Emerging Market Currencies: Multi-Decade Opportunity or Short Candidates?

"[Emerging market] currencies look more interesting to be underweight from here than they were a week ago," Luke Spajic told Bloomberg today, referring specifically to what he says is the strongest rally in seventeen years to support his bearish case. In other words, he believes these currencies have significantly overshot their "fair value."

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Mr. Spajic, who is based in Singapore, leads emerging-markets portfolio management in Asia on behalf of Pacific Investment Co. (PIMCO). His emerging-market currency fund has beaten 97% of the funds in its category over the past five years, according to Bloomberg.

In a "Cyclical Outlook" on the Asia-Pacific region published this month, three other PIMCO portfolio managers expressed their view that they "expect a further devaluation in the yuan. This will add additional downward pressure to currencies across [Emerging Market] Asia in countries that are already suffering from weak global demand and anemic export growth," adding that they "are positioning for this outcome via a basket of short positions in currencies such as the South Korean won, the Malaysian ringgit, the Thai baht, the Singapore dollar and the New Taiwan dollar."

However, it seems unwise to focus on a week-long rally to the exclusion of the long-term trend that has preceded it, as Mr. Spajic appears to be doing.

Franklin Templeton Investments' Michael Hasenstab, who is well known for his contrarian, high-conviction positions, takes a broader view. In a video interview posted online by Franklin Templeton on Oct. 5, Hasenstab said:

We're owning the Malaysian ringgit or the Indonesian rupiah at levels that we have not seen since 1998, when the Asian financial crisis struck turmoil to that region. On a valuation basis, this is a, not a once-in-decade, this is a multi-decade opportunity to be buying very cheap assets.

Like Mr. Spajic, Mr. Hasenstab has an impressive track record. The flagship Templeton Global Bond Fund, which he co-manages, has beaten 85% of the funds in its International Income Funds category over the five-year period to Jun. 30, according to research firm Lipper.

Who, of the two, is right? If you believe in mean reversion (as I do), you'll probably put in with Mr. Hasenstab. From his perspective, last week's rally could be the start of a rebound from a multi-decade low, rather than a "head-fake" move that has overshot and should be sold.

Here's where the U.S. dollar stood in relation to other major currencies as of Monday afternoon.

Source: Bloomberg. Data current as of 3:56 p.m. EDT on Oct. 12. CAD = Canadian dollar. GBP = British pound.