- Global growth in 2018 is expected to be unchanged from 2017 at 3%. US policy interest rates set to rise by 75bps to end-2018. Emerging Markets (EM) will again grow at around 5%, with inflation contained. Interest rates have bottomed out but EM FX has some downside risk.
- Mexico is the canary in the coal mine. It faces potential US protectionism, border politics and re-negotiation of the North American Free Trade (NAFTA) deal. If risks recede, it and EMs should gain. If not, EM growth is at risk.
- In Fixed Income, UBP favours hard currency debt with strong fundamentals and a duration of under five years. High yield bonds should continue to see strong demand with investors looking for carry (EM HY spreads are not as tight as US HY). FX and US rates risk make local currency bonds unattractive.
- In country terms, UBP is cautious on high yielding sovereigns like South Africa and Turkey. Yields do not compensate for political risk. UBP has a preference for Chinese credits. These dominate the new issue pipeline in Asia, especially state-owned enterprises. Indonesian and Indian HY bonds are also attractive.
- EM equities have traded at a price-to-earnings discount to DM since 2008. EM is now priced at 14x 2018 earnings vs DM at 18x. EM also offers higher earnings growth at 14% (over two years) vs 9% for DM. On a book value basis, EM at 1.6x vs 12% return on equity (ROE) is better long-term value. DM trades at 2.2x with 11% ROE.
- With appealing valuations and better sustained earnings growth, we expect pro-EM sentiment to remain. Earnings revisions favour north Asia, cyclicals and technology (semiconductors).