London
It’s not too late to ride the emerging-market equities bandwagon. From economic expansion to corporate earnings and capital expenditure, everything points to their overtaking developed peers through the middle of next year, according to Credit Suisse Group AG.
A benign trajectory for profit growth should spur the MSCI Emerging Markets Index about 8.3 per cent higher from current levels, reaching 1150 by the end of June, according to strategists at the Swiss bank. The gauge has already notched an 18-percentage point increase over its developed counterpart over the past year and a half.
“We are regularly asked by global equity and multi-asset investors if it is too late to engage in emerging market equities,” Credit Suisse analysts Alexander Redman and Arun Sai wrote in a report published last week. “We argue that the answer is no; it is not too late. This view is predicated on what we believe to be compelling evidence which indicates performance attributes to be mid- rather than late-cycle.”
Credit Suisse strategists analysed 10 emerging-market stock metrics and found that only two show signs of mid-to-late cycle behaviour.
Developing-economy equity funds posted $1.6 billion of outflows the week ending August 16, the biggest 5-day withdrawal since late December, according to EPFR data, as geopolitical tensions and concerns over US policy paralysis drove risk aversion around the world.
The broader capital-flow picture is bullish, however. Heavy positioning in US and European stocks this year is spurring fears over frothy valuations, while investors have firepower to increase exposure to developing-economy assets in the months ahead.
Global equity funds still have a 400 basis points active underweight stance on EM stocks relative to the MSCI All Country World Index, according to Credit Suisse. That follows three years of withdrawals from dedicated emerging-market funds between 2013 and 2015, followed by a flat 2016.
Still summer
After six years of profit-growth disappointments, earnings results since June have outperformed consensus estimates made 12 months earlier, for the first time since 2011.
Emerging-market equities are poised for further gains as the business cycle — commodity prices, industrial production, and productivity gains — is still in the summer of its expansion, according to the bank. It projects a further 40 basis points of margin expansion this year alone.
What’s more, non-financial net profit margins remain below the two-decade average of 7.7 per cent and significantly below the 2008 peak of 10.5 per cent. That suggests the market return on equity has “considerably” more room to run. Credit Suisse recommends overweight positioning in China, South Korea, Russia, Indonesia, Malaysia and Poland, and an underweight stance toward Taiwan, India, South Africa, Mexico, Thailand and Chile.
Over the next four years, the International Monetary Fund projects emerging-market growth outperformance to accelerate, following years of successive downgrades to consensus forecasts. That, combined with a projected decline in interest rates adjusted for inflation, should also add juice to the rally.
The big risk to watch is the outsize role of technology stocks in driving this year’s EM rally, bringing the sustainability of gains into question in a tech downturn.
“Emerging market equities seem back in vogue,” the strategists wrote. “Nonetheless, in both absolute and relative US dollar performance terms the current bull market phase for emerging equities does not appear stretched either in terms of magnitude or duration.”
Tempting stock picks in South African
South Africa’s economy is producing a steady stream of negative headlines: recession, record unemployment and the weakest manufacturing in eight years.
Amid all this bad news, some Johannesburg-traded stocks are beginning to look attractive. Investors seeking value should keep an eye on lenders, diversified industrial companies, health care providers and pharmaceuticals, said Feroz Basa, who helps manage about $150 million as joint head of Old Mutual Investment Group’s emerging markets unit.
“You’re finding some pockets of opportunity in banks,” particularly in Barclays Africa Group Ltd following the sell-down by Barclays Plc, Basa said by phone from Cape Town. The stock trades at the lowest valuation among its peers, as measured by its price-to-earnings ratio and “the dividend yield is very attractive,” he said. After rising 43 per cent last year, Johannesburg’s index of banking stocks is just 1.3 per cent higher in 2017.
While Johannesburg’s main stock gauge climbed to a record high this week, the frail local economy has held back its gains compared with its peers. The index trails far behind other developing countries, rising 9 per cent in 2017 against a 23 per cent surge in the MSCI Emerging Market Index. South African stocks are also pricier, with members of the benchmark index trading at an average 14.5 times future earnings against 12.8 times for their emerging-market counterparts.
“For a foreign investor looking into emerging markets, South Africa isn’t looking like a very attractive prospect at this point,” Basa said. “However, as the growth outlook continues to suffer, pockets of market value are likely to emerge.”
Policy ‘noise’
Policies put forward by President Jacob Zuma’s government have rattled investors, with mining stocks tumbling 3 per cent on the day in June that Resources Minister Mosebenzi Zwane put forward new regulations for the industry. Slow-moving plans to introduce National Health Insurance have contributed to the local health care sector index dropping about 9 per cent this year.
“There are good opportunities in health care because of all the government issues and noises around NHI,” Basa said. “South African companies have derated nicely.”
An economy that’s in its second recession in a decade, a jobless rate of 28 per cent and the lowest manufacturing activity figures since 2009 are testing the optimism of foreign investors, who have been net sellers of $4.8 billion of local shares this year. The central bank forecasts growth of just 0.5 per cent this year.
“While the negative sentiment around South Africa is slowly starting to feed into the companies, none of these companies have derated to a level that would position South Africa as a screaming buy right now,” Basa says. “A continued decline of South African market performance should create better buying opportunities.”
