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Transcript
For professional investors only* – not for retail use or distribution INSIGHTS Focus on emerging market corporate debt Themes in bond investing June 2009 June 2012 PLEASE VISIT jpmorgan.com/assetmanagement for access to all of our insights publications. IN BRIEF Despite the global uncertainty, emerging market debt has managed to hold on to positive returns so far in 2012. In this paper, Alain Defise examines the macroeconomic backdrop and the potential developments in the coming quarter, assessing their likely impact on emerging market debt. He then focuses on emerging market corporate debt, which has been among the bestperforming fixed income sub-asset classes over the year to date. Emerging market debt to keep muddling through Despite a turbulent May for risk assets, caused by widespread risk aversion, lowering of global growth forecasts and fears of further European peripheral stress, emerging market (EM) debt assets have managed to hang on to positive returns over the year to date. Our main expectation is for EM debt to continue to muddle through in the third quarter, although we could see a gradual rebound in the event of any significant policy response. This tepid outlook is underpinned by expectations for sub-trend global growth, with our proprietary leading economic indicators pointing towards weaker growth over the next one-to-three months (see Exhibit 1). Following a strong rebound at the end of the fourth quarter of 2011, the regional indicators have turned just below the trend growth level. It is clear that emerging markets are not decoupling from developed markets, primarily due to trade linkages. Global growth is expected to be below trend 1 0 -1 FOR INSTITUTIONAL AND PROFESSIONAL INVESTOR USE ONLY | NOT FOR RETAIL USE OR DISTRIBUTION Oct-11 Mar-12 Dec-10 May-11 Jul-10 Feb-10 Apr-09 Source: Bloomberg, J.P. Morgan Asset Management. As of June 2012. Sep-09 Jun-08 Nov-08 Jan-08 Aug-07 May-06 Jul-05 Dec-05 Feb-05 Sep-04 Apr-04 -3 LATAM Oct-06 ASIA Mar-07 EMEA -2 Jun-03 Senior Portfolio Manager Emerging Markets Debt 2 Nov-03 Alain Defise 3 Jan-03 Standard deviation around trend growth Exhibit 1 – Regional average proprietary leading indicators Focus on emerging market corporate debt February 2012 Corporate bonds and European sovereign debt after the LTRO Policy response is expected in emerging and developed markets Given expectations for slowing global growth, falling commodity prices and powerful base effects, inflation expectations are expected to remain depressed, with core inflation remaining well anchored. However, deflationary effects may be limited in some countries (e.g., Brazil, Mexico and Hungary) due to currency weakness. We expect to see policy responses in the coming quarter from both developed and emerging markets. Central banks in emerging market countries have the ability to provide stimulus in this weaker environment given their proactive interest rate rises in 2010 and 2011 and the generously high real interest rates in certain countries (e.g., Brazil and China). Range trading set to continue, with chance of a gradual recovery The extent and size of the policy response remains uncertain. Hence, in our scenario analysis (see Exhibit 2) we expect the market to rotate between risk off (scenario 1) and range trading (scenario 2) – the latter due more to covering short positions than deployment of new cash. Compared with the second quarter, this range trading is likely to become more violent (i.e., with wider ranges) given thinner volumes and lower liquidity. Exhibit 2 – Expectations for the coming months Probability 10% 20% 70% Phase Risk on triggered by policy action Gradual rebound Muddle-through – Gradual slowdown Market Dislocation SCENARIO 4 SCENARIO 3 SCENARIO 2 SCENARIO 1 Phase Growth slowing Recession fear Rotating GROWTH Accelerating Growth turns up Low but close to expectations INFLATION Up, driven by commodities Flat/under control Moderate downward pressure Downward pressure Deflation scare POLICY RESPONSE Liquidity & capital injection On hold On hold (selective easing) Easing (selective responses) Late co-ordinated rate cuts, quantitative easing, political action RATES Jump & steepening Flatter EM bias Flattening bias Steepening bias U.S. Treasuries MARKET Risk on (Short rates & duration, FX, HY) Positive (HY, FX, local currency corporates) Range-trading (IG corporate, selective FX, back end rates) Risk off (IG sovereign, front end rates) Safe haven (USD) Liquidity response Significant, powerful coordinated policy response Source: J.P. Morgan Asset Management. This information reflects J.P. Morgan Asset Management's opinion and goals and is subject to change. 