Marko Kolanovic is bullish on emerging market assets, and “in particular” China.
Although the headline takeaways from Kolanovic’s latest missive centered around energy, commodities and the notion that corrections in various “bubble segments” may be nearing an end, there were a few additional points worth highlighting.
The Fed is, of course, embarking on what’s generally expected to be the most aggressive tightening cycle in recent memory. You could argue, as one Bloomberg blogger did Thursday, that 25bps increments won’t be sufficient to rein in inflation and that the Committee won’t demonstrate the necessary fortitude when push comes to shove. “The Fed will need to inject nominal volatility and term premium back into the market if it truly wants to tame inflation,” Simon White wrote, from London, adding that it’s “not clear whether the current, hitherto ultra-dovish Fed has the appetite to do this, and thus that they are condemned to repeat the mistakes of the 1970s.”
That aside, what we can say is that the Fed is hiking rates and preparing to commence balance sheet rundown at a time when China is poised to get more aggressive about easing, as telegraphed explicitly this week when policymakers verbally intervened to halt a meltdown in Chinese equities. New easing measures from Beijing will come on top of the RRR and policy rate cuts delivered since November.
While China is an emerging market, it’s not the entire EM complex, but it’s conceivable that easing out of Beijing could drag EM assets along for the ride in the event there’s a policy-driven rally. Juxtapose that with Fed tightening and you’re left to ponder the prospect of EM outperformance.
Kolanovic touched on all of that Thursday. “EM funds rapidly de-risked due to the current geopolitical crisis and various technical pressures [but] given their policy differential to the US (e.g. China easing, Fed tightening), continued commodity upcycle and similar divergence in GDP growth trends, we believe EM will significantly outperform DM for the rest of the year,” he wrote, on the way to noting that “the apparent determination of the Fed to proceed with consecutive hikes will result in a divergence of US monetary policy relative to the rest of the world.” The figure on the left (below) offers a simple snapshot.
It’s possible, even likely, Marko went on to write, that “the large US vs RoW performance divergence that opened over the past decade will now start converging.” I suppose this goes without saying, but that gap is very wide. As the figure on the right (above) shows, there’s plenty of scope for convergence.
Adopting a positive view on Chinese assets means accepting the risks that go along with the vagaries of Party politics. That can be psychologically daunting, as many investors learned the hard way over 18 months of near constant regulatory pressure, which helped push valuations to extremes. But this week’s concerted effort to allay fears and put the brakes on the existential selloff in Hong Kong shares and burgeoning Mainland bear market may be a turning point.
As for the biggest risk of them all, Kolanovic doubts the worst-case scenario will ultimately unfold. There’s just too much on the line. “When it comes to tail risks related to China, we think they will not materialize,” he wrote Thursday. “During the Cold War, peace was preserved by virtue of ‘mutually assured destruction’,” he said, adding that “for the time being, the current relationship with China may be preserved by the equivalent of economically assured destruction.”
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