged in an environment of ample liquidity.

For now, most market participants seem to agree with the Federal Reserve narrative that inflation is temporary. The main risk to the Fed's view are pressures emanating from a higher cost of living such as higher house prices, more expensive food, and energy prices which would lead to pressures on wages and that this temporary income replacement policies becomes permanent.

In this environment, yields on 10-year US treasuries widened some 70 basis points to 1.6% in the year-to-date period, and through the 4th of May the dollar index rose 1.4%. Over the same period, commodity prices rose some 20%.

Within EM, equities outperformed fixed income as the MSCI EM rose 4.1%, while local currency bonds declined 4.4%, partially due to a 2% selloff in EM currencies.

Dollar-denominated sovereign debt was down 2.5% and corporate bonds declined 0.2%. Within dollar-denominated assets, high yield bonds outperformed investment grade thanks to a larger spread cushion, but also lower duration.

Chapter 3 –Transition’s 2nd Stage

Encouragingly, the first stage of the transition period seems to be behind us as Europe and most EM countries have been accelerating their vaccination phase, recently pointing towards a better economic environment to economy growth in the second half of the year. This is also observed in asset prices as a good part of the EM under-performance in the first quarter was recovered so far in the second quarter.

Leading indicators for April such as the manufacturing PMI released last week, points to better GDP growth in emerging markets. The chart on slide six shows most countries in emerging markets in the top right quadrant which indicates manufacturing activity is expanding at a faster pace. Only three of the economies surveyed have their PMIs in contractionary territory as per the same chart.

Furthermore, the gap between emerging markets and developing world economies is much smaller after removing the inflation sub-components of the PMI surveys as illustrated by the dotted lines in figure two. The dotted dark line shows that the contraction of EM PMIs in the first quarter of 2021 was mostly due to price effects. At the same time, the dotted light blue line shows that the acceleration of DM PMIs since the fourth quarter of last year was partially led by price pressures.

Yesterday, the US, China and some EU countries have defended breaking the patents for COVID-19 vaccines. Some analysts were quick to shout, "But that's socialism!" However, the reality is that vaccines are public goods. And the world would be much better off in social and economic terms if we managed to vaccinate middle and low income countries faster thanks to cheaper shots produced by a larger number of pharmaceutical companies. The decision to lift patents would allow for an acceleration on the vaccine convergence which is far from being priced in emerging market asset prices.

For the equity market, most of the EM underperformance can be attributed to the poor performance of China which accounts for more than one-third of the MSCI EM index today. This could be surprising at first sight since China was the first country out of the coronavirus crisis and led the global economic recovery already from the second quarter of 2020.

The second session of "EM in 10", thus will feature common questions asked by investors and China observers.

Chapter 4 - China

The first question is, “Why is China underperforming?”.

The underperformance is the result of regulatory actions in the financial technology and broader internet company services industries as well as concerns over defaults from large state-owned enterprises SOEs. We acknowledge that the regulatory pressures are a short-term headwind for Chinese equity markets as investors increased the so-called, "Equity risk premium”. However, the concerns over SOE defaults are company-specific and unlikely to trigger systemic risks in our view.

But why is China regulating it's FinTech industry?

We believe that regulations that deal with systemic risks and monopolistic practices adopted by financial technology firms is a positive long-term development. China has probably the most advanced technology sector in the world as its political system is designed to foster long-term stability and longevity rather than short-term growth. Allowing one single company to control the entire flow of loans to small companies and individuals for example, while at the same time this company would keep little credit risk on its own balance sheet, would create an incentive for predatory lending as well as systemic risks.

Regulating these industries is necessary worldwide in our view. China is again showing strong leadership and the courage to make difficult decisions by moving ahead in regulating the sector.

The third question is, “are there any other policy developments which are worth monitoring in China?”

As a matter of fact, last week we had the Politburo meeting of the Chinese Communist Party which set guidance for several policies. On the monetary policy front, the Politburo signalled no intention to shift policy sharply. So no premature or excessive tightening of monetary conditions should be expected. At the same time, they said that fiscal policy should support the needs of small companies and families impacted by COVID. So we should expect more direct stimulus to the part of the population that needs the most. The main focus though remains on accelerating structural reforms to advance innovation-driven technology and industrial upgrading.

On the regulatory front, the Chinese pledged to hold local leaders accountable for their lifetimes for any fiscal and any financial risks that were incurred irresponsibly. They emphasise enhanced supervision of internet platforms to focus on fair competition as already discussed.

Lastly, the Politburo raised concerns over house price speculation, in particular around school districts. Thus, the Chinese long-term focus and structural reforms drive remain supportive for a EM and global stability in our view.

The final question is around Taiwan. “Will China invade Taiwan in the short-term?”

The tensions in the Taiwan Strait escalated as China increased their military exercises around the border with Taiwan over the last month. However, we believe a direct conflict remains extremely unlikely. Our premise is that China will only attack if they feel their strategic position is threatened. For example, if Taiwan would be to officially declare independence, this could motivate a more aggressive response from China. But Taiwan would only declare independence if they're fully backed by the US military. And the US has little incentive to take measures that could lead to a messy war between the second largest economy and the most strategic producer of tech hardware in the world

America has historically kept a strategic ambiguous policy concerning Taiwan. Where she does not directly support the island nation but sells military technology and offers technical support. In our view, the US would be better off by maintaining the current status quo. Meanwhile, China will keep working to expand its economic ties with Taiwan, at the same time that it increases its military capabilities hoping that integration would end up offering the best solution to the Taiwanese and to the Chinese over the long term.

Chapter 5 - Summary & Conclusion

In summary, the world is going through a transition period where it attempts to normalise mobility. In the first phase of the transition, the US economy sprinted ahead aided by quick mass vaccination and unprecedented fiscal stimulus. We're now in the second phase when large EM countries and Europe accelerate their vaccination campaigns allowing for a recovery in mobility in the second half of the year.

This is not priced in EM assets which suffered the impact of wider US treasuries and vaccine divergence in the first quarter but are now likely to benefit from higher global growth, high commodity prices and ample liquidity. China continues to display leadership and is looking to regulate industries with monopolistic characteristics and business models that threaten financial stability. This was a headwind for Chinese equities over the last months but it's a welcome development for the economy and equity markets in the long term.

Thank you for watching Ashmore's "EM in 10." Please do not hesitate to contact us should you have any questions or would like to discuss any matters further.

All the best