Edmond de Rothschild sees opportunities due to decoupled markets

Melman Benjamin_Edmond de Rothschild

Benjamin Melman Head of the Asset Allocation and Sovereign Debt team

By Emily Lai

Global stock markets have seen the worst losses in more than four years in Q3 where US$ 10 trillion was lost in global equity market cap. All these have started from the fear of economic downturn in emerging markets (especially China) and that the Fed would raise rates in the near future. However, Benjamin Melman, Head of Asset Allocation and Sovereign Debt at Edmond de Rothschild Asset Management (France) says the problems are contained in emerging markets and the developed markets not affected. Opportunities can still be found in the developed world.

Decoupled world?

Emerging markets are creating much higher impacts on world economy nowadays. Given the speed and level of globalization, decoupling between emerging and developed world seems impossible, creating further worries that problems from emerging markets would spill over to the developed counterparts. Melman agrees that decoupling cannot last for long in today’s world, yet contagion has yet to be seen.

US and Europe’s economic data are still showing modest growth, with PMI industrial numbers staying over 50. “This situation is all the more remarkable in a country like Germany which is a big exporter of capital goods to the emerging zone. Significant contagion will probably have to wait for a bigger emerging country accident,” he says.

The two sources of uncertainty

Can China be the next accident then with September manufacturing PMI dropping to 47? Melman is not making a premature call. He believes the impact of the government’s latest policies would surface at the end of the year, and if it is not powerful enough, ”Beijing is likely to take further action if its growth targets are missed.” If the economy in China is stabilized, a sharp rebound would be triggered in risk assets.

The Fed’s action is also to be watched before the end of the year. Though not surprised by the Fed’s inaction in last month’s meeting, Melman thinks the decision creates more uncertainty. “With today’s excessive uncertainty, it was in fact logical for the Fed to wait before acting on rates as there was no particular pressure to move,” he says. “But on the other hand, the way it is likely to react has now become more complex.”

Melman believes there is a change in the Fed’s view in the past few weeks even when economic data remains stable, and that shows that the Fed is “less predictable, more sensitive to financial conditions and also to emerging country momentum” and he considers this as a reassurance of the Fed’s intent on keeping the recovery intact. BM

Strategy

Melman believes the market correction is overdone. Investors have been given a risk premium that is too high for developed markets as contagion has yet to surface. However, the risk premium will continue to stay until clarity appears in the emerging market.

Here is the new strategy from the firm:

  • Equities: overweight equities vs. bonds and are still focused on Europe and, to a lesser extent, Japan
  • Fixed Income: continue to prefer fixed income in Europe high yield bonds, essentially in peripheral countries, and subordinated financial debt and remain underweight US Treasuries
  • US dollar: slightly cut US dollar ratings after reinforcing them during the Greek crisis- this uncertainty now seems to have waned, a situation that could last for some time. And the lack of visibility over the Fed’s future action does not augur for a stronger dollar against the euro