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Is the tide turning for emerging markets?

A look at plausible investment opportunities in the next few years.
Image: Waldo Swiegers/Bloomberg

Headwinds caused by the Covid-19 pandemic have made investors reconsider the traditional risk-return dynamic of asset classes. They realised that risks can be found anywhere in the investment world … even in developed markets – considered a safe bet in the previous cycle.

But what plausible investment opportunities could emerging markets offer in the next few years?

Emerging market currencies have underperformed for a prolonged period 

Over a 10-year period, the key theme for underperforming emerging market currencies was the strength of the US dollar. We don’t expect this trend to continue indefinitely.

However, the impact of the strong US dollar has placed massive strain on emerging market economies and investments, and South Africa is no exception. Local political turmoil added an element of uncertainty, which placed additional strain on SA business and consumer confidence, even before the Covid-19 pandemic took effect.

Where are the opportunities?

In its April 2020 report, the International Monetary Fund (IMF) said emerging markets should outperform their developed counterparts and recover much faster. Given that emerging markets struggled over the previous cycles, and valuations came under pressure, we think that this is an interesting area to look for opportunities.

South Africa ranks among the most responsive emerging markets around the word, and we expect this position could be sustained throughout the year.

Our prime lending rate is now at the lowest levels in more than 50 years, remaining highly supportive of lending and growth.

Although we have technically been in a monetary stimulus phase (rate cuts) for three years, the cuts have been so small, slow and gradual that no real material impact was felt. But recent assertive action has been decisive, and should have a tangible positive impact.

South African corporate debt to Ebitda (a measure of earnings) compares favourably with other emerging markets. Although the debt-to-GDP ratio is a serious problem in South Africa, the same can be said for most countries now, both in emerging and developed markets. As central banks and policy makers respond with relief measures, we should expect these metrics to be under significant pressure.

Interestingly, emerging markets’ debt-to-GDP looks better than developed markets’ debt-to-GDP, as some of the larger economies around the globe sit with large amounts of growing debt.

Except for capital goods, all MSCI SA sectors are trading at a discount versus the MSCI

While SA’s real GDP growth has flatlined around 1.50% over the past 10 years, it is ironic to note the growth rate for MSCI SA’s earnings per share (EPS) has been at around 9.60% p.a. over that same period compared with the 2.70% p.a. for MSCI emerging market peers. (Data as at June 30, 2020)

Considering this data, it seems that local companies have defied gravity, especially if we consider the dismal GDP growth backdrop. Our data shows that forward earnings for the S&P 500 is much higher than its historical average.

As such, the premium investors are paying for shares on the S&P compared with emerging market shares are now at record high levels.

The flight to growth and quality has seemingly stomped out any approach that is cognisant of valuations. We believe this situation will unwind and will have a significant impact on some of the more expensive US counters, as well as stocks in emerging markets.

Adriaan Pask, CIO at PSG Wealth

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“Over a 10-year period, the key theme for underperforming emerging market currencies was the strength of the US dollar. We don’t expect this trend to continue indefinitely.”

Strong disagree. The DXY is, right now, close to a five-year low. From 2008 to 2014 the DXY was at historic lows. The dollar strength we saw March 2020 was a blip on the long-term radar. In fact, if the DXY wasn’t so weak, the Rand could easily have been trading at 25 or 30 to the Dollar.

“Interestingly, emerging markets’ debt-to-GDP looks better than developed markets’ debt-to-GDP, as some of the larger economies around the globe sit with large amounts of growing debt.”

I consider this is a misleading statement. Even a small amount of debt can be catastrophic if you’re no longer able to settle debts. Also consider the nature of the debt. First-world countries are going into debt to salvage their economies. South Africa is going into debt to pay the public services sector bill, prop up Eskom and SAA and to please the unions. So in essence throwing good money after bad.

“South Africa ranks among the most responsive emerging markets around the word, and we expect this position could be sustained throughout the year.”

South Africa has been steadily de-industrialising ever since those wonderful mining charters in 2006, not to mention Eskom and the non-existent construction industry. Are you sure we’re speaking of the same country here?

“Our prime lending rate is now at the lowest levels in more than 50 years, remaining highly supportive of lending and growth.”

Unless business in SA is so doomed that there’s no-one to lend to. SA banks have terrifying amount of bad debt on the books.

“While SA’s real GDP growth has flatlined around 1.50% over the past 10 years…”

I see we’re conveniently ignoring the devastation of the last 6 months here.

“Adriaan Pask, CIO at PSG Wealth”

Is ‘Adriaan Pask’ a pseudonym for Adrian Gore? Because this is the type of optimistic drivel he would write.

I think you’re trying to convince people that they’d be buying the bottom. My view is contrary, that they’d be buying a dead cat bounce, and that there are far worse things for the SA economy on the way.

I cannot help but agree with everything you said.

One should never mix optimism with reality which is what most commentators/fund managers are doing in trying to keep their clients invested in their local portfolios.

I was also exuberantly optimistic about the country for a long time but with the crap going on lately, I have lost hope in a big way.

I think realism is more important than dreaming impossible dreams.

Yield and not the Corona Virus will be King:

”naysayers” that promise you the ‘’ mystical millions’’ that can be made on the so-called offshore investments – they are actually ‘’$crewing Up’’ 30 % of your hard-earned funds!

Over the past decade, the emerging market economies have been the primary source of world economic growth, and they now account for around one half of the global economy. This has to make their more recent economic slowing and darkening economic prospects of considerable concern to global economic policymakers.

This would seem to be particularly the case considering that the emerging market economic slowdown has been occurring not at a time of global monetary policy tightening but rather at a time when the world’s major central banks have been shifting to an easier monetary policy stance.

The market is never wrong!

But let’s not confuse S A as the Emerging Markets you speak of. Collectively these include India, Mexico, Saudia Arabia, Russia, Pakistan, Brazil, Turkey and S A ( perhaps a few more). S A makes a a small fraction of this collective. We compete for Investment Funds with the above. The yield may be good in S A so we may attract some cash, but long term? Turkey has major Political and currency issues but offer greater attractions than S A. People are hard workers and innovative – put S A to shame.

Does not seem to matter how much we analyse the potential of the country, it seems to go in one direction only.
It is possible that we will be the same position in five to ten years time, some people might see this as positive.
The fact is that for most South Africans time goes past, we hope, we look for the positive, we grow old and get poorer.
South Africa has a lot of potential in natural resources, good weather, tourism, agriculture, manufacturing, good labour and some very smart people.

The catch in it all is time, either you have it or not.

“Does not seem to matter how much we analyse the potential of the country, it seems to go in one direction only.”

And isn’t this the crux of the economy? Our interest rates could be zero but if there are no real entrepreneurial business people with a workable future vision AND the intelligent support of an uncorrupted state, we have little hope of matching countries like Vietnam or South Korea.

It’s time to understand that the abilities of the average SA worker are probably decades behind his/her counterpart in the Far East and Turkey and that no matter how much we posture, we are no where near their league.

It’s going to take time, generations …

Don’t really get this article, is is an SA article or an Emerging Market article, it’s all really mixed up.

What these Fund Managers know yet keep on, not mentioning is that stocks are cheap for reasons and expensive for reasons.

The Democracies of the West protect private property rights and are less in the throws of corruption and I think investors worldwide are willing to pay extra for that verse the emerging markets

End of comments.

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