Financial Planning

Emerging markets offer opportunities

Emerging markets are fast becoming the global drivers of growth, with early signs of the rotation already starting from Developed to Emerging Markets, despite fears that a potential hike could reverse this most recent rally following Brexit, Emerging Markets will continue to offer opportunities based on a number of fundamentals such as low profit margins and undervalued currencies.

Speaking at the briefing in Johannesburg, Siboniso Nxumalo, Co-Head of OMIG’s Global Emerging Markets boutique, said that despite the ongoing anxiety over the impact of a US Federal Reserve Bank (Fed) interest rate hike since Emerging Markets swung back into favour, he and his team continue to see opportunities in these markets based on a number of factors.

“The Fed can only hike materially if the world is in a healthy growth phase and a world in a healthy growth phase utilises emerging markets labour, resources and commodities so this would inevitably be a positive development for Emerging Markets,” he says.

In addition to the search for yield that has driven many investors back to Emerging Markets, Nxumalo points out that they are trading on depressed earnings, with Emerging Market profit margins at 20-year lows. “We are also seeing low valuation multiples and historically undervalued currencies in these markets, which presents a number of stock opportunities.

Also speaking at the conference, Johann Els, OMIG Senior Economist, says that, in the wake of Brexit, Emerging Markets continue to look more attractive against a backdrop of low global growth and consequent low interest rates. “The global economy is stuck in a low growth band, putting it at risk of recession,” says Els. “The US rate cycle is likely to continue at a slow upward pace, considering growth concerns, slow wage growth and continued below-target inflation. This is despite a sharp drop in the unemployment rate since 2010. As a result of a very slow rate upcycle, the dollar should continue to drift weaker, which would benefit both growth and too low inflation.”

Prior to 2016, Emerging markets had been through a fairly torrid time, which culminated in investors abandoning and eventually writing off emerging markets, adds Nxumalo. “While Emerging Markets fundamentals continued to deteriorate during this time, investors were content to invest in developed markets and were handsomely rewarded for that,” he explains.

“2016 signalled a change as Developed Markets started to show the same concerning factors as the Emerging markets environment, with volatile economic and political events such as Brexit and the Trump campaign. As such, Developed Market valuations, most specifically in the US, are currently at very high levels. This has led to a sharp rerating in Emerging Markets, which has sent them higher.”

Back home, South Africa is seeing a slightly more optimistic outlook, according to Els. “Despite recent political uncertainty, there is currently a sharply improved short-term cyclical outlook for South Africa compared to earlier in the year. The rand is looking more stable and stagflation turned out to be milder than earlier anticipated, given better recent growth data and milder inflation.”  ”

Els says that a low US interest rate upcycle, a stable to weaker dollar, an improved Chinese economy and stable commodity prices are all contributing factors to the stabilising rand. “In addition, an improved Emerging Markets environment, plus SA’s smaller Current Account deficit, could also help to contribute to a better rand over the next year to 18 months,” he explains. “This is assuming a potential ratings downgrade has already been priced in. Obviously, the avoidance of a downgrade and political/policy stability could enhance this scenario.”

Regarding inflation, the outlook has improved recently with actual price increases sharply lower than earlier in the year. “The peak in the current cycle was the 7% recorded in February this year, and despite a slight drift higher from July’s 6% to about 6.6%/6.7% by December, it is likely to be sharply lower in 2017 and could be below 5% by May 2017.”

Growth is looking somewhat better outlook, according to Els, and the risk of an imminent recession is reducing after recent strong Quarter two numbers. “Quarter three is likely to be weaker again, with some payback likely,” he says. “But if the average GDP growth in the second half of the year is roughly the same as the first half, the 2016 growth will be about 0.5%”.

Els says that, unfortunately, medium to longer term growth prospects are not promising without meaningful economic reform. “However, we expect growth to rise further to about 1.3% in 2017, with possible surprise upside growth if Emerging Markets’ remain flavour of the day and confidence improves.

“Still slow economic growth, combined with a better inflation outlook – including a sharp fall in inflation during the first half of next year – should not only assist the Reserve Bank from hiking rates further, but will likely lead them to cut in rates during the second half of 2017,”.

Old Mutual Investment Group

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