Deutsche Bank: EM equities tactically oversold but structural drivers remain negative
Comment of the Day

February 07 2014

Commentary by David Fuller

Deutsche Bank: EM equities tactically oversold but structural drivers remain negative

My thanks to a subscriber at Deutsche Bank for this comprehensive review of emerging markets. 

Potentially negative endgame for China economy underpins bearish 2014 view

There is increasing evidence on both a macro and micro basis that a slowdown in nominal GDP growth once again threatens to place a significant part of the Chinese industrial sector in a potential debt trap. If EM follows the script laid down over the past five years, the Chinese authorities will loosen policy before

too long and sentiment towards both EM and China will improve, just as occurred in late 2008/early 2009 and then again in the late summer of 2012. This time may be different however, since corporate debt levels are now much higher, whilst investors and borrowers alike are much more aware of the extent of the moral hazard that underlies the Chinese corporate and financial sector. Any attempt to ease policy significantly could therefore trigger capital flight, as well as compromising the industrial restructuring which forms a key element of Beijing’s reform agenda. We are also sceptical that increasing exports to DM economies will compensate for a domestic-led slowdown, since Chinese companies are not so favourably placed as in 2002-07. If our bearish scenario begins to materialise, we believe that talk of a RMB devaluation will increase through 2014, which would be bearish for China and GEM.

David Fuller's view

Here is the Deutsche Bank report.

This is a very interesting forecast!  Deutsche Bank is looking for a Chinese reflationary effort before yearend, which would boost its stock market and those of many of the other emerging markets as well.  They then say that exports to developed economies will not compensate for a domestic slowdown, leading to devaluation! 

I have to point out that currently, there is not a shred of evidence that the Chinese Renminbi will be devalued as we last saw in 1994. This is a managed currency and China has been happy to see it appreciate since mid-2005.  I also think that devaluation at this stage of China’s development would be viewed as a loss of face. 

Looking at the Renminbi from the 1980s up to 1994, it had either clearly weakened before each official devaluation, or shown no real evidence of appreciation before the next adjustment, as one would expect.  

However, Deutsche Bank has given us a script to watch for.  They expect a reflationary move from the Bank of China before long.  That makes sense to me and I agree.  This would also be an opportunity for those of us with investments in the region. Thereafter, if Deutsche Bank is right and both China’s internal consumption and export driven efforts are insufficient to strengthen its economy, we should see the Renminbi weakening against the US Dollar.  If this was persistent over a number of months, I would want to reduce my personal investments in the region.     

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