The first reminder of EM risk in 2006 was of contagion, when fears in May and June of increasing G-3 rates led to a broad-based sell-off of EM external and local instruments. In fact, the volatility wasn’t limited just to EM debt, but impacted both equity and debt instruments across most developed and developing countries. Given PIMCO’s views on the solid position of economic and financial fundamentals for the EM asset class as a whole,2 we viewed the external disruptions as temporary and unlikely to negatively impact the asset class.3
Within our constructive secular view of the EM asset class, we try to view days when all assets trade down in response to an external event as if our local grocery store hung out a sign reading “10% off all items!” On such days, you don’t need to buy everything, but it’s certainly a good time to stock up on things that you want to have in the coming weeks and months. And while we won’t go as far as to predict another bout of price contagion in May/June 2007, it is interesting that we witnessed similar episodes in May/June of 2005 (Ford/GM downgrades), 2004 (Fed rate hikes), 2003 (U.S. rate moves), and 2002 (election concerns in Brazil) – all of which proved to be good investment opportunities.
The next reminder in 2006 was of political risk, with a military coup in Thailand in September and the rise of a leftist candidate for president in Ecuador in October. Investors initially shrugged these off, perhaps since the vast majority of the heavy 2006 political calendar had resulted in market friendly outcomes.
Unfortunately, in December these political risks morphed into financial risks. In Thailand, the military government implemented capital controls, only to partially reverse them after local equity markets dropped 15%. While in Ecuador president-elect Correa and his designated finance minister reiterated their intentions to “restructure” Ecuador’s government debt.4
The case of Ecuador is interesting, because Ecuadorian bonds had generated strong returns in 2004-2005 5– a period during which oil revenues gave Ecuador’s government ample capacity to service its debt.6 This spring, however, we became concerned about the willingness (as opposed to ability) to repay debt when in March the government effectively “nationalized” oil production facilities controlled by Occidental Petroleum. A visit to the country gave us additional concerns about the quality of the various presidential candidates and their platforms. At the same time, the market seemed complacent about the risks, with most Ecuadorian bonds callable at 100, and trading above that price! Given the increasing risks and limited upside, we aggressively sold all Ecuador exposure7 prior to the first round of the elections.8
In retrospect, these were prudent investment decisions, not because we “predicted” the unpredictable (coups, election results, etc.), but because we believe that proper investment decisions always involve weighing the potential risks and returns within a risk management philosophy that stresses capital preservation.
Outlook For 2007
So with those reminders that financial contagion, politics, and willingness to pay are still very real risks that investors face, let’s take a look at what we think will be the dominant factors in 2007.
Let’s start with the 30,000-foot view, hopefully above the pockets of turbulence. Odds are that the favorable global economic and financial conditions that we have witnessed for the past several years will remain in place. Estimates for global growth in 2007 are in the 5% range, reflecting a continuation of the recent strong trend (Chart 1). Note that this high level of global growth is being maintained despite slower growth in the large developed economies. In recent years the correlation between economic activity in the large developed economies and total global growth has fallen as EM countries have become more important engines of the global economy9 (Chart 2). Lower correlations have helped reduce the volatility of global economic growth – a supportive backdrop for emerging markets.10
Now let’s drop down to the 10,000-foot view to see how supportive macro factors have translated into risk/return in EM assets. A review of historical returns and volatilities for external debt shows an improving trend in risk-adjusted returns. The improvements in EM country fundamentals and supportive global economic conditions dramatically reduced risk while returns have remained robust (Chart 3). For 2007 we expect those same factors to remain supportive.
Some of the best potential returns can be found in EM local markets, where interest rates remain substantially higher than in their developed country counterparts (see Chart 4). We view EM local markets as the next major transition story in the asset class. Strong macro-economic fundamentals and deep-seated institutional changes in the conduct of fiscal and monetary policy have set the stage for a secular convergence of EM local interest rates toward developed country levels.
Finally let’s fly down to low altitude to take a look at how the factors we saw in 2006 might impact the individual regions and countries in EM. As for contagion, we fully expect bouts of volatility to occur in financial markets (maybe even in May!), but we think these will more likely be transient than permanent. On the political front, we will be paying close attention to developments in those countries that just completed presidential elections (Brazil, Colombia, Mexico and Peru, to mention a few) where the focus will shift to policy implementation. On the financial side, risks will of course remain for those countries with large current account deficits like Hungary, Turkey and South Africa, given their dependence on external capital.
