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M&G’s Calich: Trade war talk creating EM opportunities

15 August 2018

FE Alpha Manager Claudia Calich believes investors should focus on capitalising on the opportunities from, rather than the potential negative effects of, a trade war.

By Henry Scroggs,

Reporter, FE Trustnet

Trade wars between the US and emerging market behemoth China have dominated the headlines in recent months but it could be a positive for investors, according to M&G emerging markets portfolio manager Claudia Calich.

It is fair to start by saying that the headlines have been largely negative surrounding the US-China trade wars and for good reasons with the fund manager noting that there are some serious concerns about its potential implications.

In the latest instalment, Washington has decided to increase tariffs on $200bn worth of Chinese goods from 10 to 25 per cent.

FE Alpha Manager Calich, who runs three mandates at M&G and is deputy manager on another, said China’s response will be crucial.

“If they, for example, started using the currency as a negotiation tool – forcing a devaluation – this would add more tension and perhaps lead to financial instability,” she said.

Performance of Calich’s funds over 1yr

Source: FE Analytics

She said you can’t rule out the probability of an extreme scenario coming to fruition, which would cause a risk-off environment where spreads rise and deficits increase.

However, this is not her base case scenario because “China has reiterated its commitment to financial stability and to not using its currency as a tool.

“Like in China, other emerging market central banks have improved their governance and credibility over the past few years, so as long as their response is adequate and well communicated, their credibility – and stability – may not be hugely impacted.”

She added that the consequences of the trade war are hard to quantify because production plants and global supply chains don’t shift overnight.

Such consequences might include more expensive imports, depreciating currencies of exporters and postponement of investment decisions until more clarity is provided, according to the fund manager.

Trade wars could also reduce consumption if higher prices are passed onto consumers and financial conditions could tighten if foreign direct investment (FDI) is reduced or the risk premia on bonds or equities increases.


Certain emerging markets countries who export heavily to China would be hit harder than others by tariffs, Calich said.

“Zambia, for instance, has a large twin deficit, giving it less flexibility in an extreme scenario,” she said.

“Countries with larger US dollar-denominated debt would also suffer if an escalation of trade tensions led to a stronger US dollar.”

 

Source: M&G

On the other hand, not all China-heavy exporters would be hit as hard, Chile being one example, and this could create opportunities for investors.

The country, known for its copper production, has very little debt, a floating currency exchange and no major current account deficit concerns, said Calich.

“If copper prices collapse, the central bank would have to hike interest rates and may be forced into running fiscal deficits in the medium term – but they would have the tools to defend themselves,” she noted.

Additionally, despite the persistent talk of trade wars, there could be ways to get around the tariffs, as shown by events in Russia.

Indeed, recently the country put barriers on some Western products but French produce such as wine and cheese found a way into the country by travelling through different countries first.

Calich said there could also be third-party effects from trade wars, with Mexico being one of the beneficiaries.

Tariffs on Chinese goods could boost Mexican exports to the US, she said, and companies like Ford already have substantial operations in the country.

Away from country-specifics, one area that has been hit so far this year by the trade war are commodities, which have suffered over fears that Chinese growth may slow down. Year-to-date, the Bloomberg Commodity Index is down 5.37 per cent.

However, Calich believes that, from here, they shouldn’t decline as much as some may think.


“We could see more weakness if there was a big decline in Chinese growth. But let’s not forget that China’s current account surplus barely accounts for 1 per cent of GDP now, far less than 10 per cent 10 years ago, as the country shifts its economy towards a consumption-led model rather than a manufacturing and export one,” she said.

Performance of commodities YTD

 

Source: Bloomberg

“The commodities that China imports tend to be used in infrastructure projects – more dependent on domestic growth – whereas the tariffs are mostly on manufacturing products.

“Therefore, demand for commodities may not fall as much as some people expect – unless China’s growth suffers a major slowdown because of the trade wars and/or we see a policy response from the Chinese authorities that creates financial instability.”

Through the negative noise surrounding emerging markets at the moment, Calich does see some areas that are attractive.

One such area is China itself, and in particular, its real estate sector thanks to attractive spreads following the Chinese sell-off in credit.

She added: “We also favour local market exposure in countries where real or nominal rates look attractive, such as Brazil and Uruguay, or where it is likely that inflation has peaked, such as Mexico.

“In the corporate space, we favour quasi-sovereign oil and gas issuers with sound fundamentals and certain consumer businesses in Peru and real estate firms in Mexico.”

Finally, she said US-dollar denominated debt is more attractively priced now than it was earlier in the year thanks to widening spreads and pockets of value opening up in this space.

“As ever in emerging markets, it’s a cherry-pickers’ market,” said Calich.

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