Higher discount rates (or required returns) may sometimes win the tug of war with improved earnings and send share prices lower rather than higher. But for emerging market economies and companies, the good news about the US means higher discount rates without the benefit of an improved earnings outlook, at least in the short term, until stronger growth in the US feeds through to the global economy.
The US economy may well be picking up momentum, as Bernanke indicated on 19 June, when he first spoke of tapering off quantitative easing (QE). The emerging market economies by contrast appear to be losing momentum as does the SA economy – this was fully apparent in the statement put out by the Monetary Policy Committee of the SA Reserve Bank last Thursday. Higher discount rates (that have their origin in an improving US economic outlook), when applied to a less optimistic outlook for emerging market (EM) growth and earnings, are unambiguously negative for EM equity and bond prices, EM currencies and all of the interest rate sensitive sectors everywhere.
So much is obvious from recent market moves that saw long term interest rates in the US initially move sharply higher in response to tapering talk, pushing sharply all higher yielding asset prices lower, including real estate and utilities as well as EM bonds and equities.
Last week this pressure eased, as long dated US Treasury Bond yields, both the standard fixed interest variety and (perhaps of greater significance) the inflation linked variety declined significantly, as we show below.
The relief for EM equities, bonds, real estate and currencies was palpable and very welcome. The best news for emerging markets will be a modestly improving economic outlook in the US – modest enough to keep long term interest rates on hold and, better still, to move them lower. Higher US equity valuations, in the absence of higher interest rates, will do no harm to EM equities. They may even help support them as they did last week. Brian Kantor
