Cam and Kirsten reviewed some top highlights from 2022 and looked for any signs pointing in the right direction from the data in the week ending Jan 4. As China casts a big shadow, should we start viewing Emerging Markets as sort of EM vs EM ex-China? What about Frontier Markets vs Frontier Markets ex-Vietnam? Supply chain reallocation stories are popping up for Vietnam, Thailand, India, and Philippines in the Asia region, with Mexico part of the conversation. As we continue in inflation-fighting mode, the ECB might actually surprise in terms of having a closer than anticipated pivot point, while a lot of commentary points to concern that the Fed pivot point is beyond the current market consensus. And in the upcoming weeks, EPFR will be paying closer attention to where Japanese monetary policy goes.
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This is the EPFR Exchange Podcast. All opinions expressed by Cam, Kirsten or our podcast guests are solely of their own opinion and do not reflect the opinion of EPFR, part of private equity Montagu's portfolio of stand alone companies. This podcast is for informational purposes only and should not be relied upon for investment decisions.
00:21 Kirsten Longbottom
Hello everyone and welcome to the EPFR Exchange Podcast, my name is Kirsten Longbottom and we are joined by EPFR's resident economist, Cameron Brandt. Each week, we get together to talk about themes and trends dominating the financial landscape and reflect on Mutual Funds and ETF Flows and Allocations data tracked by EPFR. Cam, happy new year and holidays... What do you get for Christmas this year?
00:47 Cameron Brandt
Well we did try to be more moderate on the gifts this year but I have to say our success looked a lot like the average congressional spending limit resolution. So my main presents were a new fishing rod which will come as no surprise to anyone who knows me and a big box of a British biscuit called Twigglet which they're sort of baked sticks dotted with marmite and judging from the reaction of everyone I've given a sample to there an acquired taste which I have acquired.
01:25 Kirsten Longbottom
Well they do sound good [or interesting rather]. And no surprise to our listeners either that you got a fishing rod for Christmas. Good, so on the Fund Flows side, I guess last year we spoke about how China is casting such a big shadow that it's hard to see much beyond that in the emerging market space. And you noted that perspectives may view Emerging Markets as sort of EM and EM ex-china. Another more recent development was with Frontier Markets and the potential breakout of Vietnam. And with the slowing easing of zero-covid policies and more outbreaks not something investors are completely ignoring. Do you think this breakup of Emerging Markets holds true as we enter 2023?
02:17 Cameron Brandt
Certainly from a Fund Flow perspective what we saw last year and indeed sort of the first week of this year, is that China and to lesser extent Greater China and Taiwan and Hong Kong Equity Funds are soaking up the bulk of the positive flows recorded by all Emerging Markets Equity Funds. And as you mentioned on the Frontier Markets front, it's really been interest in Vietnam driving those particular flows. So there's certainly been a a long-running grumbling debate about whether China should become an asset class of its own within the EM universe, the way there are funds that are Global ex-US. These things tend to take a long time to chew over and then all of a sudden a consensus emerges and it happens. But you know we certainly noticed that GEM fund managers are reducing their exposure to China. It's gone from over a third of the average portfolio to around about a quarter. I think at least some are certainly thinking about this and you know whether you can truly run a global portfolio these days if so much of it is going to one very singular market.
03:35 Kirsten Longbottom
Interesting, to build on that, you mentioned the supply chain reallocation stories among Emerging Markets as well and I think Vietnam, Thailand, India and Philippines were the four big ones that they [investors] were focusing on. How do you see that playing out in 2023?
04:18 Cameron Brandt
Certainly that's true within the Asia region. Mexico is part of that conversation as well and I think has been benefiting. Again, this is something that's going to play out over time and some of the urgency may evaporate as it often does now that China has rolled back most of its zero-covid policies. And looks set, once it gets through the current wave, to be somewhat back to normal certainly by the end of the second quarter. Nevertheless, I mean I think it's a real debate and I think it will happen. You know you can't ignore the lessons of what happened with Covid and how ruthlessly China prioritized its zero-Covid campaign and a number of other political imperatives at the expense of the private sector and global commerce. So I think there's definitely going to be a new equilibrium. I don't think China will sit there and just watch all of these factories flow out, so I would anticipate that they'll do something. And it will be a drawnout process, you don't just lift a large production line out of China in a day but to some degree it will happen, to-- how much and which countries really end up being the beneficiaries is still a bit of an open question.
