IN THIS WEEK’S BOTTOM LINE
CONTRIBUTED BY NICK DOWNING| OVERBERG ASSET MANAGEMENT
Emerging markets do not have the same fiscal firepower as first world countries to provide lockdown financing for businesses and households nor the same central bank resources to stem liquidity shortages arising from the sudden stop to economic activity.
Global financial markets are roaring back, recouping more than two-thirds of their year-to-date (YTD) losses since hitting a bottom on the 23rd March at the peak of the Pandemic sell-off. The US equity benchmark, the S&P 500 index, which had suffered a massive 31.86% YTD drop by the 23rd March, has bounced by 35.7% from the low, trimming its loss since the start of the year to just 7.54%. The MSCI World Index is down just 9.39% YTD. Markets have been powered by the mega-cap tech stocks, which have benefited from social distancing and the need to work from home.
However, extraordinary government fiscal support and central bank monetary stimulus has provided the fuel for the stock market rally. Over the past fortnight, the gradual easing of lockdown measures and optimism over a return to normal economic activity have added further to improving investor sentiment.
Emerging markets have been less fortunate. Compared to the MSCI World index, which has moderated its YTD loss to 9.39%, the MSCI Emerging Market index is still showing a loss of 16.80%. Emerging markets do not have the same fiscal firepower as first world countries to provide lockdown financing for businesses and households nor the same central bank resources to stem liquidity shortages arising from the sudden stop to economic activity. The JSE All Share index appears not to have suffered too badly, with a relatively mild loss of 11.54% but this is skewed by the large multinational rand hedge stocks and mining resource stocks, which more closely mirror global rather than domestic economic conditions. Hence, the Industrial 25 index is actually up by 2.82% for the year, helped by an outsized contribution from Naspers and Prosus, while the Resources 20 index is down just 7.37%. By contrast, the Financial 15 index, which closely reflects conditions in the domestic economy, is still suffering a gaping 37.22% loss.
With less fiscal and monetary support at their disposal, emerging market economies are unable to sustain lockdowns for as long as first world countries, or at least until the rate of Covid-19 infections has shown a sustained decline. The threat of mass poverty, social unrest and permanent scarring to economic productive capacity has required most emerging markets to ease lockdown restrictions while infection rates and active cases continue to rise. Examples include Brazil, Russia, India, Mexico and South Africa.
South Africa moved from Level-4 to Level-3 lockdown on 1st June while infection rates, active cases and mortalities continue rising, a whole two months ahead of the expected peak rate in infections. Unfortunately, we have no choice as the funding to provide the social safety net is just not available. President Ramaphosa has an unenviable task. He has been lambasted over the past month from nearly all corners for not lifting lockdown restrictions sooner. His greatest political foe, the EFF, has remained conspicuously quiet. The EFF is arguing that the lockdown is being eased too soon and that Ramaphosa will be personally responsible for the expected rise in deaths. The vilification Ramaphosa’s government has received over the past month will be nothing compared to what is in store from the left side of the political spectrum.
As lockdown restrictions are lifted the outlook for the South African economy over the next two to three months is clouded by a likely acceleration in Covid-19 infections. This will add more pressure on Ramaphosa from the EFF and from factions within his own party, once again increasing policy uncertainty. At the same time the expected post-lockdown rebound in economic activity will remain elusive due to continued social distancing, through a combination of regulations and personal choice out of fear of the spreading virus.
Fortunately, the bad news is probably already more than discounted in the share prices of domestically oriented shares. Blue chip bank shares for instance are trading on low- to mid- single-digit price earnings multiples. ABSA is trading on an estimated forward PE multiple of just 4.7x. These kinds of valuations normally only come by once in a generation.
There are also some encouraging economic indicators showing a bottoming out in forward looking survey data such as manufacturing purchasing managers’ indices and the South African Reserve Bank (SARB) leading economic indicator, which although in deeply contractionary territory, nonetheless signal an expected gradual improvement in economic conditions. The slight uptick in survey data is attributed mainly to the benefit of sharply lower oil prices and support from a substantial 275 basis-point aggregate cut in the SARB’s repo rate since the start of the year.
While it may be advisable to use Level-3 as an opportunity to stock up on alcoholic beverages, in case alcohol restrictions return, the combination of record low valuations and the powerful effect of dramatically lower interest rates make it advisable to stock up on beaten down equities.
Read More: Overberg Market Report 2 June 2020