An Emerging Bond Trade?
Featuring Anthony Antonelli
Published on: May 1st, 2019 • Duration: 17 minutes • Topic: Emerging markets, Bonds, FX, Volatility, MacroAnthony Antonelli, CFA, CMT, director at Greylock Capital Management, makes his Real Vision debut with a bullish bet on emerging markets. He notes how mean reversion should lead to a profitable 2019, highlights the Fed’s impact on the thesis, and considers risks investors should pay attention to, in this interview with Jake Merl. Filmed on April 26, 2019.
JAKE MERL: Welcome to "Trade Ideas." I'm Jake Merl sitting down with Anthony Antonelli, director of Greylock Capital Management. Anthony, it's great to have you on the show for your very first Real Vision interview.
ANTHONY ANTONELLI: Thanks. Great to be here.
JAKE MERL: So before we get into your actual trade idea for today, can you please go over your background, who you are, and what you do at Greylock?
ANTHONY ANTONELLI: Sure. Well first of all, I'll start with Greylock Capital Management. We're an emerging markets asset manager. We focus particularly on distressed restructuring and high yield opportunities globally throughout the emerging markets. My role there, the functions that I try and fulfill, are providing macro strategy and trading color around some of the investment ideas and opportunities that we see out there, and then try and scale those down to a more granular level to try and do some security selection around it as well.
JAKE MERL: And so with that in mind, what's your trade idea for today?
ANTHONY ANTONELLI: Well I'm here to make the case for emerging markets as sort of an asset class. I'll talk a little bit about the emerging market bonds side of things because that's our primary area of expertise over at Greylock Capital. And I'm here to basically tell you that emerging markets are expected to have a good year this year, after what was a very, very ugly 2018.
JAKE MERL: So what are you specifically looking at that has you so bullish on EM?
ANTHONY ANTONELLI: Well, let me just give a little bit of the background. So 2018 brought out a lot of blood on the streets. Things were bad in the currencies. They were bad in the commodities. They were bad in the stocks. It didn't matter what asset class you were in within emerging markets, you were feeling a fair bit of pain.
And what we've seen, the data, historically speaking, is that after very poor years, the subsequent year and following years, in fact, are much, much better for the asset class. We specifically focus on the emerging market bonds, the dollar denominated. We also do FX and foreign currency bonds. But emerging markets overall are very correlated. They're all very related. So when one asset tends to do well, they all tend to move together.
Last year, we saw the Fed basically go full tilt on quantitative tightening, raising rates, trying to slow things down a bit. And we saw cracks through Argentina. We saw cracks in Turkey. We saw slowdowns that eventually led to contagion and brought things down from there. And as I pointed out, what we're seeing since then was the Fed pivoting, kind of calm things down by saying, we're no longer going to raise rates, we're not going to suck liquidity out of the system like a vacuum cleaner, and we're just going to let things ride more without our intervention for now, until we see things in the inflation pick up in the United States.
So that's actually set a much better backdrop for risk assets, and emerging markets are one of those. And we've started to see that coming up. So as I said, if you go back historically in the tough years-- like 1994, 1998, 2008, 2013-- but in the subsequent years, you see a big pickup from there.
JAKE MERL: So in addition to the mean reversion aspect of the trade, are there any other macro fundamentals that's confirming your thesis?
ANTHONY ANTONELLI: Yeah. So last year, again, in 2018, one thing that we saw was emerging markets FX. Now emerging market for FX as foreign currency, and a lot of times the currency is the early sort of barometer or indicator for how a country is doing. Their currency is almost like the stock of a country. So seeing and measuring how that's doing in relation to itself and in relation to other assets is something that gives us some tells.
And last year, what we saw in 2018 was literally the worst or most volatile year in emerging markets foreign currency since the data began in the year 2000. So what that means is that last year, we saw massive spikes in volatility in the currencies. Usually those spikes and volatilities are associated with down periods. And the readings were so extreme. I mean, you can probably see an RSI indicator, which kind of measures the extreme levels of momentum and movements in a particular price or chart. We saw readings that were some of the highest ever on a monthly basis. And usually after those types of periods, things tend to calm down. And that's sort of what we saw.
