We entered the year with a constructive view on EM corporate credit. Then inour last chartpack in March we argued that investors often get too boggeddown with fund flows for EM, and in the process miss out on some of otherimportant factors that drive it - underlying growth, commodities, USD, China,rates, etc. While almost all these factors are still supportive, the performanceso far this year has been solid with 30bp tightening and +4.5% total returns aswe write (Figure 1). We take this opportunity to turn more neutral on EMcorporate credit, expecting the next quarter to be largely range bound forspreads and carry being the name of the game. We think risk/reward lookslargely balanced with fundamentals (low default rates) and technicals strong,but valuations challenging and event risks on the rise. Other key risks in ourview are an oil collapse, geopolitics, continuation in the recent trend of softermacro data, Fed balance sheet unwind, etc.
As detailed in our 2H Outlook report published on June 1, we maintain ourpreference for HY over IG in total returns terms, albeit with a marginally lowerconviction in spread terms given pick up in idiosyncratic stories and softeroutlook for commodities. Please see Figures 2 & 3 for YTD performance. Carryon HY can't be ignored in a range-bound trading environment. And to be clearon commodities, while the outlook isn’t great, we don’t expect a shock either.
We generally remain negative oil and have Sells there in the IG space (Oil India,COSL), but are comfortable with the non-oil commodities and are expressingthis view through Buys in HY (BUMA, Chalco, Indika, Vedanta). We are alsonegative on the property sector in India & Indonesia and recommend stayingaway from names like Alam Sutera and Lodha. In India HY, we prefer defensivecredits like Motherson and Tata Steel that are potential rising stars. On Chinaproperty, though we don’t like the physical markets, we are mindful of strongtechnicals. Separately in HY, we find value in some of the high step upcorporate perps (China Grand Auto, Shui On)