Wednesday, January 26

Goldman and BofA see a lost decade for emerging markets

Expectations of a recovery in commodity prices and earnings growth are igniting bullish bets on emerging market stocks after more than a decade of underperformance that left them approaching a 20-year low versus the actions of developed countries.

Goldman Sachs Group, Bank of America, and Lazard Asset Management expect a boost for the stock development as investors take advantage of cheap valuations once vaccine launches pick up, helping the global economy rebound from the pandemic. South Africa, Russia and Brazil are among the markets that will benefit, even as China’s regulatory crackdown continues to weigh on Asian stocks.


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In the decade that followed the global financial crisis, MSCI Inc.’s emerging markets stock index gained just 8%, while the benchmark for developed countries more than doubled. That’s partly due to the slowdown in Chinese economic growth from more than 10% in 2010 to around 6% at the end of the decade, which resulted in falling commodity prices and weak earnings growth. .

Then came the pandemic. While stocks overall initially rallied strongly from the lows in March 2020, emerging markets have lagged again. MSCI’s Developed Market Stock Index has returned around 16% since early 2021, while its emerging market counterpart fell more than 4%.

That may change in the coming months as the global economic recovery gains strength, inflation picks up and commodities rebound from their worst weekly performance since June, driven by infrastructure projects from China to the United States.

There are indications that the shift has already started. Capital flows to emerging market equities in Eastern Europe, the Middle East and Africa accelerated since March, outpacing flows to bond funds for the most part since 2014, as investors rotated into value stocks. , according to BofA. The MSCI EM index rose 1.3% on Monday, the highest this month.

“We expect this trend to continue given macroeconomic drivers and equity valuations,” BofA cross-asset strategist Jure Jeric said in a note. While the energy sector has been the biggest beneficiary so far, backing Russian stocks, there is scope for increased inflows in other value sectors, including financials and materials, and South Africa is getting a boost from the latter. , said.

Meanwhile, Goldman Sachs is tactically “quite bullish” on developing stocks, according to Caesar Maasry, head of the emerging markets cross-asset strategy team, which favors stocks and currencies in Brazil, Mexico and Russia. “We generally find a ‘return to normal’ without a price in the market.”

Franklin Templeton Investments points to technology as a driver of earnings for emerging market equities, benefiting countries such as South Korea and Taiwan, which are rebounding on Monday after falling 3.5% and 3.8%. %, respectively, last week. Those two nations have handled the pandemic better than most, and their technology-dominated markets made them an attractive investment during the crisis, said Andrew Ness, portfolio manager at Franklin Templeton.

The firm remains cautious about emerging market stocks but has become more optimistic due to lower valuations, according to Gene Podkaminer, head of research at Franklin Templeton Investment Solutions.

While GDP growth in emerging markets has lagged compared to developed countries in 2021, that may start to change as early as the fourth quarter, as activity begins to slow in developed economies and amidst higher prices for raw materials, according to Lazard.

“Given the position that many emerging market companies have in the global supply chain, a rebound in capex around the world is a very good sign for emerging market stocks in general,” Lazard strategists wrote in a report. That is particularly true for “growth-sensitive stocks, names that benefit from higher commodity prices and those that produce goods, rather than services,” they said.

Over the past decade, the outperformance of US equities had a lot to do with the Fed’s lavish liquidity, money that mostly didn’t make it to emerging markets. When liquidity is removed, stocks around the world may suffer a temporary shock, but the US would lose its edge. That supports the idea that emerging market stocks may outperform in a post-stimulus world.

That’s not to say there aren’t key fundamental risks ahead for emerging market stocks. Beijing’s regulatory crackdown on tech companies has been a factor in the underperformance of MSCI’s EM index this year, with Chinese stocks accounting for nearly a third of the gauge.

While regulatory reforms could continue to depress Chinese stocks, they are unlikely to spread to the broader complex of emerging markets, according to Goldman Sachs. However, concerns about China’s economic growth are justified, the lender said in an Aug. 18 report. Developed nations outside of North Asia will continue to outperform the MSCI EM index, making them a “higher conviction” position, he said.

