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El Erian sees EM bargains as outflows continue

Jul 22, 2013

The EM selloff has led to buying opportunities across the asset class, Pimco's CEO says

A sharp selloff in emerging markets has led to buying opportunities across the asset class following a "severe technical adjustment" that is likely to have run its course, Pimco CEO and co-CIO Mohamed El Erian has said in an interview with LatinFinance.

Markets must nevertheless brace for an extended period of volatility as investors realign credit risk amid uncertainty over US monetary policy and continued global economic weakness, he added.

"I don’t see growth in the advanced world taking off, nor do I see it collapsing, but I see a lot of financial volatility ahead because people like us will be repricing the liquidity paradigm," El Erian said.

His comments come amid mounting fears that a selloff could herald an unraveling of the emerging market investment case. Last week marked the eighth consecutive week of aggregate outflows from emerging market debt funds, now totally 6.3%, in anticipation of an end to the US Federal Reserve’s bond buying program.

But El Erian said that the retreat of crossover investors from global emerging markets had led to investment opportunities, especially in local currency and rates markets. "What happens still in Latin America is the minute you have a technical dislocation in the global markets the crossover investors look to get out. At that point liquidity evaporates and you get a massive technical selloff. That selloff makes the less informed people think these are the bad old days. But the more informed people see this is a great thing, a time for differentiation, and they see this as opportunity," he said.

El Erian said that while he "wouldn’t go out and buy the [EM] index," emerging markets had become "a very differentiated story."

"History tells you that unless bad technicals lead to bad fundamentals this technical phase is often temporary and reversible," he said, citing Mexican local rates as being of particular appeal.

Asset markets will nevertheless remain "much bumpier than the real economy because you’re going to shake out crossover investors."

El Erian said that global economic weakness posed the gravest risk in Latin America to Argentina. "In this environment, there are certain countries that will tip. Argentina will tip," he said. 

Meanwhile Brazil faces the risk of "policy incoherence" in the face of slowing growth and a global re-pricing of risk. "I would put Brazil nearer to Mexico than Argentina, but it’s not Mexico. Mexico has benefitted from the institutional anchor that Brazil is still developing. In the absence of institutional anchors people will go back to old bad habits," El Erian said.

Global asset markets have been overvalued in recent years following "aggressive, experimental and unconventional policies" by developed nation central banks.

"Everything has been overvalued. We’ve had artificial pricing everywhere, starting from the US Treasury market all the way out: whatever risk factor you want to look at, be it credit, liquidity, equity, everything was overvalued. And what you’ve had is an adjustment," the investor said.

Emerging market debt was hit especially hard by recent market turmoil because of the pullout of crossover investors.

"Emerging debt suffered more than it should have because of the phenomenon of the tourist dollars and the lack of a big enough dedicated investor base," he said. "People exited simply because they didn’t want to be caught with off-benchmark exposures and there was very little appetite among the broker-dealer community to take down inventory."

He warned that markets were overestimating the capacity of developed economies, principally the US, to return to meaningful growth in the short to medium term.

"There simply isn’t enough strength in the underlying economy allowing [central banks] to exit but they will start adjusting because of the costs and risks and the net impact will be bumpiness," El Erian said.

The full interview with El Erian will appear in LatinFinance’s 25th Anniversary edition, published next month. See the LatinFinance 25th Anniversary for details. LF

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