How does the Covid vaccine impact the outlook for emerging market equities?
- There is a lot of rhetoric in the market about the shift to emerging market value
- Emerging markets have growth potential but there are factors that are important to consider
- South Africa still has the very real concern of structural problems
There is a lot of rhetoric in the market about the shift to emerging market value.
Locally, some of the Covid restrictions have been eased and the first vaccines have arrived in the country. What does this mean for the local equity market in South Africa and can we make any assumptions?
To get perspective on this issue, one must take a step back to 9 November 2020 when viability of the Covid vaccine was announced. That was the event that precipitated the movement of many investors to switch into some of the bombed-out, more cyclically and economically sensitive assets. We saw a substantial rally in many markets as a result. This included Emerging Markets but also value shares which have massively underperformed growth over the last 10 - 15 years. So the question is: with the vaccines being rolled out around the world, does this mean that there could be further legs to some of these value shares and emerging markets - and vis-à-vis the some of the real growth names which have done well for investors but are frankly quite punchy?
We think the answer is yes. We also think there will be a lot of volatility as the vaccines roll out. The world and South Africa will face real challenges as the process unfolds. However, by-and-large the world will be able to do this and in fact, the United States and United Kingdom are already successfully accelerating their vaccine rollout programmes and by the Northern Hemisphere summer, we expect that they will be well into their inoculation programmes.
Subsequently, the earnings recovery and prospects for cyclically-focussed companies which depend on the economic tide coming in will likely look better into second half of this year and into 2022. The big positive here, especially for Truffle and the Nedgroup Investments Balanced Fund is that the valuations are significantly cheaper than developed markets and MSCI growth.
So, while everyone is wondering if the view that emerging markets are the place to be is a consensus view, we believe that emerging markets are still under-indexed by historic comparisons. Even if investors were to get back to medium emerging market exposure - which is close to 9% - it implies R250bn of cash going into emerging markets.
Furthermore, as investors become more certain about the vaccines, we will start seeing more and more investors switch and rotate out of some of the popular growth (but expensive) companies. That's how we have positioned the portfolio, starting towards the end of last year and continuing this year. However, we wouldn't be surprised to see some volatility in the markets amidst all of this in the first half of the year as governments try to get on top of the vaccines and their rollout.
Unfortunately, from a South African perspective we do have a problem. We were late to the party with the vaccines and many other emerging market countries have already started rolling out their vaccines. All this means is that South Africa is going to be 6-8 months behind the rest of the countries in terms of growth.
We can see a scenario in 2022 where we once again have a global synchronisation of growth. It's important for investors to understand what this means. China has managed to control Covid in a way that many developed market countries haven't given that they command and control the economy. So, what we will likely see is that the rest of the world is going to start to catch up with China and that is going to introduce a big economic impulse into the global growth cycle towards the end of the year and into 2022.
Interestingly, after the Spanish flu, once the wold had the pandemic behind them, there was a massive boom. While we may not see it to the same extent in this instance, people are going to splurge because savings have gone up over the period if you just look at savings rate versus GDP. There is also lots of fiscal stimulus that governments are pumping into the market and we think that sets the global economic cycle up for quite a strong push - which is good for emerging markets.
So is this good for South Africa?
There are still some pockets of opportunity in terms of value in South Africa. When one looks at value in South Africa, it is cheap relative to emerging markets - and within a developed market context we screen very well in terms of valuations.
However, a caveat we must overlay is the structural problems facing South Africa. Companies ability to grow has come down, but it is still fair to expect that South Africa in general and many of our stocks as a result will get dragged up by the global recovery. We see opportunity in healthcare, the insurers and some banks look attractive to us. We also anticipate that dividends will come back now, and when you can get dividend growth of nearly 10% you don't need much capital growth. So there are opportunities in South Africa and we certainly have been putting some money to work in those areas.