Longtime Emerging-Market Critic Stephen Jen Turns ‘Constructive’

  • China, oil prices and more aggressive Fed are potential risks
  • Fed has effectively capped long-term yields, spurring EM

JPMorgan's Hui Sees More Upside for EM Rally

After years of decrying the BRIC template for emerging-market investing, Stephen Jen says it’s worth taking a look at the asset class.

Jen, who cut his teeth on emerging-market analysis at Morgan Stanley during the Asia crisis, hasn’t changed his view that many of these countries have failed to address structural economic flaws. The difference now: the Federal Reserve appears to have effectively capped long-term U.S. yields, even as it raises interest rates. That gives an incentive to move out on the risk curve.

“I admit that it is uncharacteristic for me to be constructive on non-China EM,” said Jen, chief executive officer at hedge fund Eurizon SLJ Capital Ltd. in London. “But the external environment is sufficiently supportive that all boats, including the crummy ones, float higher with the global liquidity tide.”

Jen has for years criticized the BRIC idea, coined by Goldman Sachs Group Inc., as too simplistic for its broad assumptions about the potential for the biggest emerging nations to catch up with wealthier countries. In 2012, he made a bearish assessment on those outside of China as a global slowdown drew attention to fundamental weaknesses in Brazil, Russia and India.

“I’m not abandoning my view,” he said in an interview by phone last week. “Brazil-Mexico-Poland are very unconvincing, to look at their local fundamentals,” he said. He highlighted in particular how poorly Mexico has done despite the advantages of the North American Free Trade Agreement. China has been an exception for Jen, thanks to its continuing focus on boosting the role of domestic demand, services and higher value-added manufacturing.

Monetary tightening cycles by the Fed have in the past caused ructions for emerging markets, among them the 1980s Latin American debt crisis and the 1994 Tequila crisis in Mexico. This time around, the asset class is outperforming. Even in the first quarter, when the U.S. central bank began implementing an acceleration in rate hikes, emerging stocks climbed.

Record amounts of money have flowed into emerging market ETFs, spurring some to start shorting them -- read about that here.

One dynamic that’s helping is an increasing sense that the Fed’s long-run projection for its benchmark federal funds target rate -- at about 3 percent -- serves as a cap on longer-term bond yields. Ten-year U.S. Treasuries now yield about 2.42 percent, compared with around 3 percent at the start of 2014, which was before the Fed started boosting rates.

“The latest market reactions to the FOMC decision seem to suggest that there is a great deal of credibility in the r* being low,” Jen wrote in a note last month after the Fed’s hike -- referring to the equilibrium long-run inflation-adjusted rate. “In some sense, the Fed is targeting the long-term interest rates like the BOJ has been doing.”

‘Further Outperform’

What that means for emerging markets is a continued inflow of yield-seeking capital, according to Jen. “EM assets can further outperform this year,” he wrote in a note last week. In the interview, he didn’t hide his continuing skepticism: “they’re quickly approaching fairly valued.”

Underscoring continued investor appetite, however, was the latest data on bets in the currency market, which showed leveraged funds went long on the Mexican peso versus the dollar for the first time since May last week.

Three dynamics could bring an end to the rally, he said. One is a slump in oil, a trend that’s hurt emerging markets in the past. Second is a turn in China, which continues to buy stable economic growth at the price of increasing leverage. Last -- and the least of a risk -- a more aggressive Fed that’s racing to rein in accelerating inflation, he says.

“No news is good news for these EM currencies,” he concluded.

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