Expect a post-Covid boom

SA’s vaccine rollout will be slower than other emerging markets, but it is set to benefit from the market recovery trend.
Companies that held back over the past year are likely to start paying attractive dividends again – and their free cash flow is now very strong. Image: Andrey Rudakov, Bloomberg

The announcement of vaccine rollouts across many developing countries prompted a sharp rally in emerging market stocks in recent months. South Africa may be late coming to the vaccine party, and while that may delay economic recovery, it will not ruin it.

Iain Power, chief investment officer at Truffle Asset Management, which manages the Nedgroup Investments Balanced Fund, says the vaccine rollout in the northern hemisphere countries is expected to reach full momentum by the summer of 2021. That means the earnings recovery for cyclical companies will start to manifest towards the second half of this year and into 2022.

“We can expect a lot of noise and volatility as these vaccine programmes roll out across the world, but as we enter 2022 we are expecting to see a more synchronised global recovery, and SA Inc will get carried along by the momentum.”

Emerging markets are still underweighted in most balanced portfolios, and should they return to their median portfolio weighting of 9%, this means roughly $250 billion could flow into emerging markets funds.

“As investors become more comfortable with the progress in vaccine rollout programmes, we expect to see a rotation into emerging market stocks where valuations are more attractive than they are in the developed world,” adds Power.

“China is leading the world in the containment of the virus and the way it has managed its economy post-Covid, and I think the rest of the world will catch up with it as we enter into the second half of this year.”

Power says there is a distinct parallel between the outbreak of Spanish flu in 1918 which infected about 500 million people – roughly a third of the world’s population – and killed 50 million. Though the mortality rate from Covid is far lower, lessons can be drawn from the aftermath of the Spanish flu pandemic, which was followed by a massive economic boom. A similar boom can be expected in the post-Covid global economic environment.

“The economic recovery we expect to see later into 2021 and 2022 will be driven by China, and this is very positive for SA commodity producers, which are still reasonably priced relative to their peers in the developed world.

Infrastructure spending

We are also likely to see large-scale infrastructure renewal projects being announced across the world, particularly in northern hemisphere countries that have neglected their infrastructure for decades,” says Power.

Part of this infrastructure spending will take the form of an accelerated switch to clean energy sources and electric vehicles (EVs), which will stimulate demand for EV-related commodities such as copper.

Power also expects a rerating in interest rate-sensitive stocks, such those that are heavily geared, as well as banks and properties.

A potential brake on this success story is the speed and energy with which government tackles structural weaknesses such as national debt, public sector wages and spending. “We need to see decisive steps from government on these structural issues, and I suspect we will see some cuts in the public sector wage bill in particular,” adds Power.

“The strong earnings already flowing through from the resources sector is feeding straight to the fiscus in terms of higher taxes, and that will continue as demand for commodities strengthens through the recovery cycle.

“So there is something of a windfall for National Treasury as our balance of trade at the moment is looking particularly positive,” he says.

“That is boosting the rand, and will also reflect in higher taxes to SA Revenue Service [Sars] from the resources sector.”

While individuals and households have paid down borrowings in recent years, debt has shifted to the public sector. Central banks have responded with variations iterations of quantitative easing, which may pose an inflationary risk in the future.

Pockets of SA Inc offer value

SA stocks are cheap relative to other emerging markets, including many resources companies whose prices have run hard and shot past pre-Covid levels.

Power says Truffle has been investing in health care stocks, some banks, and insurers.

“Many companies that held back on dividends over the last year are likely to start paying attractive dividends again in 2021, and their free cash flows – because they held back in investing in their businesses due to the uncertainties that abounded last year – are now very strong. Investing in these companies you are essentially getting this free cash flow and high dividends, no matter what happens to the stock price.”

Emerging market valuations at a forward price-earnings (PE) multiple of 16.5 look cheap relative to the alternatives: the S&P 500 is on a forward PE of 23, while the MSCI (Morgan Stanley Capital International) index is on a forward PE of 32.5.

SA Inc is cheap relative to all of the above, hence a rerating in local shares with good business is what is on the cards for 2021 and 2022.

Brought to you by Nedgroup Investments.

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