Emerging market currencies: a ‘generational trade’?

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In short - yes, and no. Emerging market currencies have undergone a massive re-rating over the last decade, but in many cases they are still undervalued on a purchasing power parity (PPP) basis.

[caption align="alignright" caption="Brazilian reais"] Image Courtesy Benjamin Thompson: http://www.flickr.com/people/beija/ [/caption]

Having said that, there are reasons why emerging market currencies have also undergone major volatility and even weakness in the last year. Look no further than economies that global investors think are on a long term path towards significant growth such as Brazil and South Africa.

The Brazilian real has had major volatility and depreciated from 1.70 to as high as 2.13 recently as the government has aggressively cut rates and worked to keep it weak.

Many emerging market countries are fearful of what they saw back in 2007-2008 when they saw their export competitiveness compromised by a rising currency making their goods more expensive. Clearly with emerging market FX there is a short term view and a long term view.

In the long term there are many that are on a path higher, especially those countries with solid domestic fundamentals with the ability to fund themselves.

The "generational trade" in emerging market FX is that these have solid fundamental credit and economic stories that offer a solid backdrop.

This is why we own emerging markets overall.

To start the year and in the short term here are my thoughts:

Positive and negative factors:

1) Fresh portfolio allocations into emerging markets by global real money investors at the start of the year are strong.

2) Yen weakness is boosting Japanese retail appetite for emerging market assets. Japanese and Asian investors are major players in the "carry trade" i.e. borrowing in local currency where money is cheap and investing in higher yielding assets.

3) Rotational asset allocation is shifting within emerging markets from credit to foreign exchange.

4) Global cyclical recovery - China and U.S. housing is spurring buying of resources and emerging markets. On the negative side - it's been such a massive run into emerging markets over the last six weeks that it's time to take some profits. Technically we are overbought.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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