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Skilful allocation crucial to success
Mon, 04/07/2016 - 13:38

After heightened volatility earlier in 2016, risk assets rallied well in the final month of the first quarter, helped by factors such as better economic data from the US and China, plus ongoing dovish central bank policies.

In addition, there was an upturn in oil prices, although the prospect of oversupply continues, and China’s central bank signalled that it was not looking to devalue as quickly as previously thought.

Amid reduced fears about weaker oil, US growth and renminbi devaluation, sentiment notably improved towards emerging market assets. However, the size of the recent rally should be viewed with some caution, as emerging bond market fundamentals have not significantly changed so far year to date.

In Latin America, as elsewhere across global emerging markets, successful asset allocation and security selection are key when investing in bonds and currencies. In spite of the headwinds still faced by emerging bond markets, value can be found by investing on a selective basis.

For example, Argentina’s recent return to the sovereign new issues market was a favourable development that represented an attractive investment. The move helps to normalise the country’s financial relations with international markets and should also promote an increase in its foreign exchange reserves, which had fallen after being excluded from markets.

Looking ahead, Argentina seems on course to deliver positive reform momentum, managing its economy with more orthodox policies and continuing to improve its relations with the West.

Elsewhere, holding exposure to select smaller markets in Central America and the Caribbean that have strong ties to the US economy presents opportunities. Relevantly, low oil prices should have beneficial effects on US consumer spending, helping economies that export there. In addition, certain countries should also gain from increased remittances from their citizens based in the US who are employed in its healthy jobs market.

Based on these considerations, sovereign bonds in Honduras, Guatemala and the Dominican Republic look appealing.

Among larger markets, Mexico’s sustained fiscal deficit and the collapse in the oil price are adversely affecting its economy, while Moody’s recently downgraded its outlook on the country. On the other hand, lower oil prices led to a depreciation of the peso that is positive for export-oriented Mexican companies, some of which benefit from the relative strength of the US economy.

There remain concerns about the outlook for Brazil, given the extent of its political and economic problems. It is important to see how much support the interim president Michel Temer will have from Congress. Congress will need to approve reforms – particularly measures to reduce the country’s high fiscal deficit, including reforms to the social security of public employees and de-linking pension increases from the minimum wage.

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