Exactly two thirds of the audience at this week’s Expert Investor Finland event believe the Fed should raise rates at its next monetary policy meeting in December. As David Hogarty, head of strategy development at Kleinwort Benson Investors and one of the speakers at the event, noted: “Large cap growth stocks go up the most when interest rates come down (see chart below). So a rate hike would be quite negative for these stocks. You’d therefore expect a rotation into value stocks when interest rates rise.”
So is this what Hogarty’s audience, Finnish fund selectors, are doing? Not quite. Moreover, in May more than 40% of them said they had a preference for value stocks in US equities. Now, this has come down to a mere 6%, with the majority of the audience being style agnostic.
It’s often assumed that emerging markets will be hit hardest by a rate rise, as this would trigger capital outflows and drive up their borrowing costs, since much of emerging market companies’ debt has been financed by corporate bond issues denominated in dollars.
And it’s the Finns who are Europe’s biggest emerging market enthusiasts at the moment. The majority of Finland’s fund buyers plan to increase their exposure to EM equities after the recent market turmoil. And The Finns are also Europe’s most upbeat about emerging market debt, with buyers outnumbering sellers for both government and corporate bonds.
Demographics, deflation and disruption
Sze sze Yap, an Asia specialist at Schroders who also spoke at the event, gave a mixed outlook for the asset class. “Leverage in emerging markets has picked up quite a fair bit, and a rate hike will have its implications on highly leveraged businesses,” she issued a cautious warning to the exuberant Finns. However, it’s mainly the “old economy names, such as real estate companies”, as she put it, which are highly leveraged. “They face a mismatch between their revenues in local currency and borrowing in dollars.”
Ultimately, it’s the three D’s which matter in Asia: demography, deflation and disruption. “Demographics are deteriorating, apart from India. Producer prices are in deflationary territory which causes real interest rates to rise,” she said.
“And the final D is disruption. The rise of smartphones and e-commerce are disruptive to existing businesses and business models. Examples are Tencent and Alibaba’s payments platforms competing with banks for deposits through their own money market funds. Such developments have allowed for smaller businesses to reach their target clients more easily and compete with bigger businesses, forcing incumbents to re-think their business models. Overall that can be quite a game changer.”
Kenneth Orchard, manager of the T Rowe Price Global Unconstrained Bond Fund, preferred to look at the positive impact of deflation.
“Countries in a disinflationary environment can provide very high and sustained returns as their local bond yields come down,” he said. “An example is Serbia, where government bond yields have come down from 10% to 6% because inflation. Russia is another potential place, where inflation is currently 15%. If inflation comes down there, this would signal a very high appreciation potential for Russian bonds.” So the Finns’ enthusiasm for emerging market debt might be not that bad an idea after all…
Click here for a full overview of the voting results from Expert Investor Finland.
And click here to see a slideshow of photos taken at the event.