We believe Brexit could lead to a recessionary environment in the UK and a marked slowdown in the EU economy. The ECB is therefore likely to continue its accommodative monetary policy, and the expected US tightening cycle might be postponed or be more modest than initially anticipated.
After almost five years of underperformance and strong currency depreciation, several emerging markets now have high real interest rates compared to developed markets. Brexit is likely to enable EM central banks to implement more accommodative policies as inflationary pressures recede further. In our view, there will be strong similarities between Brexit and the events of September
2001 in the US in terms of market impact.
The events of September 2001 were an exogenous risk to the US economy that drove the US into recession at a time when EM economies were emerging from four years of crisis. This was the starting point of a multi-year bull run for EM equities. Brexit could be a similar driver, pressuring DM economies while the green shoots in EM economies are further reinforced by supportive local policies.
US RECESSION AND EM PERFORMANCE
Source: LOIM at 31 May 2016, Bloomberg US National Bureau of Economics, Federal Reserve.
For illustrative purpose only.
These implications, combined with attractive valuations for EM equities compared to DM equities, have further reinforced our belief in EM equities. Like in 2001, from a corporate standpoint, ROEs in DMs are high but are cyclically low in EMs. This spread will likely narrow to the benefit of EM corporates, which, due to depressed relative valuations, now look even more attractive.
Over the last few months, we reduced our exposure to the DM-listed global players (from 30% to approximately 10%) and are progressing further along the path of increasing our direct exposure to EM. We believe our strategy is therefore well positioned to benefit from increasing domestic demand in emerging markets.
Emerging governments have generally been pushing for a rebalancing of their fledging economies by favouring domestic demand compensating for their export-driven sectors. We believe their actions have room to accelerate due to the implications of Brexit. In our view, our strategy should benefit from this trend since we increasingly favoured attractively priced markets such as Russia and Brazil.
We also view China as attractive with multiple opportunities. Companies such as Want Want and Tingyi deliver free cash flow yields of close to 10% and have depressed valuations.
For professional investor use only
Holdings and/or allocations are subject to change. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice. No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document. Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources. Please refer to our website for more Important information.
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