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Investors Scour Emerging Markets in Search for Trade War Gains

It may be too early to buy the dips in emerging markets, but investors are looking for opportunities.

Investors Scour Emerging Markets in Search for Trade War Gains
A pedestrian walks past a currency exchange store in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

(Bloomberg) -- It may be too early to buy the dips in emerging markets, but investors are finding opportunities to stay engaged with the asset class amid the sell-off.

Shorting the most vulnerable currencies, buying the less volatile markets or extending duration are among the strategies picked by strategists at big financial firms including BBVA, Wells Fargo and Morgan Stanley to get around the trade war. As a deal between the U.S. and China before the G-20 summit in late June grows increasingly unlikely, investors say it is time to get selective.

Reasons for caution are everywhere. Developing-nation stocks are headed toward their worst month since October, and all but two currencies tracked by Bloomberg are down in May as investors scale back their exposure to risk.

“Investors have largely given up on the positive scenario, but the worst case is also not priced,” Citi strategists led by Dirk Willer wrote in a report. “It’s prudent to keep risks low.”

Read more: Fund Managers Dump Emerging Markets to Navigate Trade Talks

Here are some of investors and analysts trade ideas.

Long euro, short Czech koruna

For Morgan Stanley, the Czech Republic’s economy is more exposed to a slowdown in global trade and growth, which is likely to happen as a result of the trade spat between the world’s two largest economies. Strategists led by James Lord are recommending shorting the koruna funded with euros on a bet that the Czech currency will continue to weaken toward the 26.1 per euro level.

"We stay long EURCZK as a trade for heightened trade tensions and global growth concerns," strategists wrote in a Friday note.

Investors Scour Emerging Markets in Search for Trade War Gains

Short Asian currencies

Asian economies should be impacted by any slowdown in China’s economic activity as a result of additional tariffs, so shorting these currencies against the dollar can offer some gains, according to Citi and Wells Fargo.

“In EMFX, we are long USD-Asia, defensive elsewhere,” Citi strategists led by Willer wrote in a note Friday. They are recommending expressing this bet via a dollar versus Indian rupee call spread and a bearish offshore yuan position by paying points.

Investors Scour Emerging Markets in Search for Trade War Gains

Brendan McKenna, a strategist at Wells Fargo in New York, says that investors should bet against any currencies with a high exposure to Chinese risk. In particular, he’s betting against the Korean won, the Philippine peso and the Taiwanese dollar. Outside of Asia, he says the usual suspects that are susceptible to trade risk will be hard hit, and people should stay away from the Brazilian real, Mexico’s peso, the Chilean peso and the South African rand.

Societe Generale, on the other hand, is recommending investors short dollar versus offshore yuan in the two to four weeks leading up to the G-20 meeting in late June. The Asian currency could become “meaningfully stronger in the short term” if the PBOC deploys more policy tools and if there’s a positive development in China-U.S. trade talks, says Jason Daw, head of emerging markets strategy at the bank. He suggests a short dollar against the offshore yuan bet at 6.9045 with a target of 6.82 and a stop at 6.94.

Valuation Not Enough

For Satoru Matsumoto, a fund manager in Tokyo at Asset Management One Co., with over $500 billion in assets under management, attractive valuation isn’t enough to start buying.

While emerging-market asset prices have become relatively attractive, growth concerns due to the lingering trade war could still put a downward pressure of both developed and developing markets from here, he said.

“Like the South African rand, which looks pretty attractive on the chart, it is still not a good time to enter because it’s vulnerable to the global and Chinese economic slowdown and also as it is used as proxy to the EM trade,” Matsumoto said in a phone interview. “Investors are looking for a good investment opportunity, but it’s actually quite difficult now.”

Extend duration

As central banks around the world may adopt a more dovish stance in response to the impact of the trade war on global activity, it makes sense to be long duration -- a position that profits from interest rates falling in the future -- some investors say.

Citi strategists are long duration in Brazil, Mexico, China and Thailand, and BBVA is extending duration on rates, while limiting foreign exchange exposure. Alejandro Cuadrado, a senior strategist at BBVA in New York, says that while there is technical room for a rebound in currencies, that looks unlikely as the external outlook remains clouded.

“A full or immediate resolution to trade tensions seems unlikely,” Cuadrado said. “The fact that EM and particularly LatAm FX underperformed through 1Q19 when the market was in full risk on and pricing U.S./Chinese agreements, growth rebounds, a dovish Fed and so forth makes a prolonged EM/LatAm fX rebound unlikely.”

Paul Greer, a London-based money manager at Fidelity International, says he prefers rates over currencies because the latter is likely to be under pressure as trade tensions should remain elevated until the G-20 meeting in late June.

“Within EM, currencies remain the most sensitive part of our asset class to global growth, global trade and the U.S. dollar,” said Greer, whose emerging-market debt fund has outperformed 98% of peers this year after reducing risk in recent months. Within EM local markets he prefer local rates over FX, “especially duration in some of the lower beta Asian and Latam countries.”

Domestically driven stocks

In equities, JPMorgan Asset Management says it makes sense to bet on companies that depend more on the domestic market and are, therefore, protected to some extent from a trade slowdown. Even technology shares can be a good play if they are less dependent on external revenues, according to Richard Titherington, the firm’s chief investment officer for emerging markets and Asia Pacific equities.

Investors Scour Emerging Markets in Search for Trade War Gains

--With assistance from Justin Villamil, Yumi Teso and Tomoko Yamazaki.

To contact the reporter on this story: Aline Oyamada in Sao Paulo at aoyamada3@bloomberg.net

To contact the editors responsible for this story: Julia Leite at jleite3@bloomberg.net, Philip Sanders

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