Bearish Bets Lurk Beneath Emerging-Market Veneer of Confidence

(Bloomberg) -- While Wall Street is almost universally united in calling for a bull year across emerging markets, strategists from HSBC Holdings Plc to Societe Generale SA are warning investors to curb their enthusiasm.

With stock valuations already stretched to their limits, potential stumbling blocks include the difficulty of vaccine distribution systems, an uneven recovery and precarious debt burdens. Questions are also being raised about whether less wealthy nations stand at the end of the line to receive vaccines.

Even firms betting on a recovery are beginning to show some signs of pared expectations. Natwest Markets closed its bet on the Colombian peso as it nears pre-pandemic levels. Morgan Stanley recommended pausing U.S. dollar shorts. BBVA said some local rate curves in Latin America, such as Chile, could underperform due to political instability.

“Navigating markets was extremely challenging in 2020, and 2021 should prove similarly complicated,” Societe Generale strategists including Jason Daw in Singapore and Phoenix Kalen in London wrote earlier this month. “Right now, the market is filled with euphoria, and that is the path of least resistance, but various events could upset the apple cart.”

Societe Generale warned against all-out currency optimism, saying a bearish cycle has just been delayed -- not ended. The French bank said differentiation will be key, meaning outperformance in central Europe and EMEA while Asia and Latin America struggle. HSBC, meantime, favors external bonds over local debt as emerging-market policy makers run out of room for accommodation.

The bullish crowd includes money managers and strategists from State Street Global Advisors to Franklin Templeton Fixed Income. Yet even Bank of America Corp., which falls more squarely into the bullish camp for 2021, said last week that much of the good news is already priced in.

The $9.2 trillion rally since March has already taken emerging-market stock valuations to levels rarely seen in the past. The MSCI Inc. gauge trades at 15.1 times the projected earnings of its constituents, or 33% above its long-term average. That puts the index at the 98th percentile of its valuation range of the past 14 years and suggests underlying pressure for equity valuations could moderate.

It’s unclear how long earnings estimates can continue to rise, because the average level of profit in emerging-market companies has fallen to the lowest level since June 2016. If earnings shortfall widens, investors may face a reality check.

Even so, the majority of 63 investors, strategists and traders in a Bloomberg survey said they expected stocks, bonds and currencies to maintain their strength in 2021. That cheery tone is set by the likes of Jacob Grapengiesser, a partner at East Capital in Moscow, who said emerging-market equities are on track to have their best year in more than a decade in 2021.

From other perspectives, that optimism may be a bit over the top. HSBC strategists, led by Hong Kong-based Andre de Silva, pointed to overdone optimism on how much vaccines will stoke growth in the developing world. Many developing-market economies outside China will be near the end of the queue to receive shots, they wrote. Nations such as Brazil, South Africa and India could come under downgrade stress without either structural reforms or a pickup in government revenue, they wrote earlier this month.

“While 2021 should bring a cyclical upswing, we see too much optimism over the economic rebound and potential vaccine roll-out,” they wrote.

©2020 Bloomberg L.P.