Right now, we're in a little bit of another sort of retest. The way I like to think about these things is when you have an earthquake, you have a subsequent sometimes aftershock. And right now, it feels like we're having a bit of an aftershock. The dollar's sort of breaking out. But the expectation is that we won't see the emerging markets foreign currency volatility relative to the developed markets volatility that we saw last year. And if we don't see that, then that probably means that we're going to have a better back half of this year.
JAKE MERL: So you're not worried about the dollar continuing to strengthen?
ANTHONY ANTONELLI: In the short term, the dollar has been very strong. There's been a lot of flows into the dollar. It's definitely broken out recently here. So the dollar is a primary pressure point for emerging markets. And the real reason that's the case is because a lot of these countries have borrowed in dollars. And as a dollar goes up, the local currency goes down.
Now they have to have a lot more dollars to pay back that debt. So it gets more expensive. People don't trust that they'll pay them back. And then all of a sudden, next thing you know, investors aren't loaning to them, and bonds start to fall to the price where people would begin to want to get enticed to purchase them. So strong dollar is definitely a concern for the emerging markets. But we do have some reasons to believe that the current dollar situation's probably not going to last throughout the entire year.
JAKE MERL: And why is that?
ANTHONY ANTONELLI: One of the main reasons is that the US needs to borrow a lot of money. The reality is that the US is running massive budget deficits, and they do have to come up with the money somehow. And usually the two ways you can do that are you either borrow it or you print it up, you have the Fed monetize it. So far, there's no problem. The world loves treasuries. The world loves dollars. And I think as we move forward over the course of time, the sheer supply of treasuries that are going to be issued is going to put some crimps on the strength of the dollar, as people get flooded with the total supply of dollars that they need for those investments.
JAKE MERL: But how much time do you think that will actually take? Is this like a short-term thesis, or will that take longer term for people to get bearish on bonds?
ANTHONY ANTONELLI: Well we've started to see bonds come off the lows. I mean, about a month or two ago, yields were really screaming lower. We're starting to see that come back a little bit, things to normalize a little bit. We had GDP data we're starting to see. If the US economy continues to improve, then you should start to see yields coming back. And I would imagine that we'll probably start to see that within the next quarter, two quarters.
It's hard to dictate exactly when people will start to move away from the dollar. But it would probably really be contingent on also Europe getting its act together, which they started their quantitative easing programs over there, which is basically money printing, in a sense, to try and get things moving over there to try and spark activity. There's a possibility that that will ultimately start to filter through, and you'll get that weaker dollar.
JAKE MERL: And so how do you see the Fed affecting your thesis?
ANTHONY ANTONELLI: The Fed, I think, is going to remain on pause. I've been one of those that thought that they did start to overdo it. I understood what they were trying to do. But the reality is that the world has a lot more debt now than it ever has. And I think they made a slight miscalculation on how fast rates can go up before that debt starts to cause pain to investors out there. And when debt starts to go down, stocks also start to go down.
And so I think that cascading effect was what alerted the Fed that maybe they need to hit the brakes. So in terms of how long the Fed stays on pause, I think they're going to be on pause for quite some time. And in fact, maybe their next move, if the world doesn't get better, if we do start to see things weakening, I mean, futures are already starting to price in Fed cuts sometime next year. It's not that far-fetched.
JAKE MERL: So with all this in mind, how would you actually go about making this trade?
ANTHONY ANTONELLI: Well at Greylock, we focus on emerging market bonds. Specifically, one broad index that we use is the EMBI, the Emerging Markets Bond Index. It's sort of a hodgepodge global mix of sovereign bonds. And that's something that we follow because it's something that's tracked as a measuring tool for how things are doing in the asset class.
So I'm looking at the EMBI here. It's been basically trapped in a range between 380 and 360. We've had the 200-day moving average start to slope down. The 50-day has crossed below that 200-day. We've been trading in this range, and we keep touching that low end of the range. And the expectation is that that low end of the range starts to break. When you have numerous hits of a specific area over the course of time, that area tends to get weakened.