While 2007 will undoubtedly contain surprises, as always our primary objective will remain to manage our clients investments in a prudent and optimal manner, and we look forward to meeting that challenge in 2007.
Curtis Mewbourne
Executive Vice President
1 As represented by JPM EMBIG and GBI-EMGD indices2 See the discussions in March 2006 EM Watch “It’s the Economy, Stupid…” and September 2006 EM Watch “Is it Safe?”3 See the June 2006 EM Watch “The End of the Asset Class…Hardly”4 Restructure likely means lowering the coupon payments and extending the maturities of bonds, both of which reduce the value of the investment5 JPMorgan EMBIG Ecuador Subindex returned over 17% per year from 12/31/03 - 12/31/056 Oil revenues in 2005 for Ecuador were $2.2bn and $1.6bn for first half of 2006 according to Morgan Stanley7 Over 25% of Ecuador’s outstanding government debt8 Bonds have since fallen some 25 points on concerns of a debt restructuring 9 Correlation shown in chart is for rolling 10yr periods10 Volatility shown in chart is for 5yr rolling periods
ピムコ ジャパンリミテッド105-0001 東京都港区虎ノ門4-1-28虎ノ門タワーズ オフィス18階 金融商品取引業者 関東財務局長（金商） 第382号加入協会/ （社）日本証券投資顧問業協会､（社）投資信託協会ピムコジャパンリミテッドが提供する投資信託商品やサービスは、日本の居住者であり、かつ法律による制約のない方に対して提供するものであり、かかる商品やサービスが許可されていない国・地域の方に提供するものではありません。過去の実績は将来の運用成果を保証するものではありません。 本資料には、本資料作成時点での著者の見解が含まれていますが、これは必ずしもPIMCOグループの見解ではありません。著者の見解は、予告なしに変更される場合があります。本資料は情報提供を目的として配布されるものであり、投資助言や特定の証券、戦略、もしくは投資商品の推奨を目的としたものではありません。本資料に記載されている情報は、信頼に足ると判断した情報源から得たものですが、その信頼性について保証するものではありません。自国通貨建て債券以外への債券投資には投資対象各国の経済及び政治情勢に起因するリスクが伴うことがあり、新興成長市場への投資にはかかるリスクが増大することがあります。記載されている金融市場動向は現在の市場状態により変動します。これらの投資戦略はすべての市場状況下での効果を保証するものではありません。また、各投資家は特に市場の低迷時に長期投資の能力があることを評価する必要があります。見通しおよび戦略は予告なしに変更される場合があります。各種インデックスと証券の間の相関やインフレに対する相関は長期間のデータを基に算定したものです。こうした相関は将来的に、もしくは短期間で大きく変化する可能性があり、その結果、ボラティリティの上昇を招く可能性があります。JPモルガンEMBIグローバル・インデックスはエマージング市場諸国の政府や準政府が発行した米ドル建ての証券、ブレイディ債、ローン、ユーロ債、および各国現地市場の金融商品に投資した場合のトータル・リターンを測定するインデックスであり、測定対象は特定の地域や国に限定されます。合成指数に直接投資することはできません。運用を行なう資産の評価額は、組入有価証券等の価格、金融市場の相場や金利等の変動、及び組入有価証券の発行体の財務状況による信用力等の影響を受けて変動します。また、外貨建資産に投資する場合は為替変動による影響も受けます。運用によって生じた損益は、全て投資家の皆様に帰属します。したがって投資元本や一定の運用成果が保証されているものではなく、損失をこうむることがあります。弊社が行う金融商品取引業に係る手数料または報酬は、締結される契約の種類や契約資産額により異なるため、当資料には具体的な金額・計算方法は記載しておりませんのでご了承ください。本資料の一部、もしくは全部を書面による許可なくして転載、引用することを禁じます。本資料の著作権はＰＩＭＣＯに帰属します。 2008年（注）ＰＩＭＣＯはパシフィック・インベストメント・マネジメント・カンパニー・エルエルシーを意味します。