The Daily Prophet: Goldman Sachs Goes All In on Emerging Markets

Connecting the dots in global markets.

There are plenty of trouble spots in emerging markets, from the Venezuelan debt default to North Korea's nuclear program to Saudi Arabia's corruption crackdown. Still, those are no reasons to bail out of the biggest rally in emerging-market stocks since 2009, according to Goldman Sachs. Even though the MSCI EM Index is up 31.5 percent this year, closing at a record high on Tuesday, the firm sees the benchmark gaining an additional 10 percent by the end of 2018.

In many ways, Goldman Sachs represents the consensus. It's hard to find anyone betting against this volatile part of the global markets as commodities begin to rally and the worldwide economy enjoys a rare synchronized economic recovery. Foreign-exchange reserves for the 12 largest EM economies, excluding China, have risen to $3.08 trillion from less than $2 trillion during the financial crisis, providing a nice cushion when a slowdown actually comes. As such, Goldman Sachs sees corporate earnings in emerging markets rising about 11 percent in 2018. "We agree with the 'macro-consensus' bullish EM equity view and see further upside to the EM equity rally," the firm's strategist wrote in a report dated Nov 7.

To be sure, one big concern is that there's too much money flowing into emerging markets, pushing asset values to unsustainably high levels and allowing even the weakest borrowers to obtain cash at shockingly low rates. Demand to invest in hedge funds that focus on emerging markets is so high that some are turning away new money, according to Bloomberg News' Suzy Waite and Nishant Kumar. They report that Pharo Management (UK) closed one of its developing-economy macro pools to new clients after it made 25 percent this year through September. And Antoine Estier raised twice what he expected for his new Amia Capital venture, which invests across markets, closing part of the fund to additional clients, according to a person familiar with the matter.

One of those EM hot spots is Russia, but it seems as if investors just woke up to the fact that the nation is the world's biggest energy exporter. Russian equities climbed the most in the world on Tuesday with both the Micex and the RTS indexes gaining more than 3 percent. Investors who following the market credited oil's recovery for the biggest rally since 2015, which they say outweighs concerns over possible new sanctions, according to Bloomberg News' Ksenia Galouchko. “Perhaps investors now have more confidence in oil’s strength,” Pavel Laberko, a London-based equity money manager at Union Bancaire Privee, told Bloomberg News. “It is hard to say how long this will last, but given the Russian equity market’s underperformance this year, I think we could see more upwards momentum.” That underperformance has been stark, with the Micex dropping 6.79 percent this year through Monday, compared with a gain of 30.6 percent for the MSCI Emerging Markets Index. Investors are bracing for a report by the U.S. Treasury, due next quarter, on the possible effect of sanctioning Russian sovereign debt. Whatever the reasons for the gains in equities, currency traders weren't buying it. An expansion of sanctions to local Russian debt not only raises the prospect of a selloff in the bond market but also poses risks to the ruble, according to Bloomberg News. 

One of the biggest surprises of the currency market this year has been the strength of the euro. The Bloomberg Euro Index gained as much 11.4 percent between mid-April and late August. Since then, though, the shared currency has been drifting lower, with the index falling Tuesday to its lowest level since July. Despite an improving economic outlook, the euro has been struggling since the European Central Bank decided to extend its bond purchase program longer than traders expected. That means more euros in the financial system. Now, Goldman Sachs is warning that after reaching as high as $1.2092 against the dollar in early September, the euro could weaken to $1.15 by year-end from about $1.16 on Tuesday. "Over the medium term, the Euro probably has more upside than downside, but we think the near-term trajectory is still lower," the firm's strategists wrote in a research note. Their forecast is lower than the median estimate of $1.17 in a Bloomberg survey of economists and strategists. They note that positioning indicates that investors are still long the euro, and as those positions get unwound the currency could suffer.

It's been a tough year for commercial real estate stocks, with the Bloomberg REIT Index's 5.37 percent gain trailing the S&P 500 Index's 15.7 percent surge. The knee-jerk response is to blame for higher interest rates from the Federal Reserve, but a new report shows that commercial real estate values are falling, in part, because struggling retailers are weighing on shopping malls. A Green Street Advisors LLC index that tracks values for U.S. office buildings, apartments, hotels and shopping malls fell 1 percent in October, marking the first decline in more than four years and the biggest monthly drop since the aftermath of the financial crisis, according to Bloomberg's Sarah Mulholland. A 5.5 percent slump in mall values was enough to drag down the entire group, leading to one of only two broad declines for the index in the past seven years. The other was a 0.6 percent decrease in July 2013. Mulholland reports that retail landlords have been squeezed by the rise of e-commerce, leading to a surge of store closures. Property owners have spent $8 billion in the past three years in an effort to update centers with a focus on entertainment and other types of experiences that can’t be found online, according to brokerage Jones Lang LaSalle.

Lumber prices that have soared amid a Canada-U.S. trade dispute could rise even higher after a fire at a British Columbia sawmill cuts supplies. Bloomberg News' Jen Skerritt reports that futures are trading at a 23-year high amid rising demand for housing and after the U.S. imposed tariffs on softwood imports from Canada. The rally could extend after a major fire at Tolko Industries’ Lakeview mill, which accounts for about 2 percent of production in British Columbia’s interior, CIBC analyst Hamir Patel wrote in a research note Monday. Canada is the world’s largest softwood lumber exporter and the U.S. is its biggest market. Lumber futures have gained as much as 40 percent this year to $459.60 per 1,000 board feet, the second-best performing commodity, according to data tracked by Bloomberg. Some Canadian sawmills are raising prices above $500 in an effort to offset countervailing duties of 14.25 percent and anti-dumping duties of 6.58 percent, according to Kevin Mason, managing director of Vancouver-based ERA Forest Products Research. They are “hoping to jack up prices at the Canadian mills to offset final duties,” Mason said in an email.


So far, so good. That's the takeaway from the U.S. Treasury Department's auction Tuesday of $24 billion in three-year notes. The results were deemed "reasonable" by the fixed-income strategists at FTN Financial. The more important auctions come Wednesday and Thursday, when the Treasury seeks buyers for $23 billion of 10-year notes and $15 billion of 30-year bonds. The results will be closely watched because yields on those maturities have fallen sharply since Oct. 26, causing the so-called yield curve to shrink to its narrowest levels since 2007 and raising concerns about the health of the economy. That's because a narrowing yield curve is typically associated with slowing growth. Demand at the auctions could  either help ratify the declines, paving the way for a further drop  in yields, or  show that they were just a temporary respite from a longer-term move higher. 

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