2 | Focus on emerging market corporate debt Focus on emerging market corporate debt February 2012 Corporate bonds and European sovereign debt after the LTRO EM corporate debt has outperformed in 2012 Exhibit 3 – EM versus other indices – 2012, through May CEMBI Broad High Yield U.S. High Yield CEMBI Broad S&P 500 U.S. High Grade EMBIG U.S. Treasuries - Intermediate GBI-EM Global Diversified ELMI+ EM Equities Commodities 6.3% 5.2% 4.8% 4.2% 4.0% 3.7% 2.0% 1.3% -0.2% -0.6% -10.6% Source: J.P. Morgan Asset Management, Bloomberg, As of June 2012. We are hopeful that policy responses, particularly from developed markets, may allow a move from our core muddle-through scenario to a gradual rebound (scenario 3) towards the end of the quarter. However, we cannot discount a dislocation phase from the scenarios mentioned previously for the quarter, particularly given the significant event risks resulting from the eurozone debt crisis. We would expect such a dislocation to take the form of a nasty phase of negative price action that could lead to significant coordinated policy response, both monetary and, importantly, fiscal. This would have the potential to kickstart a major risk-on rally (scenario 4). Fundamentals remain strong EM corporate fundamentals will undoubtedly be somewhat challenged by the current macro backdrop. There has already been some evidence of this in the most recent quarterly corporate earnings releases, particularly from China, where industrials are suffering margin compression as a result of higher costs and revenues are coming under some pressure. However, after acknowledging the potential for some deterioration, it is important to emphasise just how strong fundamentals currently are. Emerging market corporate debt EM corporate high yield debt has been the best-performing fixed income sub-asset class so far this year, with investment grade not far behind (see Exhibit 3). Broadly speaking, the period can be split into two phases: a phase of strong outperformance in the first four months of the year and then a phase of consolidation in May’s turbulence. However, even in May, EM corporate debt was surprisingly resilient. The outperformance of EM corporate debt has been driven, in part, by the strong fundamentals of emerging market companies. But given the macro environment, can we expect this strength to persist? 3 | Focus on emerging market corporate debt Compared with their history, EM corporate issuers have high cash balances as a percentage of their total debt. In fact, compared with their peers in the U.S., both investment grade and high yield EM companies have higher cash balances and lower net leverage, yet EM corporate debt yields are significantly higher than those of similar quality developed market corporates. The premium on EM corporates is often justified by the explanation that they are significantly more volatile. However, on the investment grade side, emerging market corporates are not dramatically more volatile than their U.S. peers (see Exhibit 4A). High yield does still tend to be more volatile, particularly in periods of broad market stress, when spreads on EM corporate high yield tend to overshoot as a result of risk aversion (see Exhibit 4B). We believe, though, that this is driven by the difference in the investor base for high yield in emerging markets versus the U.S., rather than being a reflection of fundamentals. Focus on emerging market corporate debt February 2012 Corporate bonds and European sovereign debt after the LTRO EM versus U.S. corporate volatility and spread ratios Exhibit 4A: Volatility and spread ratios in investment grade Exhibit 4B: Volatility and spread ratios in high yield Source: Bank of America, May 2012. EM corporates are still good value Despite their outperformance so far this year, EM corporate bonds continue to offer good value, particularly in the investment grade sector. Investment Grade EM corporates trade at a premium to their U.S. peers, despite higher ratings and a shorter average duration. High yield EM corporates, too, trade at a significant yield premium to U.S. high yield, although default rates and recovery rates are similar. The credit cycle has peaked, with the upgrade to downgrade ratio fading, but we are not revising our default rate expectations at this stage. We still expect defaults of around 3% this year, a level that is largely priced into the market. Fundamentals remain solid and more than 80% of the high yield investment universe has a stable or positive rating outlook. In the investment grade sector, too, the vast majority of issuers (88%) have positive or stable ratings outlooks (see Exhibit 5). In recent years, many companies have taken advantage of the appetite for new issuance to roll over their debt and extend their maturity profiles, reducing refinancing risk for the coming years, which would be beneficial for valuations. Also positive is the fact that the appetite for new issuance has not disregarded fundamentals. Rather, the market has become more disciplined, so that even in the first quarter, when demand for corporate credit was very high, a number of new issuers were unable to find buyers as investors continued to focus on quality. Exhibit 5 – Global emerging market rating outlook Positive 10% Negative 12% The new issuance pipeline is robust The EM corporate bond market is growing rapidly and, at USD 800 billion, is now bigger than the EM sovereign market. It is one of the only fixed income sub-asset classes in which we expect positive net issuance this year, as strong issuance in Asia and Latin America offsets weakness in Europe, the Middle East and Africa. New issuance is positive because it increases not only the size of the market but also the diversity, in terms both of sectors and of single issuers. Issuance is also a good source of liquidity, helping to drive inflows into the asset class. 