Much has been said about the potential for the US Federal Reserve to taper its asset purchases. We do not dispute the significance of a reversal in their money printing policy but draw comfort from the bias towards caution and an “easy as she goes” approach that other central bankers in developed markets are likely to take when considering tightening monetary policy. In the US, investors in companies exposed to the domestic economy will weigh improved growth prospects against higher cost of capital (See our February blog on ‘Mind the discount rate’). While the strong year to May performance of US stocks suggests that the improvement in corporate earnings have been at least in part priced in, but the potential for higher cost of capital was not expected. Nevertheless, we think the US market will find a footing and that ultimately a (gradual) tightening of monetary policy is indicative of a healthier economy.

However, the same cannot be said of certain large emerging markets. Markets such as Brazil and China are at a different phase in the economic cycle compared to US and Europe. China has witnessed a fall in annualised GDP growth rate from close to 12% in 2010 to 9% in 2011, and is likely to be in the region of 7.5% in 2013. Annualised earnings growth recorded by the A share market on the Mainland has slowed from 30% in 2010 to 15% in 2011. Q1 2013 was 10% on average across the 300 companies in the CSI 300 index. The once a decade leadership change last year provided a short honeymoon period for local stocks but with Beijing appearing ready to accept slower growth in exchange for sustainability and structural reforms, gains have been given back. The result is that Chinese A-shares are down -0.4% in the second quarter to date and Hang Seng China Enterprise Index (Hong Kong listed Chinese companies) is lower by -7.5% over the same period.

In Brazil, investors also face higher interest rates as its central bank raised short term rates by a larger-than-expected 0.5% to 8% in May to fight inflationary pressures. This came as Brazil recorded GDP growth of only 0.9% in 2012, which had dropped from a post GFC high of 9% in Q1 2010. Furthermore, President Rousseff has seen her economic experiments back fire when international investors withdrew support after her policies cut returns for utilities and infrastructure projects. The currency, Real, has fallen 7% in May as its central bank undertakes a U-turn on interest rates to tackle stubbornly high inflation.

Furthermore, signs of malaise are not limited to equities. While EM stocks have underperformed for some time despite cheap valuations, USD denominated bonds of major EMs had returned 12% a year from 2010-2012 as investors chased after higher yielding ‘safe’ investments. But so far in 2013 the JP Morgan Emerging Markets Bond Index (EMBI) is down 6% in USD as the additional yield return for owning EM government debt over US treasuries reached a low of 2.5% in January 2013 from a post GFC high of 4.5%. As EM bonds are sold, domestic currencies are likely to weaken further as capital is repatriated back to USD, rendering EM equities again less attractive. The risk we see is that emerging market assets have grown as a percentage of global portfolios and losses now are much more broadly felt.

The Milford Global Fund had 4% exposure each to South America and Asia as of the end of May.

The table below highlights major EM currencies against the US dollar year to date (31 May 2013).


% change against USD (YTD 31 May 2013)

Chinese Renminbi


Russian Ruble


South African Rand


Brazil Real


Indian Rupee


Felix Fok

Portfolio Manager