The global economic recovery continued throughout the quarter, and the OECD now expects world GDP for 2020 to contract by only 4.5%, compared with 6% in their previous forecast from June.
The key reason for the improvement is the unprecedented stimulus, both fiscal and monetary, that has supported household incomes and kept companies alive.
Global indices gained broadly during Q3, with MSCI Emerging Markets up 9.6%, MSCI Frontier Markets 8.3% and MSCI World 7.9%. Their year-to-date figures now show surprisingly few signs of the recent turmoil, and MSCI World is up 1.7%, while MSCI Emerging Markets is down only 1.2%. MSCI Frontier Markets lags however, down 8.8%.
Headline figures rarely give the full picture, though, and going into the details and reading the management reports of our strategies over the quarter reveals interesting diverging trends.
On the economic and stock market front, what stands out is China. Already during Q2, when most countries saw their GDPs contract at a record pace, China posted a 3.2% gain and was the only G20 country showing growth. Since then, numbers have continued to improve, with strong real estate and auto sales as examples, with China successfully controlling the pandemic and managing to restart its economy.
Its success in shifting the economy from a mainly export-driven to a domestic consumption and investment-driven model, with important implications for the country’s ability to deal with the US’ harsher stance on trade and technology, is a recipe for its resilience towards weaker global demand.
For the rest of emerging markets, and especially those outside Asia, the impact has been harder and the recovery weaker. Many countries in Africa and Latin America will likely need longer to return to pre-coronavirus (COVID-19) levels, partly as they have not had the full ability to use fiscal stimuli due to weaker public balance sheets.
South Africa, for example, is anticipated to contract by 11.5% this year and grow by only 1.5% next year. Also under pressure is Turkey. The weak global environment, combined with geopolitical conflicts and policy errors, has put Turkey’s FX in a downward trend which creates a significant risk for inflation running out of control.
In Europe, the frontier and emerging countries of the region have not been able to escape the dire environment, but in Eastern Europe we anticipate a much faster recovery than in Western Europe. Many of these countries have far less public debt and remain an important part of the EU supply chains, with both affordable and skilled labour and a productive manufacturing sector thanks to huge past investments. This makes them well positioned for the nearshoring we expect to happen when global trade picks up. They are also expected to see a steady inflow of both EU recovery and cohesion funds, equivalent to up to 35% of GDP in some countries, which will allow for structural growth for years to come.
Looking at equity markets, it is clear that growth stocks have massively outperformed value stocks, and tech-related, including “digital leaders”, have outperformed traditional sectors and companies. This is equally true for both emerging markets and developed markets.
Among the regions we invest in, Asian countries with strong footprints in the technological sector rank among the best markets this year. Central European and Balkan countries on the other hand, with more traditional and banking-heavy sector compositions, have unsurprisingly shown much weaker returns.
It is important, however, to note that their lagging returns do not necessarily reflect deteriorating trends in underlying fundamentals, just a low investor appetite for value stocks. We expect the latter to change once the pandemic is under control, which should hopefully happen next year. The outlook for these equity markets therefore remains attractive.
When it comes to emerging market tech stocks, these followed the global trend. Chinese e-commerce giant Alibaba gained 36% during the quarter, while leading Russian tech company Yandex was up 30%. The latter also announced that it was in talks to acquire online bank Tinkoff, up 31% during the period, paving the way for an entry into fintech. In Poland, we saw the record-breaking IPO of Allegro, a “local Amazon” with 36% domestic market share, which attracted massive demand and a post-market valuation of $11bn.
When it comes to geopolitics, uncertainty remains high. Relations between the US and China have not improved, and both had a consulate of the other country closed.
In Eastern Europe, the poisoning of Russian opposition leader Alexei Navalny resulted in the EU hardening its stance on the country. We also saw a dubious presidential election in Belarus, which led to massive and still ongoing protests in the country, as well as a flare-up of violence between Armenia and Azerbaijan in the disputed area of Nagorno-Karabakh; two events that raised fears of Russian involvement.
While all this is a clear negative for sentiment, the impact on markets is likely limited, as we expect any sanctions stemming from these to be aimed at individuals rather than the financial systems or corporates.
Finally, we have the US election coming up in November. There, at this stage, the key worry is on the electoral process rather than the outcome, and any narrow result risks being contested. In terms of election outcome, a Biden win will likely help risk premiums come down and act as a support for global markets, while a Trump win might be the preferred choice for the US domestic economy, thanks to his more lenient policies on tax and regulation.
Looking ahead, a stronger-than-expected recovery has supported sentiment and markets, but the pace of improvement has slowed, and uncertainty on the future recovery has increased. In the US, a lack of new stimulus, combined with a potentially turbulent election process, poses a key risk, and tensions with China are likely to endure.
In the EU, a rising number of COVID-19 cases has dented sentiment, and leading indicators now imply a contraction in the service sector. Despite this, we see a limited risk of a broad correction thanks to all the measures taken by governments and central banks throughout the year, as well as better knowledge on the virus. The abundance of liquidity also remains in place, as does the demand for risky assets supported by low rates and a “hunt for yield”.
Finally, we find that a continued high valuation discrepancy between growth and value stocks offers good opportunities for stock selection, especially within emerging and frontier markets.