Emerging Markets: Two countries where we see opportunities
We believe the next opportunity in Emerging Markets lies with identifying the rebounds and the countries that have lagged.
Here James Syme and Paul Wimborne — managers of Pendal’s Global Emerging Markets Opportunities strategy (pictured above) — reveal two countries where they see new opportunities.
- We believe opportunities in Emerging Markets lie with identifying the rebounds and the countries that have lagged
- India and South Africa have suffered hard post-pandemic economic landings.
- Both have a huge build-up in domestic bank deposits, significantly increasing the potential for domestic demand recoveries as confidence returns.
- We are excited about the potential for the domestic demand cycle in both countries and have been adding to domestically-focused stocks in both markets.
MUCH OF the commentary on the impact of coronavirus on global economies has emphasised the unprecedented nature of the crisis.
However, the outcome is not new to emerging markets in some ways.
Sudden, brutal hard stops in domestic consumption and activity — accompanied by capital flight and spectacular correlated sell-offs in equities and currencies — have been a sporadic feature of the asset class since at least the Latin American debt crisis of the early 1980s.
That pattern allows us to look for signs indicating which economies — and potentially which markets — are in the best positions to recover.
There are particular indicators that, in our experience, show an economy has the foundations of a recovery in place — although history suggests it is usually worth looking for positive momentum in economic indicators and corporate results/expectations as well.
Looking at these indicators, India and South Africa stand out as two particularly interesting markets right now.
The signs of a hard landing in the economy are obvious: GDP, PMIs, industrial production, retail sales, imports, investment and corporate profits all fall sharply, whether the shock is country-specific, regional or global.
Clearly this has happened in India and South Africa.
India’s composite PMI bottomed out at 7.2 in April, while year-on-year GDP in the quarter to June was -23.9% and -7.5% in the quarter to September.
In South Africa the main PMI index had a lowest reading of 30.3 in April, while year-on-year GDP in the quarter to June was -17.1%.
These numbers represent huge output gaps of economies operating below capacity.
For recovery to happen, though, there has to be a source of demand.
One of these is the stimulative effect of weaker, real effective exchange rates. Weaker currencies stimulate exports (and import substitution) and can also attract capital inflows (when sufficient time has passed after a sell-off — memories are short in the carry trade).
As a result, one key metric for us is change in trade balances and current account balances. Several important historical recoveries in economies and markets have followed big upward moves in external balances.
Looking at the two markets in focus, we see India’s trade deficit averaging US$172 billion per month through 2018 and 2019, but sharply recovering through 2020. The the last two prints show a monthly deficit of less than US$95 billion.
Similarly, India’s current account balance was in surplus in the June quarter for the first time since 2004.
Both balances have also moved strongly towards the positive in South Africa as well. The trade balance in South Africa is the strongest it’s been since the end of apartheid and liberalisation. The current account balance is the strongest it has been in nine years.
While these moves are very positive, they are also seen in several other emerging markets.
Bank deposits are the key
It is another metric that makes India and South Africa stand out: bank deposits.
Both countries experienced a huge build-up in domestic bank deposits during the crisis, significantly increasing the potential for domestic demand recoveries when confidence returns.
In the year to September 2020, credit in India grew by only 5.8%, but aggregate deposits were 11% higher. The central bank noted “the increase was witnessed across all population groups”. Meanwhile the credit/deposit ratio declined to 72%.
This huge growth in incremental deposits was coincidental with an undershoot of consumer spending and private sector investment.
With the central bank’s reverse repo rate sitting well below the banking system’s average cost of funds, there is very real economic pressure on banks to grow credit as soon as demand returns.
South Africa has also seen a sharp move higher in bank deposits. In the year-to-date up to September, public sector deposits were up ZAR95.3bn (US$6.3bn), private sector corporate deposits lifted ZAR109.0bn (US$7.2bn) and household deposits grew ZAR97.1bn (US$6.4bn).
After sharp falls in interest rates there is huge potential for a drawdown of South African bank deposits to drive investment and consumption.
Excess saving has been a global problem since at least 2009.
There is only so much that conventional monetary policy can do in an absence of demand and Keynesian “animal spirits”.
It may partly fall to government spending to convert private sector savings into end demand.
But with improving coronavirus case data in both countries, a vaccine potentially to be deployed soon and other parts of the global economy picking up, we are excited about the potential for the domestic demand cycle in both countries.
We have been adding to domestically-focused stocks, notably banks, in both markets.
James Syme and Paul Wimborne are senior portfolio managers and co-managers of Pendal’s Global Emerging Markets Opportunities fund.
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