Are we seeing a rotation from developed markets to emerging markets?
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By Adriaan Pask
As global economies continue to recover, available data suggests that the tide may be turning toward emerging markets (EMs), while developed markets (DMs) slowly fall out of favour. PSG Wealth and the industry have always recognised the value of select assets in the EM space. Now the media has started to report on similar opportunities.
Commodity prices have improved, and we’re starting to see the positive impact of this flowing into government current accounts
Supported by loose monetary policies, reduced supply and increased demand, as well as the reopening of economies, commodity prices have recovered over the past few months. For EMs reliant on exporting raw materials, the rise in commodity prices bode well for public finances.
Despite headwinds, equities and currencies in EMs have gained momentum since the start of 2021
The valuations of global equity markets may face pressure from tapering monetary support as economies continue to recover.
However, EMs, like China, are expected to outperform their DM peers over the next few years. The expectation comes from China’s limited monetary easing during the 2020 financial decline and its proactive normalisation, which have resulted in reasonable equity valuations. China’s Shanghai Composite Index has since recovered from a record low of 2 657 index points recorded on 23 March 2020 to 3 532 points a year later. Locally, the FTSE/JSE All Share Index (ALSI) surpassed its pre-pandemic record high reached in 2018 in 1Q21, recording its strongest first-quarter performance in over a decade by posting a total return of 13.20%. Poland, Brazil, Taiwan, Argentina, and Greece all outperformed the MSCI EM Index in the first quarter this year, buoyed by higher commodity prices and currency strength.
Markets are currently bullish about riskier assets which benefits EM currencies
EM currencies have made gains over the past few months given the weakness in the US dollar and its uncertain outlook amid a dovish Federal Reserve (Fed) and accelerating global growth.
The dollar has been through a Goldilocks phase where capital over the last decade has gone into US dollar-denominated assets. Although tech stocks, exchange traded funds (ETF), US Treasuries, US-denominated gold, Bitcoin and special purpose acquisition companies (SPACs) have gathered quite a lot of money recently, which supports the greenback. Our projections show that capital is unlikely to stay in US tech stocks, US Treasuries or any of these spaces forever. Moreover, given that sentiment is improving in EMs and deteriorating in DMs, with more inflation risk in the latter than there is in the former, we could more than likely see sustained EM currency strength. On Thursday 3 June 2021, the local currency traded at R13.54/$, R19.21/£ and R16.51/€. Reuters reported that: “the rand’s recent rally has been mainly on the back of global factors, including higher commodity prices which benefit resource-rich South Africa and expectations [that] US lending rates will stay lower for longer.” The dollar has also weakened against other EM currencies like the Chinese yuan and the Indian rupee.
Investors are starting to see heightened risks in the DM space with some investments moving from higher valuations in the US to other DM and EM markets
We are currently seeing a lot of re-rating potential as positive sentiment turns from DMs towards EMs in general. Moreover, some of the things that would have concerned investors such as the discussions around Regulation 28 in South Africa for instance, appear to be subsiding with the Financial Sector Conduct Authority (FSCA) announcing that prescribed assets are off the table and should remain that way. This creates a lot more investor certainty. While it is still not smooth sailing in SA, we are in a much better spot than a year ago.
Foreign direct investment (FDI) has since returned to EMs as politics stabilise
FDI inflows to South Africa increased by R16.01 billion in the fourth quarter of 2020 thanks to “non-resident parent entities increasing equity investments and granting loans to domestic subsidiaries” according to a Reuters report. This is compared to total outflows of R12.17 billion in the previous quarter. Moreover, available data shows that foreign investors continue to be the net buyers of local government bonds. Similarly, Chinese bonds have also gained popularity, as shown by JPMorgan’s China Bond Opportunities Fund. It recorded over $120 million in AUM at the end of the first quarter of 2021, only a few months since its inception in 2020.
Developed markets falling out of favour?
The bottom line?
In general our underlying managers are slowly adjusting their asset allocations away from US exposure towards exposure in other DMs and/or EMs. This reflects the increased concern among investors about elevated valuations in the US, while asset classes in EMs, like South Africa, are starting to offer value again.
Adriaan Pask is the Chief Investment Officer at PSG Wealth