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Benefitting from the bull

The pendulum of sentiment has been swinging wildly this year. Lots of volatility for traders, sure, but a lot of uncertainty for investors. The sharp sell-off we saw in January swung sentiment to one extreme of the scale, followed by a sharp recovery fuelled by a shift in sentiment to the other extreme of the scale. 

This in itself also only lasted so long, as post-Brexit the pendulum swung again, much faster, back to extreme pessimism, then optimism. Sentiment, it seems, is a rather fickle thing to base an investment case on. It is said, too, that when the last bear turns into a bull, it is likely that the rally is near its end. 

So thinking about my own interpretation of the market, and my own views on what is likely to unfold going forward, the mere fact that I have turned from bear to bull over the last nine months is a source of concern for me. That being said, the drivers behind my change in outlook from pessimistic to optimistic are, in my opinion at least, ones that hold some merit. 

At present, and perhaps subject to change as the inevitable swing of the pendulum exerts its influence on me, I am optimistic about the world economy and particularly the outlook for emerging markets. A number of things have changed since we saw the lows in equities and commodities in January until now, and they are primarily the reason behind my shift in thinking.

Considering that we operate primarily in the South African market, it is only natural that my thinking is born from an emerging market perspective. 

January blues

As always, we need to start with some history in order to put the present into perspective. In January of this year we saw the US Federal Reserve pause their rate hiking cycle, as well as the European Central Bank (ECB) give hints of a possible expansion to their quantitative easing (QE) programme. There was also much uncertainty around whether or not China was going to experience a “hard landing” in their economy. 

Oil was trading at around the $30/barrel-mark and we started hearing the first whispers of orchestrated attempts (agreements) by Russia and Saudi Arabia to “put a floor” to the oil price. Brazil and Ukraine were going through some major economic turmoil at the time as well. 

This all resulted in a sharp 'risk-off' driven sell-off in most global markets, although outflows from emerging market debt instruments were not as much as was anticipated. This could perhaps be explained by the fact that all the while yields in developed markets were negative, and still are, and international investors almost have no choice but to search for yield in risk, or emerging, markets.

Then, by the second quarter of the year, the Fed started to become somewhat more dovish and in all practicality put a stop to interest rate hikes in the US. The ECB also delivered on their promise for further stimulus and in fact delivered slightly more than what the market had been expecting. Coordinated action, then. 

At the same time the People’s Bank of China (PBOC) greatly improved their communications around its currency regime, finalised their transition from a quasi-US dollar peg to a managed float against a broader currency basket, and provided assurances that they are unlikely to make any more large and unexpected changes to the valuation of their currency. Thus the uncertainties around China started to dissipate and it started looking as if the Chinese economy could be in for a “soft landing”. 

During this period, we also saw the oil price break up from its $30/barrel-level on the beginnings of talks within the Organization of the Petroleum Exporting Countries (Opec) about a possible freeze on oil output (production) volumes, the Ukrainian situation became less tense and Brazil had impeached its president. So emerging market political risk had abated.

Most global equity and debt markets rallied as well, although seemingly emerging markets did not experience very strong inflows of developed market capital. 

The state of emerging markets 

Enter Brexit and the great three-day sell-off. It was short-lived. This time around though, unlike the 'risk-off' driven sell-off in January, emerging markets did not share so sharply in the downside. This was partially due to what had by now become higher commodity prices, most prolifically perhaps being oil, and the re-emergence of economic growth in China. 

Oil had now started to stabilise at between $45 and $50/barrel, lifting the prices of most other commodities with it, which in turn brought relief to many companies and economies on the brink of collapse. Brexit of course had its consequences, which were an even more dovish Fed (holding off rate hikes) and QE from the Bank of England (BoE). This gave birth to some  “push and pull” factors that saw investors start buying the dip, as they say, in emerging market exchange-traded funds (ETFs), which led to very large inflows into emerging markets on the whole. 

The Institute of International Finance (IIF) estimates that inflows into emerging market debt instruments post-Brexit tipped the scales at $25bn of non-resident flows. Moreover, the coordinated response from central banks injected some much needed confidence into equity markets and we saw the Nasdaq, Dow Jones Industrial Average and S&P500 all trade to record highs in the same week for the first time since 1999.

This is a shortened version of the cover story that originally appeared in the 6 October edition of finweek. Buy and download the magazine here.

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