So the way I think about it is like if you had a shield and it keeps getting bashed by somebody with a sword, eventually that shield breaks. Or if you have a paper bag and you put some water in it, at first, it holds fine. But you keep pouring more water in it, eventually the bag breaks. And so we're looking at that key level, that 360 area on this index. And by the way, it's a spread level. So 360 means that it's 360 basis points above a risk-free rate, a measurement there. So this is kind of a spread index.
For viewers at home, there's different ways to play this. But the expectation is that if the spreads start to break below 340-- in this case, by the way, lower spread means higher prices-- so the spread starts to break below 360, the target area would be 340, and there's a chance that by the end of this year, we could be somewhere in that 320 to 340 area that we saw kind of late 2017, early 2018.
So on the EMBI index, the weekly chart that you're probably seeing right now, one of the things there we have, we have momentum has flipped from negative to positive on this trade. We have the MACD, which is momentum indicator. That's trending lower, which again, lower in this case is good. And you have the RSI, the Relative Strength Index. That's another momentum indicator. Measures overbought, oversold. And that one is below 50, which is another point of strength that we like to see. Plus, I have the 35-week moving average that I use on that chart, and that is also trending lower as well. So things are moving in the positive direction this year versus the negative direction last year.
JAKE MERL: So how would you recommend traders or investors express this bullish view on emerging markets?
ANTHONY ANTONELLI: Well for them, there's different ways to do it. There's ETFs.
JAKE MERL: Going to be equities, currencies, bonds, everything? Or are you specifically just recommending emerging market bonds denominated in dollars?
ANTHONY ANTONELLI: I specifically like the emerging market bonds. You get paid to wait. You get some upside potential. You clip a coupon in the meantime. It really depends on people's risk appetite. For fast or money traders, certainly the equities are probably the way to go. For people that are a little bit more conservative than emerging market bonds, currencies, of course, are for people that have a very high risk tolerance. So it really depends on the individual investor and how they like to play the game.
JAKE MERL: And for that EMBI index, would you have a stop loss on the upside?
ANTHONY ANTONELLI: Yeah, so I'd be targeting above the 200-day moving average, which I believe was about 384 last time I checked. So a little bit above that if you want to keep a tighter stop. For longer term investors, I think you can stay at a higher area. And in fact, that's probably for many people. Especially when you're investing in bonds, usually you capture more of the return when you stay holding the securities a little bit longer.
So for more patient longer term investors, I would say you probably can stay in longer. Put the stop loss higher than that. The last year's lows were 440. Obviously we start getting to those areas again, I would say forget this trade, maybe go the other way, or get out. But there's a lot of sort of room from here to there.
JAKE MERL: So before we wrap things up for today, what would you say are the biggest risks to this trade?
ANTHONY ANTONELLI: Well the ones always in the forefront are the Fed and anything that they say that sort of gets the dollar moving. The reality is that the dollar strength is usually a sign of global liquidity tightening. When global liquidity tightens, money leaves emerging markets and comes to dollars, because it's like, why do I need to invest in something that's risky when I can just park it in cash? So stronger dollar, rising US interest rates, that's the type of thing that attracts inflows out of emerging markets and into the US, let's say. So that would be a key one to watch.
Trade deal between China and the US, that's always more of a topical noise. We see a lot of trading and volatility that happens around that, so I would keep my eyes on that as well. I think that a trade deal will eventually happen sooner rather than later. And when it does, that should also be a catalyst on the positive side. But certainly if there is rhetoric the wrong way, then emerging markets are going to feel that pain.
JAKE MERL: Anthony, that was great. Thanks so much for joining us.
ANTHONY ANTONELLI: Great to be here. Thanks.
JAKE MERL: So Anthony is bullish on emerging markets. Specifically, he thinks that JPMorgan emerging markets bond index could reach between 320 and 340 over the next eight months. You would have a stop loss above the 200-day moving average. And he suggests expressing this thesis through emerging market ETFs. That was Anthony Antonelli of Greylock Capital Management. And for Real Vision, I'm Jake Merl.