4 | Focus on emerging market corporate debt Stable 78% Source: Deutsche Bank, May 2012. Focus on emerging market corporate debt February 2012 Corporate bonds and European sovereign debt after the LTRO Conclusion Global growth is expected to weaken somewhat in the coming months, which is likely to lead to some form of policy response from central banks. With the extent of any policy support unknown as yet, we expect EM debt to remain range bound. Despite this backdrop, the secular case for targeted exposure to EM corporate bonds remains compelling, based on the solid macro backdrop for emerging markets, as well as the stronger underlying credit fundamentals and higher yields of many EM corporate bond issues relative to similarly rated bonds issued by companies in developed markets. The strong new issuance calendar should also improve the liquidity of EM corporate bonds. These factors will continue to help the asset class, which we believe means that EM corporate debt will become a more integral part of investor portfolios. 5 | Focus on emerging market corporate debt Alain Defise is the lead portfolio manager for Corporate Emerging Markets Debt. In this role, Alain is responsible for identifying credit opportunities and managing corporate exposures in emerging market portfolios. Prior to joining the firm in October 2009, Alain spent nine years at Fortis Investments, holding various corporate credit roles in London, Paris and Brussels. Most recently, Alain served as a senior portfolio manager within Emerging Markets Fixed Income, managing corporate allocations across a range of emerging market bond funds. Before this, he worked as a senior credit analyst, focusing on the high yield market, and as a credit analyst, specializing in investment grade corporate debt. Previously, Alain spent four years as a financial control analyst at Citigroup (Brussels). Alain holds a master’s degree in business engineering from the Ecole de Commerce Solvay (Belgium) and a diploma in finance analysis from the European Federation of Financial Analysts (EFFAS). Focus on emerging market corporate debt “Professional Investors” corresponds to professional clients and eligible counterparties as defined within the European Union Directive 2004/39/EC on Markets in Financial Instruments (MiFID). This material is intended to report solely on the investment strategies and opportunities identified by J.P. Morgan Asset Management. Additional information is available upon request. Information herein is believed to be reliable but J.P. Morgan Asset Management does not warrant its completeness or accuracy. Opinions and estimates constitute our judgment and are subject to change without notice. Past performance is not indicative of future results. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. J.P. Morgan Asset Management and/or its affiliates and employees may hold a position or act as market maker in the financial instruments of any issuer discussed herein or act as underwriter, placement agent, advisor or lender to such issuer. The investments and strategies discussed herein may not be suitable for all investors. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Changes in rates of exchange may have an adverse effect on the value, price or income of investments. All case studies are shown for illustrative purposes only and should not be relied upon as advice or interpreted as a recommendation. Results shown are not meant to be representative of actual investment results. Any securities mentioned throughout the presentation are shown for illustrative purposes only and should not be interpreted as recommendations to buy or sell. A full list of firm recommendations for the past year is available upon request. International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Also, some overseas markets may not be as politically and economically stable as the United States and other nations. The Fund's investments in emerging markets could lead to more volatility in the value of the Fund. As mentioned above, the normal risks of investing in foreign countries are heightened when investing in emerging markets. In addition, the small size of securities markets and the low trading volume may lead to a lack of liquidity, which leads to increased volatility. Also, emerging markets may not provide adequate legal protection for private or foreign investment or private property. J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited which is regulated by the Financial Services Authority; in other EU jurisdictions by JPMorgan Asset Management (Europe) S.à r.l., Issued in Switzerland by J.P. Morgan (Suisse) SA, which is regulated by the Swiss Financial Market Supervisory Authority FINMA; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited, all of which are regulated by the Securities and Futures Commission; in Singapore by JPMorgan Asset Management (Singapore) Limited which is regulated by the Monetary Authority of Singapore; in Japan by JPMorgan Securities Japan Limited which is regulated by the Financial Services Agency, in Australia by JPMorgan Asset Management (Australia) Limited which is regulated by the Australian Securities and Investments Commission and in the United States by J.P. Morgan Investment Management Inc. which is regulated by the Securities and Exchange Commission. Accordingly this document should not be circulated or presented to persons other than to professional, institutional or wholesale investors as defined in the relevant local regulations. The value of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. 270 Park Avenue, New York, NY 10017 © 2012 JPMorgan Chase & Co. | MI to II Institutional_ Focus on emerging market corporate debt_2012 FOR INSTITUTIONAL AND PROFESSIONAL INVESTOR USE ONLY | NOT FOR RETAIL USE OR DISTRIBUTION jpmorganinstitutional.com