Talk of a Covid vaccine being available in the near future has fired enthusiasm for emerging market stocks.
“Indications are that an emerging market recovery is underway and that emerging markets are on track for a better 2021,” says Iain Power of Truffle Asset Management, which manages the Nedgroup Investments Balanced Fund. “This [recovery] will be particularly enjoyed by some of the more defensive, dollar-based assets. The basis for our view on growth assets is largely based on the fact that it seems likely that there are some viable vaccines coming online.”
There are signs that the huge exodus of around $90 billion that flowed out of emerging markets in 2020 is now starting to come back.
SA stands to benefit from this return flow of funds as it still forms part of the emerging market index.
While this bodes well for a decent first half of 2021 for SA, it does not necessarily point to a sustained recovery for the domestic economy.
The big issue is the speed and efficiency with which these vaccines can be manufactured and distributed, adds Power. “This will provide a solid runway for the level of economic activity around the world to get back to pre-Covid levels, particularly in some of the countries that have been hardest hit and where tourism plays a major role.
“We are already starting to see investors position for that by selling some of the defensive-type assets and taking a position in more economically-sensitive assets.”
Nedgroup Investments Balanced Fund has upweighted stocks likely to benefit from this recovery, including financials, retail counters such as Cashbuild, Italtile, Woolworths and Pepkor, and bombed-out property shares like Hyprop.
Economically-sensitive stocks, which typically lead the economic recovery, had a good November on the JSE, with gains of 20% to 30%, and even higher in some cases. This is reflected in the Nedgroup Investments Balanced Fund’s strong performance last month. The fund is now positioned for the expected emerging market recovery as we head into 2021.
Of course, there are always risks. For example, questions remain as to whether the US fiscal stimulus will be sufficient to refloat the US and, by extension, the global economy. “Will Republicans and Democrats agree [to fiscal stimulus]? While these are all factors which could introduce short-term noise, by and large it looks like all the classic signs of a recovery are in place,” adds Power.
Another risk is that SA is not one of the most favoured emerging market destinations for inward flows.
It’s important to note that all emerging markets are not equal. SA and Brazil probably sit in the category of the least loved due to their fiscal and structural issues, but the likes of Mexico, Columbia and some of the Asian emerging markets look more promising. The fund’s weighting in these geographies reflects this view.
Power says he would want to see significant cutbacks on the fiscal side, particularly in the bloated public sector wage bill, to change his position on SA.
“The elephant in the room is obviously SA’s fiscal position. We need to see a sustained earnings recovery for SA to truly recover. The problem in not dealing with the fiscal issue means the window of opportunity for South Africa Inc to do well will probably be shorter than other, more sustainable emerging market geographies.”
Nedgroup Investments Balanced Fund positioned itself to benefit from these shifting global dynamics by upweighting offshore equities exposure, increasing exposures to other more attractive emerging markets without many of systemic risks facing South Africa.
“We took a barbell approach with heavy weightings in certain cyclicals like the diversified miners, PGMs [platinum group metals], AB InBev and Richemont, and on the other side increasing our exposure to a basket of quality SA Inc companies – but specifically banks, Bidvest, Cashbuild, Italtile, Pep Group and selective insurers, all of which were discounting a significant amount of bad news. We also added some exposure to the bombed-out property stocks which have decent underlying assets like Hyprop, Growthpoint, Vukile and Nepi [Rockcastle].
“This has worked well for the portfolio and we expect the above shift from defensive and growth companies into more economically-cyclical companies to continue into 2021.
“We think investors should continue to sell some of their exposure to the high-growth offshore stocks, especially tech given their sensitivity to a rise in long-bond rates, which we think is likely in the course of 2021 and beyond,” adds Power.
“If US 10-year Treasuries are at 1.5% to 1.7% by this time next year, I think you will see significantly lower ratings in many of these high-growth stocks.
“We’re not saying that the earnings growth of these high-growth shares will stall, but valuations are certainly reaching extreme levels. This may be a good time to take some profits in these shares and rotate into more cyclical shares that are well positioned as we head into 2021.”
Brought to you by Nedgroup Investments.