06:00 Kirsten Longbottom
So some reports I've read have mentioned that major economies are heading into a recession, led by the Eurozone and UK. In the latest week, Europe Equity Funds came very close to snapping their record outflow streak since it began in mid-2Q22, so that's 47 straight weeks. While UK Equity Funds saw their first consecutive weekly inflow in over seven months. Europe and UK Bond Funds have also fared slightly well recently, the former recording an inflow and the latter extending their longest run of inflows since the first quarter of 2020 at eight weeks long. Are investors showing signs of sentiment towards Europe picking back up?
06:48 Cameron Brandt
I think so, equity markets and mutual fund flows do reflect a degree of sort of forward thinking. Especially institutional investors are trying to put money ahead of good opportunities rather than just piling into ones that have already happened. It does sort of look like Europe is going to get through this winter in better shape than certainly many people thought going into it in the fall. The European Central Bank, though at the moment it is in an inflation fighting mode, has historically very much prioritized growth and the roll growth plays in keeping the Eurozone together. So there's definitely a feeling that the pivot point for the ECB might actually surprise, in terms of being closer. Whereas a lot of commentary, regarding the US focuses on the concern that the Fed pivot point it may well be beyond what the current market consensus is. So I mean Europe is fairly nicely positioned in some ways for a rebound of sorts in the second half of next year. The other thing too is that when you're investing in a lot of certainly the Large-Cap European stocks, you're not really investing in the country or only to a limited degree. A lot of the major European Large-Cap plays are very much international firms with multiple revenue sources and march to drums that have a different beat than what's going on in their home base.
08:50 Kirsten Longbottom
Interesting. So I guess expanding that, Bond Funds ended 2022 on quite a rough note and with investors defensive on the account of anticipated rate hikes in the first quarter. You mentioned how price growth was north of 7% in the US and 9% in the Eurozone, central banks were not giving such clear remarks on the level of the next rate hikes and also lagged effects of previous rate hikes are hitting markets now. What are your views on the Bond market overall?
Well the Bond Market certainly seems to be signaling hopes that people will respond to the rhetorical blast coming out of Central Banks. I mean obviously from the Central Bank's perspective if they can talk down inflationary expectations without actually having to hit people with interest rates that's ideal. So I think there's a point to their fairly aggressive tone and and they're right too. I mean if you take the foot off too quickly, inflation could easily roar back, especially given how tight labor markets are. But I think in general fixed income markets are anticipating that the worm will turn by the second half of the year and you know it's starting to be time to position yourself for that. Europe Bond Funds have actually done quite well for some time, certainly in the second half of last year. I definitely think that there is a lingering sense that the ECB for a variety of reasons is very reluctant to sort of surrender its role as the buyer of last resort, you know, given the potential consequences if that monetary tightening starts to fray various bonds within the eurozone. One thing I do think we may be paying a bit more attention to in the coming weeks is where Japanese monetary policy goes. The bank of Japan is certainly trying to ease it with enough to soak up market forces without abandoning it completely. If they're forced to lift the band which they are sort of using to constrain 10-year Sovereign yields, you could certainly see Japanese investors repatriating some of the money that they've used to buy foreign bonds especially in the eurozone. They own a fairly healthy chunk of France and Italy's debt stock for instance and if they start selling that down that creates another wrinkle for policymakers in Europe. So I certainly see signs of optimism, they could easily get frostbitten in the first three months of the year, but I think the assumption that the overall climate is going to be more suitable to cutting interest rates by the third quarter isn't unjustified.
12:36 Kirsten Longbottom
Another round of cautious optimism as we start 2023 so good and we'll look forward to hearing how all of that is playing out over the next few weeks. Thank you, Cam!
12:52 Cameron Brandt
Great. Sorry I monopolized today's conversation but we'll get your views on some of the sectors next week.
12:58 Kirsten Longbottom
Perfect sounds good. Alright, bye!
13:01 Cameron Brandt