18 May 2020
Key highlights: RenCap COVID-19 update: Temperature Check – handling the potential second wave of the virus, making toughest investment decisions – who’s better placed to rebound quicker?

Renaissance Capital online press briefing: ‘RenCap COVID-19 update: Temperature Check – handling the potential second wave of the virus, making toughest investment decisions – who’s better placed to rebound quicker?”

 

Key highlights

Daniel Salter, Head of Eurasia Research & Head of Equity Strategy

Potential equity market winners and losers if the rebound continues: Based on the rebound from previous crises, our research shows that at the sector level consumer discretionary, materials, IT and energy are most likely to outperform over the course of 12m during an EM rebound; with communications, utilities, healthcare, consumer staples, industrials and real estate most likely to underperform. At the country level, we found Russia, Korea and Thailand most likely to outperform; China, Malaysia, Mexico and Turkey most likely to underperform.

On COVID-19 damage: Taking the latest IMF forecasts vs the growth we would have seen had the October 2019 base case materialised, we can get a sense of the overall damage the virus will cause. China, Indonesia and Argentina emerge with the smallest gap between current projections and where they would have been under the old assumptions, while Greece, Thailand and Mexico have the largest. In FM, Ivory Coast, Bangladesh and Vietnam are the closest to the October 2019 base case, while Croatia, Mauritius and Slovenia are the furthest away.

Very little inflation pressure in EM this year: only Turkey, Pakistan and Egypt expected to have meaningful inflation above 4% in EM. Also no major current account issue in EM – less than 5% of the MSCI EM index by weight is expected to have a a current account deficit of more than 3% of GDP. But some big deficits in Frontier – 17 countries or 78% of the index has a current account deficit of over 3% of GDP (12 countries of 64% of the index over 5%). We will see some enormous budget deficits – over 10% in South Africa, Saudi Arabia, China and the UAE. Approaching it in Brazil, Pakistan, Greece. And this leaves some countries with very high debt burdens – Greece 200% of GDP, Brazil 100%, (Egypt 87%), Pakistan 85%, South Africa at 77%. Russia looks great here, at 18%, gov’t debt to GDP the lowest in EM – one of the reasons we think the fiscal space is so important

In the equity market rebound to date, as we expected, DM is leading EM which is leading Frontier, with DM up 25%, EM up 19% and Frontier up just 7% from the global equity low on 23 March (all figures in $). And within EM Emerging Asia is outperforming EMEA which is outperforming Latin America, with Emerging Asia up 20%, EMEA up 18% and Latin America up 12% from the global equity low on 23 March. We think there are two things at work here. The first is progress in tackling the virus itself and coming out of lockdowns, second and arguably more important is the economic and particularly fiscal capacity countries have to deal with the crisis.

 

Charles Robertson, Global Chief Economist, Head of Macro-Strategy Unit

On Trump (non) re-election: In the last 100 years, the three US presidents who have fought a second-term election after a recession late in their first term have all lost: Hoover, Carter and Bush Snr. We should therefore assume a Democrat victory in November 2020. The Trump presidency has promoted protectionism and injected event risk into the global trade and investment arena and will continue to do so until November. We have seen US foreign direct investment (FDI) abroad fall significantly, while EU and other investment into the US has meant that net FDI has turned dollar positive. Dollar strength has damaged EM returns.

On Democrat presidency’s implications for EM: We expect a more stable Democrat presidency would improve the global investment climate, which will encourage firms to seek the best returns globally, without fear of sudden tariff wars. We believe the strong dollar, already roughly 10% overvalued relative to its long term, could depreciate, supporting US export jobs and helpfully offsetting US deflationary trends. For EM investor returns, a weaker dollar tends to be helpful. More FDI into EM by US companies is a positive both in terms of greater capital efficiency of US companies themselves and in terms of lifting investment in EM. We expect the COVID-19 recession will have three medium-term effects, each good for emerging markets, but might add political risk to energy exporters and those facing elections in 2020.

On lockdowns in large-population low-income EM and FM: Testing data suggests lockdowns do not work in lower income countries where the virus has arrived in significant numbers already, but clearly do in high income countries. The reality is that running lockdowns is not an option for many emerging and especially frontier markets.

On epidemic’s political implications: While we cannot estimate the economic toll yet, we can for sure anticipate political consequences across countries with upcoming elections, including Ghana, Ivory Coast and Romania. As for oil producing countries, if oil remains low long enough, this may result in improved democracy or regime change, as was the case with the Soviet Union back in 1980s.

On China and rest of East Asia managing the aftershock: The economic data for the last 1.5 months is pretty bullish out of China -  their PMI did come back in March, and the trade figures were much better for Korea in April telling us the trade in East Asia has been performing surprisingly well. Evidently, China Korea and Taiwan are the countries fighting the virus most successfully, and will also be the countries coming out of the virus with least economic impact. Trade does get destabilized with US-China tensions, with tariffs threatened by the U.S. and the Chinese currency potentially weakening as a result. The investor allocations can go to other EM regions or stay in the U.S. as the safe heaven. This makes the next few months pretty volatile.

On the second wave of covid-19: The second wave of the virus is well under way in countries like Iran, for example, showing what happens when you fail to contain it and ease the lockdowns. Potentially, in countries with successful testing there can be no second wave at all. Russia has got less problems than most, due to its large health system relative to the population, compared to other emerging markets.

On pressure on currency pegs in GCC countries: The negative scenario here is pretty minimal and given how little difference a few percent move in the currency would make they are unlikely to do it. They have all shown before how to use deflationary pressures to bring the overvalued currencies back into line. A few years of deflation tends to make the difference – it’s not the currency pegs that will go but rather the earnings story out of Gulf companies is not going to be very attractive due to non-positive returns – the difficulty that stems from this.

On Nigeria current account deficit and oil price impact: Lots of damage has already been done but we are assuming oil will go back to about $40/bl by Q4 and higher in 2021, but this is not an ideal scenario for Nigeria until it turns itself into an industrial economy It’s going to be a few challenging years for Nigeria, with the budget not being sustainable at this exchange rate, in order to keep that budget manageable. Nigerian authorities have done well to take the IMF loan, to unify the exchange rate and to suggest that the fuel subsidy is gone forever – that is an improvement for Nigeria in the mid-term. However, Nigeria is going to be in a difficult phase.