- Marketing communication -
Coronavirus, economic growth, and inflation – all terms that characterised 2021. In 2022, the signs point to a normalisation of economic growth and, beyond that, everything indicates a turnaround in interest rates. The high level of inflation, combined with the ongoing economic recovery, should prompt the US Federal Reserve in particular to raise the Fed Funds rate for the first time. Europe will probably follow suit at the end of 2023. Therefore, we are likely to see turbulence on the bond markets and the upward pressure on yields could increase.
Consequently, it seems likely that the sovereign bonds of the industrialised nations will result in real losses for investors in 2022. The outlook for corporate bonds with good credit ratings is somewhat better, but higher coupons are unlikely to compensate for the price losses.
In contrast, we have the emerging markets and, above all, their companies. Here we assess the environment for the coming year as very positive. This is due to the fact that, despite more moderate economic growth, the potential increase in the Fed Funds rate in the US, as well as monetary policy tightening in other parts of the world, spreads on high-yield bonds from emerging markets are likely to narrow. Spreads are still wide, both in historical terms and compared to the developed economies. The high-yield segment of the market, in particular, offers a premium of around 100 – 120 basis points over US high-yield bonds. In part, this stems from recent repricing in countries such as China, Peru, the Ukraine, and Turkey, and suggests that there is scope for narrowing as these events normalise and the overall recovery progresses. The persistence of negative real interest rates will mean that the investment focus will continue to be on higher-yielding asset classes.
Commodity markets should continue their rally
We are also optimistic about the developments on the commodity markets. After the significant price movements in 2021, the fluctuations on the commodity markets could decrease somewhat in 2022, but the upward pressure could continue overall. Not only precious metals, but also agricultural products (soybeans, protein) are enjoying continued high interest. Industrial metals in particular, however, appear to have further price potential. One of the drivers of demand is the fact that the issue of sustainability is gaining in importance. The conversion to a green economy is increasingly being driven forward. In the meantime, the conviction seems to have prevailed on a broad front that the green transformation of the economy, although it incurs costs, ultimately has clearly positive effects on economic development in the long term. It is not only individual industrialised countries that are investing in the green transformation; more sustainable economic activity is now a global goal. As building a sustainable infrastructure over a long period of time is very energy- and resource-intensive, the demand for traditional raw materials should be supported over the long term. Copper and iron ores, for example, should benefit from this.
The oil market is also likely to continue its rally in 2022. At current oil prices of just over USD 70 per barrel, supply is relatively limited and there appears to be little likelihood of an increase in supply in the new year. Over the longer term, the reluctance to invest due to stricter environmental regulations and CO2 pricing could reduce production and push up the oil price.
For many emerging markets, commodities are and will remain important growth drivers. More than two-thirds of the investable universe are net exporters of commodities and, in many cases, the revenue derived from commodity exports are substantial. The positive price dynamics will be felt throughout the entire value chain. GDP growth in many countries (Angola, Ghana, Kazakhstan, Oman, Nigeria, etc.) should provide a positive surprise to the upside, and the balance sheets of many companies in the emerging market high-yield sector should improve. For some issuers, this could lead to double-digit revenue and EBITDA growth and be a significant driver of spread compression.
Showdown in China
The Chinese economy has faced some headwinds over the past year, as a result of government decisions as well as exogenous factors. Monetary and fiscal tightening, property sector reforms, regulatory crackdowns, and carbon emission controls are all measures to achieve the long-term goal of shared prosperity. However, these measures are exerting downward pressure on China's growth and contributing to Chinese market instability. With the hosting of the Olympic Games and the confirmation of President Xi's unquestioned leadership for a third term, 2022 will be a pivotal year for the world's second largest economy. The government in Beijing is likely to have a vested interest in celebrating this event with solid growth figures. One current goal is to stabilise the real estate sector, where monetary tightening has led to the failure of some companies. Regulators have already eased access to land auctions and bank lending to the sector has resumed. Some developers are also selling assets or recapitalising through injections of capital. The Chinese central bank also seems to have already positioned itself for this with a more flexible monetary policy. A partial rollback of tighter market regulation seems possible, as does an increase in fiscal measures. Green investments in solar and wind energy, electric grid modernisation and storage, as well as efficiency improvements in various sectors are likely to become a new growth driver in 2022 and beyond. Therefore, we are optimistic that China's growth has bottomed out and will enter an upward trend in 2022. With this in mind, the high-yield segment of the market looks particularly attractive, as spreads are very wide relative to historical levels and much of the bad news is already priced in. Credit selection is crucial. Only companies with strong fundamentals, access to capital, and ample liquidity will successfully navigate choppy waters. The Chinese real estate sector is one area where we have increased risk, in particular by focusing on the names that we believe have viable and strong fundamentals over the long term, although we are aware of the high volatility of this market segment.
Conclusion
Over the medium term, emerging market corporate bonds offer a very attractive risk/return profile and performance potential. On the one hand, bond segments have still not fully recovered from the March 2020 low or, on the other, they are trading at unjustifiably high risk spreads. This phase of the economic cycle has its own challenges for riskier fixed income assets, as growth weakens while central banks seek to end ultra-expansionary monetary policy. However, emerging market companies are generally less affected by this. Spreads have more often trended positively with the Fed's rate hike. Therefore, we expect spreads to tighten in 2022, with positive returns. The main headwind in 2021 from China’s high-yield real estate market could turn into a positive contributor as the sector stabilises, successfully contributing to performance in 2022. Commodity-sensitive companies should also benefit from the economic cycle. Therefore, we expect commodity markets to continue their rally amid high price volatility. Similar to the last commodity bull market (2001 to 2011), emerging markets and their companies should benefit strongly.
Authors: Roman Kostal, Cornel Bruhin and Andranik Safaryan, the Portfoliomanagement team of the MainFirst Emerging Markets Corporate Bond Fund Balanced & MainFirst Emerging Markets Credit Opportunities Fund
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