Neuberger Berman Thinks Investors Should Overweight Non-U.S. Stocks
The dollar and the Fed once again tag-teamed the living daylights out of emerging markets like Brazil, but that’s the end of that. Call it the “taper tantrum 2,” the sell-off in non-core equity and bonds was overdone. Time to move in. So thinks the asset allocators over at Neuberger Berman, a mutual fund company with approximately $300 billion in assets under management.
Neuberger Berman has an overweight on emerging market stocks and bonds.
One of the more notable stories in financial markets this year has been the underperformance of emerging markets debt, particularly against U.S. high yield, its perennial competitor in the yield-seeking portion of many portfolios. Both local currency emerging market bonds (LEMB) and dollar ones (EMD) were sold off heavily in May. No one wanted them.
The spread of the JPMorgan EMBI Global Diversified Index over U.S. Treasuries is as wide as that of the Barclays U.S. High Yield Index for the first time since 2005, even though many of the bonds in the EMBI are investment grade.
The mutual fund company said they upgraded their hard currency bonds from neutral to overweight, but downgraded local currency bonds to neutral weight. The move reflects the current potential of higher than expected U.S. yields, a shrinking Federal Reserve balance sheet giving fresh meat to bond traders and more safe-haven flows to the dollar. For them, it is better to own the bonds of foreign countries priced in dollars.
Some of Neuberger Berman’s allocation committee members compared the current sell-off to the so-called “Taper Tantrum” of 2013. Declining commodity prices and the troubles in the big economies of Russia and Brazil, coupled with more localized issues in Turkey, Argentina and trade disputes with China and Mexico as a drag on sentiment. That’s kept big money investors away.
The sensitivity of local currency bonds to rising Fed interest rates this year has been relatively subdued compared with the turmoil of the Taper Tantrum that sent even the assets of strong economies crashing. By contrast, the sell-off in hard currency bonds has been more pronounced this year. Neuberger Berman considers them to be “extremely oversold.”
“After a two-year recovery emerging markets debt was ripe for a correction,” as one Committee member put it. “It may get worse before it gets better, but our long-term fundamental views haven’t changed and if we are right to expect more agreement on trade then current valuations may represent an attractive opportunity.”
Chris Dhanraj, head of ETF Investment Strategy at BlackRock said they were still very much “pro-risk”—with a preference for U.S. equities. “Rising risk premia have created value in some emerging market assets,” he says, adding that hard-currency emerging market bonds “look attractive again.”
Trade tensions with China and NAFTA may cool the Fed’s desire to hike interest rates. That means the dollar might settle down a bit, which is a positive for commodities and the big commodity players in emerging markets.
“Even if the economy temporarily picks up speed in the summer or fall in spite of uncertain trade conditions, or if inflation pushes above the Fed’s longer-run objective with a further round of trade levies, the Fed is unlikely to increase the expected number of rate hikes for 2018,” says Stifel chief economist Lindsey Piegza.