As global markets continue to grapple with uncertainty, emerging market equities have made an unexpected comeback in the past six months. The recently released Bank of America (BofA) Merrill Lynch Fund Manager Survey shows that the market is at its most undervalued since October 2011 – and that South African fund managers have suddenly turned bullish on equities.
As recently as December, BofA Merrill Lynch published a report showing that managers had been hoarding cash earlier in the year: a net 75% were overweight on cash and a net 58% underweight equities. A few months later and cash is no longer king.
“They are firm buyers of equities, record buyers of industrials and strong buyers of financials,” says John Morris, South Africa strategist at Merrill Lynch. “Preferred sectors are banks, general miners and food and drug retailers.”
Interestingly, emerging markets seem to be the major beneficiary.
“Well, both emerging markets and developed markets equities are seeing a resurgence,” says Nesan Nair, a senior portfolio manager at Sasfin securities. “But I think many of the fund managers are leaning towards emerging market equities as this was heavily sold off. The softer US-China relation could also be helping emerging market equities.”
The headwinds of 2018 can be summed up as a slowdown in economic activity, US Federal Reserve hikes and US-China trade wars – but with relief on all fronts, all bets are off.
“We have seen relief in all aspects recently, with a strong labour market report in the US, the Fed shifting towards a more dovish stance, and optimism that the US and China are moving towards an agreement,” says Mark Andersen, managing director of UBS Chief Investment Office. “We therefore believe the more upbeat tone is justified, and we recommend clients to be overweight equities.”
Fund managers have definitely started the year in bullish spirit, with only 38% overweight on cash and a lower net 15% underweight equities, but more importantly, bank equities remain an outright favourite. As the survey report states: “Banks, general miners and food and drug retailers are most preferred. Disliked are life insurance and real estate.”
The first few weeks of 2019 have seen managers move less underweight personal goods and more underweight telecommunication.
Diversification to counter contagion
While 2018 was tough on emerging market (EM) equities, with the Fed raising interest rates and the dollar strengthening, the tide seems to have turned: this week’s Federal Open Market Committee meeting saw Fed chair Jerome Powell confirm that the Fed will be patient with hikes. This comes as much-welcome relief as the Fed’s four hikes last year alone saw EM exchange traded funds across Mexico, Brazil, Russia and India shed at least 7%.
“Powell did a 180 in January when he suddenly turned dovish from being hawkish in December and risk was turned back on,” says Nair.
The ‘risk on’ environment has been confirmed by Andersen who says that UBS has also moved towards EM equities. “We moved to a position of being overweight EM equities by end of last year and have been recommending to our clients that they seek opportunities here. We like that EM equities are trading at a large discount to developed market equities, where a country like China in particular stands out, and then we think the more dovish stance of the Fed should support EMs.”
As a result of the relatively muted exogenous forces in 2019, many outlooks are forecasting an EM equity rally.
According to Divya Mathur, a portfolio manager at Martin Currie: “Historically, risk for emerging markets has always involved the sudden removal of an external stimulus, like the evaporation of demand from the US consumer, or the sudden shutdown of financing from the developed capital markets, as was the case in 2008.
“This time round, though, the EM asset class is largely running without external stimuli, which means its trajectory is less likely to be derailed by exogenous forces.”
Over the last 15 years, the description of blue chip equities has changed radically with the once-resolute commodities now accounting for a meagre 17% of aggregate trades and a mammoth 54% leaning towards technology and financials. No surprise really, given the massive discount financials are trading at. “Financials are trading at a 25% discount to the broader market,” affirms Andersen, “and we are in a phase of the cycle where financials typically do better on the back of higher interest rate levels.”
However, the timing of the recent financials binge indicates an imminent slowdown in the market. “Financials were the most sold off as they are viewed as late cycle plays and the first casualties of a slowdown,” says Nair. And as Winston Churchill once said: ‘Never let a good crisis go to waste.’
Emerging market assets are at a three-year low, and with the Shanghai Composite shedding more than 24% in 2018, this might be the perfect time to get some undervalued stocks in the east.
“Emerging market valuations have been approaching crisis levels due to substantially weakened performance, yet cash flows and earnings generally remain resilient,” says Chetan Sehgal, senior MD at Franklin Templeton.
“These conditions, when paired with improving corporate governance that includes dividend payouts and buybacks, present an increasingly attractive long-term buying opportunity.”