We are two months into the year and market sentiment has improved as investors dissect inflation numbers, economic data, and the path of the Federal Reserve. Levels in both the Cboe Volatility Index and ICE BofAML MOVE index – respectively used to gauge volatility in stocks and U.S. Treasurys –have declined from the most recent highs seen in October 2022.TRG’s macro analysts and portfolio managers in public markets revisited and debated four themes driving stocks, bonds and currencies. Bottomline: we contend the outlook for growth is more positive in emerging markets, but portfolios are not reflective of that because of the asset class’s past underperformance over the last decade.
- Inflation
The debate yielded a stronger consensus among portfolio managers and analysts about the ongoing disinflationary trend. The factors we previously highlighted behind the easing in goods’ price pressures keep playing out: food and energy prices are near lows unseen in a year or more, supply chains are normalizing, shipping costs are falling, and spending has shifted in favor of services. Outside the U.S., a weaker dollar has helped stem inflation. While questions remain about service costs, incoming data suggests the determinants of core inflation are improving. The more obvious sign comes from an inflection lower in wage pressures, particularly in spots with historically tight labor markets, including the U.S.
- Positioning
Inflows into emerging market debt and equities accelerated in recent weeks, reversing course from last year. Equity inflows in January alone more than offset outflows for the entirety of 2022. According to JPMorgan research, more than $8 billion worth of inflows have poured into emerging market bonds, and approximately $27 billion into equities. Even after the strong inflows of late, our investment team believes there is scope for further rebalancing towards emerging markets as the asset class remains under owned compared to the last decade.
- Growth
The International Monetary Fund upgraded its global outlook at the end of January, and the numbers reveal the growth balance is tilting in favor of emerging markets. The IMF now projects the global economy will grow 2.9% this year, up from its October projection of 2.7%. Splitting the projections between emerging and developed markets, the IMF revised upward sits estimates of emerging market growth to 4.0% in2023 (+0.3pp upward revision) from 3.9% last year. It estimates a slowdown in developed markets to 1.2% in2023 (+0.1pp revision) from 2.7% in 2022. Furthermore, encouraging mobility data from the Lunar New Year holiday in China – the brighter growth spot in emerging markets – indicates a rapid normalization in activity is on track.
- Monetary policy
The prospects of dollar depreciation are supportive of risky assets – and a weaker dollar is ultimately linked to the Federal Reserve’s policy path. There is internal consensus that the Fed’s tightening cycle is approaching its end, and TRG participants broadly agree with the market’s pricing of one additional quarter-point interest rate increase. As future policy decisions become increasingly data dependent, TRG participants argue temporary setbacks to the ongoing rally are likely on the horizon – though they believe the larger picture for emerging markets remains intact. Any disappointing inflation or employment figures (there are two of each before the Fed’s next March 22decision) will likely spur volatility. Looking further ahead, our research team reiterated their conviction in higher U.S. neutral rates that will settle around 2.75-3.0%.
The U.S. dollar is one variable playing an important role in the outperformance of emerging markets - and the rest of the world. Our portfolio managers and strategists all agreed the dollar has room to weaken further, reflecting shifts in relative monetary policy stances, lack of valuation support for the dollar, and limited safe-haven bids on the perception of diminished geopolitical risks.
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The information provided herein is for educational and informational purposes only, and neither The Rohatyn Group nor any of its affiliates (together, “TRG”) is offering any product or service hereby. The information provided herein is not a recommendation, offer, or solicitation of an offer to buy or sell any security, commodity, or derivative, nor is it a recommendation to adopt any investment strategy or otherwise to be construed as investment advice. Any projections, market outlooks, investment outlooks or estimates included herein are forward-looking statements, are based upon certain assumptions, and should not be construed as an indication that certain circumstances or events will actually occur.
Other circumstances or events that were not anticipated or considered may occur and may lead to materially different outcomes. The information provided herein should not be used as the basis for making any investment decision. Unless otherwise noted, the views expressed in the content herein reflect those of the author(s) as of the date published and are not necessarily the views of TRG. In fact the views of TRG (and other asset managers) may diverge significantly from certain of the views expressed in the content herein. The views expressed in the content herein are subject to change without notice, and TRG disclaims any responsibility to furnish updated information in the event of any such change in views. Certain information contained herein has been obtained from third-party sources. While TRG deems such sources to be reliable, TRG cannot and does not warrant the information to be accurate, complete or timely, and TRG disclaims any responsibility for any loss or damage arising from reliance upon such third-party information or any other content provided herein.
Exposure to emerging markets generally entails greater risks and higher volatility than exposure to well-developed markets, including significant legal, economic and political risks. The prices of emerging market exchange rates, securities and other assets are often highly volatile and movements in such prices are influenced by, among other things, interest rates, changing market supply and demand, external market forces (particularly in relation to major trading partners), trade, fiscal and monetary programs, policies of governments and international political and economic events and policies. All investments entail risks, including possible loss of principal. Past performance is not necessarily indicative of future performance.The information provided herein is neither tax nor legal advice. You must consult with your own tax and legal advisors regarding your particularcircumstances.
