A rare anomaly seen during times of extreme stress has returned to emerging markets.
The slump in US Treasuries this week has exacerbated a selloff in developing-nation debt, sending the yield on bonds in the Bloomberg EM Aggregate Sovereign Index to a one-year high of 8.93% on Tuesday. That exceeded the earnings yield of 8.63% on stocks in the equities benchmark, the MSCI Emerging Markets Index.
That upends the typical relationship between bond and stock yields, with equities normally offering a higher rate to compensate for their additional risk. In emerging markets, this premium has typically hovered in the 2-6 percentage-point range over the past two decades, but turned negative twice: during the global financial crisis in 2008 and the Covid-driven rout of 2020. On both occasions, emerging-market losses didn’t abate until US yields started falling.
“The selloff in US bonds is where the risk is coming from - risk to US equities, risk to low-rated emerging-market credits, and indirectly, a risk for global equities,” said Charles Robertson, head of macro strategy at FIM Partners. “History is not telling us we should assume a big reversal in US yields.”
The anomaly typically lasts only a few days. Earlier this year, it was seen briefly in the corporate sphere, as the yield on dollar bonds from emerging-market companies exceeded the expected earnings yield on their stocks, calculated using profit estimates as a percentage of stock prices.
Risk Premiums
For investors in developing-market sovereign debt, signs of a strong US job market before the official non-farm payrolls data have refueled concern that US interest rates would remain elevated. The ensuing global selloff sent risk-free rates in the US and Europe to the highest levels in more than a decade. Emerging-market bond yields reflected this increase, as well as an accompanying rise in sovereign risk premiums to a three-month high.
“Pricing is nowhere near as extreme as in 2008-09, but EM bonds do become more attractive the higher US yields go,” Robertson said.
Meanwhile, emerging-market stocks erased almost $100 billion in market value on Tuesday, taking the wipeout in shareholder wealth since July to $1.5 trillion. A modest recovery in earnings estimates has helped to keep valuations in check, however, with the MSCI gauge trading at 11.6 times projected earnings, compared with its five-year average of 12.3 times.
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