U.S. Rate Rise And Emerging Markets - Glass Half Full Or Half Empty?

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by: Legg Mason

Summary

Kim Catechis of Legg Mason's International equities affiliate Martin Currie outlines two responses to the rate hike.

Half Full: The hike can be seen as an indicator of renewed confidence in the U.S. economy.

Half Empty: Concern for the frequency and magnitude of subsequent rate hikes.

By: Kim Catechis, Martin Currie

As emerging market (EM) investors, with a truly international perspective, we recognize there will be potentially mixed responses to the US Federal Reserve (Fed) rate hike. Below, we consider two contrasting viewpoints - the glass half full and the glass half empty.

Glass Half Full

On the one hand, it can be seen positively: an indicator of renewed confidence in the growth trajectory of the US economy, which is important for many emerging market companies' prospects.

· It signals US growth recovery, and has positive implications for world growth.

· A widely expected rate rise, therefore no big impact on valuations.

· Any rate rise is good, because it forces companies who take on debt to be more disciplined.

· An increase in the cost of debt will reveal the better-quality companies.

Glass Half Empty

On the other, the key concern of investors is not the immediate rate hike - which was widely flagged and probably 'in the price' - rather the frequency and magnitude of subsequent rises. Will the Fed tighten in autumn? And also in December?

· US dollar strength could put a strain on highly leveraged EM companies' finances.

· Due to potential trade policy disruptions, historical relationship between US economic growth and EM economic growth may no longer hold true.

· If US demand rises, it may in this case, preclude greater FDI in EM countries given the protectionist pressures from the White House.

Regardless of whether you're a glass half full or half empty investor, it is important for investors not to lose sight of the long-term drivers underpinning emerging markets, which have been overshadowed by recent volatility.

Demographic trends provide a young and growing workforce, and debt levels at both a sovereign and household level are low, especially compared with developed market peers. Many emerging market countries are also at an advantage in terms of natural resources and technology benefits.

Adjustments following large-scale changes in monetary policy are rarely smooth, and as long-term, fundamental and research-driven stock pickers, we see any short-term volatility resulting from the rate hike as a potential buying opportunity.

Kim Catechis is a Portfolio Manager at Martin Currie, a Legg Mason affiliate. His opinions are not meant to be viewed as investment advice or a solicitation for investment.

© 2017 Legg Mason Investor Services, LLC. Member FINRA, SIPC

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.