Allview Market News & Views

Alison Shimada: Hello, my name is Alison Shimada, senior portfolio manager for the Total Emerging Markets Equity team here at Allspring Global Investments. I'd like to take this opportunity to share with you my observations from Q2, where we're seeing opportunities and challenges across sectors and regions, and why we remain positive on emerging markets going forward. Emerging markets equities rebounded 3.5% in June, boosting Q2 performance back to positive territory. A weak economic recovery in China this year and geopolitical risks are well known and almost already priced in. The Chinese government has aired on the conservative side and needs to introduce more fiscal and monetary support in the coming months to preserve GDP (gross domestic product) growth in the 4% to 5% range. Risk/reward for Chinese equities is starting to look more attractive on low valuation, increased efforts by China and the U.S. to engage, and potential fiscal stimulus. Alongside China is India, which is China 20 years ago, with a young, increasingly well-educated population, a stable central bank, and a popular government that is becoming more operationally efficient. There are multiyear possibilities of returns in India in banking, real estate, and infrastructure, in particular. While the developed market recession is possible, we expect the semiconductor cycle to bottom this quarter and look to the rise of machine learning, artificial intelligence, and ChatGPT to drive new product cycles. This bodes well for technology-heavy markets, including Taiwan and Korea. Latin America looks attractive given low valuations, stable ROEs (return on equity), access to natural resources that are important in the EV (electric vehicle) supply chain, and government reform in countries like Brazil. Mexico should continue to benefit from tourism, as well as manufacturing reshoring. Brazil could also start to be considered more favorably as an industrial base, due to its abundance of land, labor, and improving legal transparency. At the moment, the Middle East is not as compelling, due to its higher valuations and the correlation with oil prices that are rangebound currently. Also, the government in South Africa is not as proactive in addressing corruption and stabilizing its power infrastructure, so we remain cautious there. We see an earlier end to tightening cycles in emerging markets compared to developed markets and EM (emerging markets) valuations overall are attractive at 12 times forward earnings and 1.5 times price to book, trading at a large discount to developed markets. Emerging markets corporate balance sheet strength and returns are near pre-pandemic highs. We remain positive on emerging markets with the U.S. dollar having peaked and as the relative growth premium of emerging markets versus developed markets expands once again. Thank you.

Mike Schueller: It’s been quite a year in the high yield market after last year’s double-digit draw down. Year-to-date, through the end of July, the ICE Bank of America (BofA) (U.S.) High Yield Index has returned just under 7%. That compares to just over 2% for the Bloomberg U.S. Aggregate (Bond) Index. CCCs, which are the lowest quality and most economically sensitive portion of the high yield market, have done even better, generating equity-like returns of nearly 13%. And this strong performance has occurred despite tightening monetary policy, an inverted yield curve, a mini-banking crisis, and widespread expectations that a recession is just around the corner. So, where does that leave us now? High yield spreads, which is the compensation that investors earn for taking credit risk, are inside long-term averages, but they’re wide of both the post-pandemic tights and the all-time tights. Now spreads could tighten further, but at these valuations, we think the market is discounting a no-recession scenario. Now, it’s certainly possible that what we are experiencing is really just a normalization of the global economy after the pandemic led to historic demand and supply shocks that in turn induced a historic fiscal and monetary policy response and maybe we will avoid a recession, after all. But in the past, when the Fed (Federal Reserve) has tightened this much, there has ultimately been a recession, so we do think, at this point, some caution is warranted. Now, we are seeing some evidence of tighter monetary policy in the high yield market. Currently, roughly 20% of the high yield market matures in the next three years. This so-called maturity wall is at the highest level that it’s been at in over two decades and has been driven by the dramatic increase in rates. What do we mean by that? Well, we believe the maturity wall grew in part because many issuers have waited to refinance maturities because of the higher interest rate they’ll have to pay on a new bond. For example, for BB and B issuers, we estimate they will have to pay roughly 2% more when they refinance. That’s a headwind for those companies and there will be winners and losers, but ultimately, we don’t necessarily think this derails the market. The story for CCCs is a bit more challenging. The average CCC issuer will see its interest cost increase by approximately 6% based on current market rates. This is a very big increase and many CCC issuers may struggle to make those higher coupon payments. While there is reason for caution, we don’t think now is the time to panic. The average rating of the high yield market is low-BB, as high as it’s been in many decades, and the percentage of CCCs in the market is close to historical lows. High yield issuer fundamentals are solid, as well, with leverage near the low end of the historical range and interest coverage near the high end. And while I noted earlier that Fed hiking cycles often lead to recessions, there is typically a period of a year or more following the last hike in which high yield performs relatively well. For example, right now, BBs and Bs yield almost 7.5%. For those of you who may be worried about rate volatility, you can get a similar yield in short maturity BBs and Bs. The key, however, is that investors take care to pick the winners and avoid the losers. We do think you should probably avoid the refi risk of CCCs. And in any event, if CCCs do well, it’s very likely equities will do even better. In short, we believe short maturity, high quality high yield bonds can offer investors the opportunity to compound attractive real yields right now while keeping volatility at relatively low levels, despite all of the ongoing uncertainty.