Goldman Sachs and BofA see decade lost for emerging markets

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(Bloomberg) – High commodity prices and earnings growth expectations trigger bullish bets on emerging market stocks after more than a decade of underperformance that has left them near a 20-year low by in relation to the actions of developed countries.

Goldman Sachs Group Inc., Bank of America Corp. and Lazard Asset Management expect a boost in equity development as investors capitalize on cheap valuations once vaccine rollout resumes, helping the global economy recover from the pandemic. South Africa, Russia and Brazil are among the markets expected to benefit, even as Chinese regulatory crackdown continues to weigh on Asian stocks.

In the decade following the global financial crisis, MSCI Inc.’s emerging markets stock index gained just 8%, while the benchmark developed countries index more than doubled. Part of the reason is China’s economic growth slowing from over 10% in 2010 to around 6% by the end of the decade, leading to lower commodity prices and weak earnings growth.

Then came the pandemic. While equities in all areas initially rallied sharply from the March 2020 lows, emerging market equities lagged again. MSCI’s developed markets stock index has returned around 14% since the start of 2021, while its emerging market counterpart has fallen 5%.

That could change in the coming months as the global economic recovery accelerates, inflation accelerates and commodities remain dynamic, driven by China’s infrastructure projects in the United States.

There are signs that the turn has already started. According to BofA, capital flows to equities in emerging markets in Eastern Europe, the Middle East and Africa have accelerated since March – beating the most flows to bond funds since 2014 – so that investors have turned to value stocks.

“We expect this trend to continue given macroeconomic factors and favorable equity valuations,” BofA multi-asset strategist Jure Jeric said in a note. While the energy sector has been the biggest beneficiary so far, supporting Russian stocks, there is room to increase inflows into other valuable sectors including financials and materials, the South Africa receiving a boost from the latter, he said.

Meanwhile, Goldman Sachs is tactically “fairly bullish” on developing stocks, according to Caesar Maasry, head of the emerging markets cross-asset strategy team, which favors stocks and currencies in Brazil, Mexico and China. Russia. “We generally find that a ‘return to normal’ is not built into the market. “

Franklin Templeton Investments reports that technology is driving stock market gains in emerging markets, benefiting countries like South Korea and Taiwan. These two countries have handled the pandemic better than most, and their tech-dominated markets have made them an attractive investment during the crisis, said Andrew Ness, portfolio manager at Franklin Templeton. The company remains cautious on emerging market equities but has become more bullish due to low valuations, according to chief researcher Gene Podkamine.

While GDP growth in emerging markets has lagged behind that in developed countries in 2021, this could start to change as early as the fourth quarter as activity begins to slow in developed economies and against a backdrop of rising commodity prices, according to Lazard.

“Given the position that many emerging market companies occupy in the global supply chain, a pickup in global capital spending is a very good signal for emerging market equities in general,” the strategists wrote. of Lazard in a report. This is particularly true for “growth-sensitive stocks, stocks that benefit from rising commodity prices and those that produce goods rather than services,” they said.

Over the past decade, the outperformance of US stocks has a lot to do with the Fed’s abundant liquidity – money that for the most part has not reached emerging markets. When liquidity is removed, stocks around the world could take a temporary shock, but the United States would lose its advantage. This supports the idea that emerging market equities can outperform in a post-stimulus world.

That’s not to say that there aren’t key fundamental risks ahead for emerging market equities. Beijing’s regulatory crackdown on tech companies has been a factor in the MSCI EM Index’s underperformance this year, with Chinese stocks accounting for nearly a third of the gauge.

While regulatory reforms could continue to depress Chinese equities, they are unlikely to spill over into the wider complex of emerging markets, according to Goldman Sachs. Concerns about China’s economic growth are justified, however, the lender said in an Aug. 18 report. Developed countries outside of North Asia will continue to outperform the MSCI EM Index, making it a “higher conviction” asset, he said.

Developing country stocks have also proven their sensitivity to the outlook for a slump after falling along with global equities after the Federal Reserve signaled it could start cutting stimulus from year-end. . The Fed’s minutes also pushed commodity prices down as they boosted the dollar on Thursday, putting more pressure on developing country stocks.

Not everyone is fully convinced that the worst is over. The BlackRock Investment Institute downgraded emerging market equities to neutral earlier this month due to uncertainty over the outlook for the US dollar and tighter policy.

“Permanent scars”

“We believe that emerging market growth is more at risk of long-term permanent scars due to slow vaccination rates and limited political space,” said Wei Li, the company’s chief global investment strategist, adding that the equity risk premium is lower than the historical average. for developing countries.

Others buy into the growth story, but warn it can take time. State Street Global Markets multi-asset strategist Daniel Gerard believes headwinds in emerging markets, like the uncertainty surrounding China’s regulatory environment, will keep their stocks from outperforming over the medium term. In the long run, he sees “huge opportunities” as countries reduce their reliance on physical infrastructure in favor of technology.

“Once immunization rates improve in emerging markets, we expect not only EM stocks to outperform EM debt, but also EM stocks to catch up with developed market stocks,” he said. said Gerard. “Don’t neglect the EM consumer when the pandemic’s grip on consumer activity wanes.”

South Korea at a glance

South Korea’s rate decision on Thursday will be closely watched, with six of 11 economists polled by Bloomberg predicting the central bank will keep rates on hold. The other five expect a rise of 25 basis points. 22 basis points increase over next three months, up from 37 basis points at end-July Doubts increased over South Korea’s policy trajectory after Reserve Bank of New Zealand held rates benchmark following lockdown to contain new wave of virus cases Citigroup maintains call for a 25 basis point hike at next meeting as concerns over financial imbalances outweigh growth risks , wrote strategists led by Johanna Chua in an August 19 research note. Sri Lanka’s central bank unexpectedly raised policy rates on August 19, becoming the first of 13 Asia-Pacific countries to hike rates from Pakistan in July 2019 Elsewhere, Hungary’s central bank could raise policy rate by 30 basis points to 1.5% on Tuesday to tackle the European Union’s fastest rate of inflation The forint topped all of its peers in the past month.

What else to watch

Malaysia will release July inflation figures on Wednesday, with the report set to show prices rose 3% year-over-year after rising 3.4% in June Inflation eased over the years two months before as lockdowns in large parts of the country weighed on growth Ismail Sabri Yaakob was sworn in as Malaysia’s third prime minister in 18 months on Saturday, announcing the return of a pro-Malaysian party after weeks of political upheavals. Taiwan is expected to report on Monday that industrial production growth moderated in July while maintaining double-digit pace this year’s best-performing Asian currency Thailand’s customs trade report released on Tuesday is expected to show import growth higher than that of exports. The lack of recovery in tourism and manufacturing has weighed on the baht, the wor’s best-performing currency in Asia this year, according to a forecast by a Thai government agency In Mexico, traders will be watching a plethora of data for clues to the country’s recovery, June retail sales on Monday and bimonthly CPI figures from Tuesday to July, employment figures on Thursday A reading of the country’s final GDP growth in Wednesday’s second quarter will be likely unchanged from the 19.7% estimated in July, according to Bloomberg Economics, June economic activity figures forecast for the same day are expected to show an annual increase, while remaining below pre-pandemic levels. central bank minutes Thursday for clues on the way forward for policy A reading of Brazil’s IPCA-15 inflation data on Wednesday will be analyzed for clues as the central bank appears poised to hike policy rates by 100 percentage points base amid price hike concerns current account data to be released on Wednesday

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