One Strategist Asks: ‘Dude, Where’s The Contagion?’

Listen, Bloomberg’s Mark Cudmore is “a structural emerging-market bull who forecast a material tactical correction several times in the last few months,” ok?

But the thing is, “it hasn’t happened.” And Mark is a man who “re-evaluates the macro framework” and “reviews the roadmap” when circumstances change, which is good news for anyone who plans on taking a road trip with him.

No, but seriously, Mark was out with a piece overnight on EM that pretty much sums up the consensus view and I’ve got to tell you that I don’t agree with it, for two reasons:

  1. Country-specific, idiosyncratic risk is a built-in feature of EM. It’s structural. It’s part of the equation. It can wax and wane depending on the day and depending on the country, but indeed, that’s the point. You never know what an Erdogan is going to do. He could “come all of the sudden, in the middle of the night” (as the Turkish autocrat is fond of saying). Or take Brazil, which just careens from one corruption scandal to the next. And then there’s South Korea which, as it turns out, is next to North Korea. And on, and on.
  2. This thing where the bull thesis increasingly rests on the assumption that Jeff Bezos and robots are going to ensure that inflation stays low enough to keep DM central bankers at bay when it comes to normalization seems absurd. And not because it’s not in some sense plausible. But rather because in the near- to medium-term, they (DM central bankers) are going to give it a go when it comes to tightening. They have to replenish their ammo. They are out of dry powder and Draghi’s protestations notwithstanding, there are bubbles everywhere you look and the idea that they don’t realize that’s at least in part attributable to the persistence of accommodation is laughable.

So while I understand that for lack of acceptable alternatives, investors will be predisposed to chase yield and favor carry trades, EM has run a long way and between North Korea, the escalating situation in Iraq, and the very real possibility that the Fed is going to hike and thereby underpin the dollar come hell, Trump or high water, I’m not sure that this rally is as bulletproof as everyone seems to think it is.

For the opposing argument, find Cudmore’s piece below, entitled “Dude, Where’s My Emerging-Market Contagion”…

Via Bloomberg

I’m a structural emerging-market bull who forecast a material tactical correction several times in the last few months. It hasn’t happened. So it’s time to re-evaluate the macro framework and review the roadmap.

  • Successful trading depends on a delicate balancing act between confidence and fear. If you stray off the path, it’s best to take a few minutes to get your bearings before rushing headlong again
  • What is the macro environment for EM? Global growth is solid, led by Asia and China in particular. Liquidity is abundant, and financial conditions are easy. Few global equity markets appear cheap, but the bullish framework remains in place
  • Emerging markets are resilient overall and far more fundamentally secure and independent than any previous cycle. This makes contagion from an idiosyncratic story much less likely
  • For the sector to experience a broader and larger correction, it’s likely to require a fundamental shift in key macro assets. But what could that be?
  • Technology, demographics and excess energy supply provide structural long-term disinflationary pressures. As a result, investors are extremely reluctant to buy into the concept of an extended Fed hiking cycle. Trump won’t want one either, which plays into the debate around the new Fed chair
  • And it’s not like other major central banks such as the ECB or BOJ are in a rush to withdraw liquidity
  • An oil shock, maybe? Beyond a short-term spike, that seems unlikely. Energy supply is much more diversified and there are too many producers keen and able to step into the breach as soon as prices rise
  • A steep pullback in the U.S. equity-market could have painful knock-on effects in the short term. But investors will soon realize that, on a relative basis, most EM stock markets provide far superior long-term stories
  • And most bonds in EM offer higher real yields, backed by better growth rates and also lower debt ratios
  • When put like this, why try to be too clever? Overall, the outlook remains extremely constructive for most emerging markets. There may be periods to rein in enthusiasm, but that doesn’t justify a bearish stance
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