Developing nation stocks also demonstrated their sensitivity to downside prospects after they tumbled along with global stocks after the Federal Reserve signaled that it could start tapering off stimulus later this year. The Fed minutes also led to a drop in commodity prices as they boosted the dollar on Thursday, putting further pressure on developing country stocks.

Not everyone is totally convinced that the worst is over. The BlackRock Investment Institute downgraded emerging market stocks to neutral in July due to uncertainty about the US dollar outlook and tighter policy.

‘Permanent scars’

“We believe emerging markets growth has a higher risk of permanent long-term scarring due to slow vaccination rates and limited policy space,” said Wei Li, the company’s chief global investment strategist, and He added that the equity risk premium is below the historical average. for developing nations.

Others are buying into the growth story, but caution that it may take time. State Street Global Markets multi-asset strategist Daniel Gerard believes that emerging market headwinds, such as uncertainty around the Chinese regulatory environment, will prevent his stocks from performing better in the medium term. In the long term, he sees “tremendous opportunities” as countries reduce dependence on physical infrastructure in favor of technology.

“Once vaccination rates improve in emerging markets, we expect not only emerging market stocks to outperform emerging market debt, but emerging market stocks to catch up with stocks in emerging markets. developed markets, ”Gerard said. “Don’t write off the emerging market consumer when the pandemic’s grip on consumer activity wears off.”

South Korea in focus

  • South Korea’s rate decision on Thursday will be closely watched, with 18 economists polled by Bloomberg split evenly in their prediction that the bank will hold or raise rates by 25 basis points.
    • Expectations for rate hikes have plummeted, with swaps now registering a 22 basis point increase in the next three months, compared to 37 basis points at the end of July.
    • Doubts have been raised about the trajectory of South Korea’s policy after the Reserve Bank of New Zealand maintained benchmark rates following a lockdown to contain a new wave of virus cases.
    • Citigroup maintains its call for a 25 basis point increase at the next meeting as concerns about financial imbalances outweigh growth risks, strategists led by Johanna Chua wrote in an Aug. 19 research note.
  • Sri Lanka’s central bank unexpectedly raised official interest rates on August 19, becoming the first of 13 Asia-Pacific peers to raise rates from Pakistan in July 2019.
  • Elsewhere, Hungary’s central bank could raise the main rate by 30 basis points to 1.5% on Tuesday to combat the fastest rate of inflation in the European Union.
    • The forint has outperformed all of its peers in the last month.
  • Israel will keep the base rate at 0.1% on Monday, with higher Covid-19 cases threatening the economic rebound.

What else to look at

  • Malaysia will release inflation figures for July on Wednesday, and the report is expected to show prices rose 2.9% from a year earlier after gaining 3.4% in June.
    • Inflation decreased in the previous two months because the blockade in much of the country affected growth.
    • Ismail Sabri Yaakob was sworn in on Saturday as Malaysia’s third prime minister in 18 months, announcing the return of a pro-Malay party after weeks of political turmoil.
  • Taiwan is expected to report on Monday that industrial production growth moderated in July, maintaining a double-digit pace.
    • The Taiwan dollar is the highest-performing Asian currency this year.
  • South Korea’s 20-day export figures for August rose 40.9% on Monday, compared to the previous month, while Thailand’s customs exports beat consensus estimates by gaining 20.27% the same day, as the trade figures of both nations increased mainly due to base effects. after exports last year collapsed in the aftermath of the pandemic.
  • In Mexico, traders will monitor a wealth of data for clues to the country’s recovery, from June retail sales on Monday and biweekly CPI figures on Tuesday to July employment figures on Thursday.
    • A reading of the nation’s final second-quarter GDP growth on Wednesday will likely remain unchanged from an estimated 19.7% in July, according to Bloomberg Economics.
    • June economic activity figures scheduled for the same day are expected to show an annual increase, while remaining below pre-pandemic levels.
    • Investors will also watch Mexico’s central bank minutes on Thursday for clues on the way forward for policy.
  • A reading of Brazilian IPCA-15 inflation data on Wednesday will be analyzed for clues, as the central bank appears poised to raise its key rates by 100 basis points amid concerns about rising prices.
    • Brazil’s July current account data will be released on Wednesday.

© 2021 Bloomberg

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