Countries across the world are recovering differently from the COVID-19 pandemic. The varying extent of infections, stringency of lockdowns, and government stimuli mean that countries are looking at different recovery curves, and therefore present differentiated opportunities. This is segregating markets that are usually clubbed together, as emerging or developed markets, and splitting up the usual baskets for global investing.
Recent Fitch and Bloomberg studies on emerging markets highlight this divergence. According to the reports, indicators such as market performance, GDP outlook, and fiscal debt place countries such as India, Indonesia and South Africa on a different footing than other emerging economies such as China, Korea and Taiwan. A similar divergence can be seen in the developed markets, with the still raging virus and political uncertainty threatening current valuations in the US. Table 1 presents our estimates of global GDP growth over the next four quarters.
From a retail investor's perspective, this makes entering international markets a bit more complicated. However, the need to diversify is stronger than ever, as concentrating your investments in one market may expose you to greater risk of uncertain recovery. This is especially true for the Indian market; Indian equities are looking at an uphill struggle due to a weak capex cycle, continuing demand and supply shocks with a rising COVID-19 graph, bank credit de-growth and no immediate relief from fiscal stimuli.
Amidst all the uncertainty, and the contradictions in economic outlook and market behaviour, we are looking at two key indicators for our research recommendations in this period: rate of economic recovery from COVID-19, and outlook on equity valuations. Let's look at how these indicators can help us identify a steady course of action in global investing.
(R)Acing the curve
Different timelines and intensities of COVID-19 infections have led to different states of unlock across countries. Nations that are past the peak of COVID-19 infections have been able to kick-start their economies, posting better-than-expected trade and manufacturing data, and will therefore benefit from greater price momentum as optimism builds up. For example, research estimates that the 2021 growth for Australia and New Zealand, countries with early success in flattening the curve, will be higher than the US .
China, the earliest country to cross the peak, has been pegged by the IMF as the only economy in the world to avoid a contraction this year, while its growth in 2021 and 2022 is expected surpass that of its peers. This estimate is supported by expansionary service and manufacturing PMI data since May, and the country's ability to counter disruption to supply chains and foreign demand through domestic production and demand.
In turn, the steady recovery in macro conditions across the second half of 2020 are creating headroom for further expansion in both, earnings per share and price to earnings ratio (PE) for China A and China H equities. We estimate potential upsides of 20 per cent and 60 per cent, respectively for the China A and H equities over the next two years.
When compared to India, therefore, whether in terms of economic growth or potential market returns, China's position on the curve is its biggest advantage right now. Looking forward, with India's GDP expected to shrink, and its earnings recovery uncertain, China represents a strong diversification opportunity for investors.
Valuation windows
For an illustration of the valuation opportunities in global markets, we can look at the Eurozone. Rated ‘Neutral' as a market by our global research desk since last year, the Eurozone entered a recession in the second quarter this year on the back of already anaemic growth. However, better-than-expected economic recovery, the recent agreement on the Euro 75 Bn EU Recovery Fund, along with European Central Bank's planned quantitative easing up to end-June 2021, have significantly improved economic sentiment and investor confidence in the region.
With more than half of Europe's STOXX 600 index comprising cyclical sectors, the region's equities are particularly well-positioned to benefit from this economic rebound. Given the structural composition, European equities (especially in comparison to the US) tend to have a heavier weight in ‘cheaper' sectors. Even the valuation for Europe's IT sector remains greatly below that of the US. Investing in Europe thus offers a play on value, and should benefit during the expansion phase of the business cycle.
According to a recent Bank of America Global Fund Manager Survey report, fund managers have been rotating into European equities, seeking greater exposure. There was significant rotation into European equites in August, making it the topmost overweight region at that point. The survey further reveals that Fund Managers' current positions in Europe have still not reached their long-term average, indicating a continuation of inflows if the pandemic is kept in check.
Valuation-wise, we believe European equities are trading cheaper than their estimated FY21 earnings, and our team expects a long-term upside potential of +18.4 per cent by end-2022. This is relatively attractive within developed markets, and also offers Indian investors the opportunity to invest in larger, more stable companies at fair prices.
Conclusion
As markets everywhere remain noisy in the aftermath of the pandemic, and economic and market data create divergent views, knowing the right parameters to look at can make all the difference. Investing via mutual funds remains the best bet for retail investors new to global markets, whether through feeder funds available in India, or as direct investments abroad. The Indian market is already reflecting this, with September inflows into Fund of Funds investing overseas showing a 470 per cent increase over August inflows.
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