Outlook 2016: EM underperforms again; China, Russia, Turkey, Brazil eyed; Ukraine improves

By Christine Van Dusen

Atlanta, Dec. 31 – Emerging markets assets had a challenging and underperforming year in 2015 as low commodity prices, slower global growth, a U.S. interest rate hike and concerns about China, Ukraine, Russia, Turkey and Brazil made an impact.

The asset class has been underperforming for at least three years, and “the gloom on emerging markets seemed all-consuming at times in 2015,” said UBS Investment Bank in a report. “Commodities have plumbed multi-year lows.”

To be sure, emerging markets have always been a mixed bag, a London-based trader said.

But 2015 still was, “without doubt, another challenging year,” he said. “Over the year, spreads are generally wider across the board, with few exceptions – namely Russia and Ukraine – and liquidity remained tricky at most times ahead of a potential Fed lift-off.”

The first half of the year saw commodity prices plummet while U.S. Treasuries faced volatility and Greece worked to deal with its crushing debt.

“Global, and specifically China’s, economic growth has been a concern for many investors this year, putting renewed pressure on many credits and commodity prices in the second half of 2015,” the trader said.

For emerging markets, “this meant a slowdown in growth dynamics and a deterioration of credit metrics,” he said. “This is most evident in Africa, where commodity exporters are among both the worst-performing credits and currencies so far.”

Overall, “geopolitical and regional conflicts remain omnipresent,” another trader said. “The focus has shifted ever more from Eastern Europe – where we saw fighting in Ukraine subsiding – to the [Gulf] region.”

EM faced challenges

Most of the challenges for EM were “internally generated,” said James Barrineau, co-head of the Emerging Markets Debt Relative at Schroders.

Contributing to the problems were “headwinds from a strong dollar, and volatility surrounding the divergences in developed country monetary policy,” he said.

For the most part, investors “mostly ignored” the fact that emerging market growth, while somewhat limited, was and is consistently better than the developed world, Barrineau said.

“Latin America, outside of Venezuela and Brazil, is growing between 2˝% and 3%, while European emerging markets outside Russia are showing similar numbers,” he said.

Many Asian countries, outside of China, are seeing growth of more than 3%. India has seen about 7%.

Attractive returns

Dollar-denominated sovereign and corporate debt produced a return of about 3% in 2015, “despite ongoing fears,” Barrineau said, which is attractive relative to the asset class’s five-year history.

“Those higher spreads have allowed dollar, sovereign and corporate debt to produce about a 3% positive return this year despite ongoing fears about the asset class,” he said.

Since the financial crisis, investment-grade dollar-denominated bonds from emerging markets have “consistently offered average yields ½% to 1% higher than equivalent-rated bonds from the U.S.,” UBS Investment Bank said in a report.

Russia loses steam

Taking a look at the primary market in 2015, the appetite for Russian corporates was lost early in the year as a result of sanctions from the United States and European Union, said Alexandre Dray, an emerging markets analyst with Gimme Credit LLC. “Against this backdrop, corporate bond issuers rather tried to cut capital spending and reduce their debt pile so as to maintain adequate credit measures.”

Still, the year did see three Russian corporates – Russia’s OJSC MMC Norilsk Nickel, OAO Gazprom and Evraz Group – tap the bond market.

“But most Russian corporates raised debt via syndicated credit loans this year,” he said. “Besides, thanks to the relatively large share of sales outside Russia for most corporate debt issuers, many companies managed to raise pre-export facilities to refinance their short term debt maturities.”

Russian CDS declines

After the hike in the Russian credit default swaps in fourth-quarter 2014 due to the sanctions imposed by the U.S. and the EU, the country’s CDS decreased gradually in 2015, Dray said.

“It led to a strong performance for Russian corporates compared to 2014,” he said.

Russian bonds have seen a return of about 20%, year to date, making them among the strongest performers during 2015, he said. Standouts included OAO Lukoil and TMK Capital SA, “which were severely oversold due to their footprint in Russia and their exposure to the oil industry” but “actually generated very strong returns this year.”

An increase in CDS for Turkey, South Africa, Brazil and Chile, meanwhile, put pressure on bond yields, he said.

“The rout in oil and commodities also negatively impacted companies in these sectors,” Dray said. “For instance, South Africa-based gold makers had poor performance this year on the back of the gold rout.”

Asian high-grade dominates

From Asia, bond sales were dominated by high-grade and bank issuers like Agricultural Bank of China Ltd. and China Construction Bank Corp., said Nuj Chiaranussati, an analyst who focuses on Asia for Gimme Credit.

“Debts were coming due, and as such, some issuers aimed to pre-fund their financing needs ahead of the Fed hike,” he said. “Banks also issued more capital as part of the Basel III requirements.”

The primary market also hosted deals from China Petroleum & Chemical Corp. (Sinopec Group), Industrial and Commercial Bank of China Ltd. and Alibaba Group Holding Ltd.

“The opening up of the domestic markets in China had diverted some of the high-yield issuers to issue locally,” he said. “In the first wave in 2015, we already saw stronger high-yield China credits gaining approvals to issue their renminbi bonds on their home ground.”

Domestic bonds in focus

Most Asian property names were seeking renminbi approval at the end of 2015, Chiaranussati said.

“Issuing domestic bonds will provide lower borrowing costs and lower foreign-exchange volatility for them,” he said. “There had not been a lot of issuances coming from other regions where domestic markets are well-supported by liquidity.”

He pointed to Thailand, Philippines and India as examples.

China high-yield stands out

High-yield names from China were strong performers in the secondary market in 2015, Chairanussati said.

The government aimed to stimulate domestic consumption and support the property sector by lowering rates and the loan-to-valuation ratio, which “spurred more buying and improved the sector outlook,” he said.

Commodity and energy names, meanwhile, suffered, he said.

Ukraine performed

Among sovereigns, Ukraine was the best performer in 2015, following its debt deal with its creditors, which included $18 billion of sovereign debt and saw a 20% haircut.

The debt deal also gave Ukraine access to a $17.5 billion bailout program by the IMF.

Meanwhile, conflict continued in Ukraine, though fighting in Donbas declined during the second half of the year.

Middle Eastern bonds mixed

Middle Eastern bonds put in “mixed performance” during the year, a London-based trader said, with corporate bonds from Bahrain, Qatar and Saudi Arabia widening.

Corporates from Abu Dhabi and Dubai, along with sovereign bonds from Qatar, outperformed and traded slightly tighter by the end of 2015.

“[Gulf region] economies remained fairly resilient,” he said. “Nonetheless, 2015 marks a full speed transition year for the Arabian Peninsula as sovereigns are adapting to the new reality [of] persistently lower oil and gas.”

Zambia spikes

Bonds from Sub-Saharan Africa were affected during 2015 by lower oil prices and concerns about the global economy, a trader said.

“Commodity exporters were most hit as the low prices revealed the fiscal weaknesses of many sovereigns,” he said.

As an example, he highlighted Zambia's 8˝% notes due in 2024 that traded as low as a 7% yield in early 2015 but spiked to 11.7% in November as the country dealt with falling copper prices, power shortages and lower agricultural output due to dry conditions.

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