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EMs: Positioned to Carry On as Carry Trade Unwinds
Nick Niziolek, CFA
August 9, 2024
Calamos Evolving World Growth Fund (CNWIX)
Morningstar Overall RatingTM Among 712 Diversified Emerging Mkts funds. The Fund's risk-adjusted returns based on load-waived Class I Shares had 2 stars for 3 years, 4 stars for 5 years and 4 stars for 10 years out of 712, 641 and 422 Diversified Emerging Mkts Funds, respectively, for the period ended 8/31/2024.
- The recent upswing in global volatility has riled investors, but we believe we’re seeing a normal and healthy market pullback.
- Historically, the most liquid assets typically feel the first brunt of the initial stages of an unwinding carry trade, which is what has played out over recent days. In other words, in many cases, the selloff is not about company fundamentals.
- Global markets are likely closer to the end than the start of the unwinding; we expect the next chapter to be more of a range-bound market, with less-liquid assets under pressure.
- We are using volatility as a buying opportunity for Calamos Evolving World Growth Fund (CNWIX), and our outlook on emerging markets remains positive.
We’ll likely look back at the unwinding of the yen carry trade as similar to the Silicon Valley Bank crisis of 1Q23 or the UK pension crisis of 4Q22. Both selloffs ultimately proved to be healthy pullbacks, and equity markets recovered quickly. Weak hands were pushed out of the market, but more importantly, buying opportunities emerged for long-term investors like us.
We believe the true “source” of this recent pullback is selling by overleveraged investors forced to unwind positions after being caught on the wrong side of the yen carry trade. Other narratives—such as AI bubble risk, recession concerns and contagion fears—are also at work. Here's our take:
| AI Bubble Risk |
Risks are overstated. AI cap-ex spending remains robust. Although supply chain issues exist for the most sought-after chips, this is a transitory issue. Companies will adapt and use the best chips they can in the short term. Moreover, the impact on earnings for the leading chip producers seems to be contained to the next quarter or two, with full-year estimates out to next year moving upward. Key point: AI demand is “real,” and any push-out of new products only delays supply—it doesn’t impact demand. |
|---|---|
| US Global Recession Fears |
We are sympathetic to the view that the economy is not as strong as economic data has indicated. However, we also believe that Hurricane Beryl impacted some of the employment and retail data that concerned the market in July. We would not be surprised to see “relief-like” data reports in the weeks and months ahead. A more prolonged market pullback could weaken the “wealth effect” and the resilience of high-income consumers. Greater caution on the consumer is warranted, but there are still many opportunities elsewhere (e.g., technology and industrials). Globally, central banks have the firepower to respond and are willing to do so. |
| Contagion Fears |
It’s impossible to know exactly how much more of the carry trade remains to unwind, but the peak appears to be in the rear-view mirror. There has been no indication of any systematic risks arising from this pullback. Credit and liquidity conditions are all within normal ranges. |
Our Outlook on Emerging Markets Is Positive
The pullback in emerging markets has been less about the yen carry trade and more about short-term AI-supply chain issues. For example, Brazil and Mexico have held up better than South Korea and Tawain during this recent spate of volatility. We remain confident that the issues dogging the AI supply chain are transitory, and we expect the opportunity set to broaden from here.
Our constructive outlook also reflects the fact that the earnings growth potential of emerging market companies is less tied to the US economic growth outlook than it was in the past. Emerging market economies are more resilient today, with less vulnerability to high twin deficits, as in 2013 and prior cycles.
Emerging Market Earnings Growth Remains Resilient
Consensus EM earnings estimates show no obvious fear of US slowdown
Source: UBS, using IBES, Datastream, “Are these the late stages of EM underperformance?”, August 7, 2024. Past performance is no guarantee of future results.
CNWIX: Where We See Opportunity
The Calamos Global Equity Team invests in companies with attractive bottom-up fundamentals that are positioned to benefit from top-down drivers, such as secular and cycle growth themes and macroeconomic tailwinds. Ahead of the market pullback, our team had been trimming positions to lock in gains. We’ve been using the short-term volatility to add back to some of these positions. We’ve also found opportunities to consolidate into high-conviction names. From a sector standpoint, information technology and industrials are our largest allocations; as noted, these areas are less vulnerable to consumer weakness. (For more on our industrials positioning, see our July commentary, “Perspectives on Emerging Markets Opportunity.") From a country standpoint, the fund’s largest exposures include India, South Korea, and Taiwan. We’re also finding bottom-up opportunities to invest in markets expected to benefit most from falling real rates and a weaker US dollar, such as Turkey, Brazil, Indonesia, and the Philippines.
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The principal risks of investing in the Calamos Evolving World Growth Fund include: equity securities risk consisting of market prices declining in general, growth stock risk consisting of potential increased volatility due to securities trading at higher multiples, foreign securities risk, emerging markets risk, convertible securities risk consisting of the potential for a decline in value during periods of rising interest rates and the risk of the borrower to miss payments, and portfolio selection risk. As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities, including fluctuations in currency exchange rates, increased price volatility and difficulty obtaining information. In addition, emerging markets may present additional risk due to potential for greater economic and political instability in less developed countries.
Performance data quoted represents past performance, which is no guarantee of future results. Current performance may be lower or higher than the performance quoted. Please refer to Important Risk Information. The principal value and return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance reflected at NAV does not include the Fund's maximum front-end sales load of 4.75%. Had it been included, the Fund's return would have been lower.
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