By Scott Gibb
A global economic divergence is unfolding, carrying risks which need to be navigated in order to access the available opportunities. Pockets of value in US financials, specific catalyst-driven stories in Japan, fundamental and event-driven opportunities in Europe along with significant growth potential in less known African stocks are forming a compelling and healthy opportunity set for investors.
Previous favourites such as emerging markets and US corporate credit appear at risk with China slowing alongside US yield curve and interest rate normalisation. Previously, yields were pushed to low levels as a result of “yield hog” investors, particularly in frontier and emerging market government bond issuances where budget and fiscal balances may have been neglected.
These market participants may realise that they are not being compensated sufficiently, given default risks and recovery rates relative to yields and divergent fundamentals. However, with dealers holding significantly diminished inventories (of bonds) due to regulations, meaning that liquidity can evaporate – and price falls may ensue as crowded positions unwind. Despite these caveats there are pots of risk-adjusted value across various geographies and sectors.
The US, with housing on the mend, consumer confidence improving, a steepening yield curve and credit growth returning, presents attractive entry-points in financials where exposure to regional banks, in particular, should reap triple benefits from yield curve steepening, credit expansion, and sector consolidation.
Looking to Asia, investors can be moderately positive on Japan following the house elections, as Abe and Kuroda continue with their monetary and fiscal drives, in addition to unveiling detailed plans for achieving structural reform, increasing labour participation and companies’ competitiveness. This provides potential for Japanese equities to continue their upward trajectory while the yen weakens relative to the US dollar. Investors should be wary though, as notoriously slow Japanese institutional investors will be important to push the rally higher.
The slowdown in China has large repercussions for numerous emerging market economies. Markets that are commodity exporters are most at risk, especially those who were not previously fiscally prudent. Countries with large external deficits could suffer US dollar shortages, with serious consequences for their economies. For China in the short term, risks of a low probability tail event outweigh the appealing valuations for most investors.
The continually troubled Europe looks to be bottoming out. The ECB president has followed in the footsteps of his US counterpart in seeking to guide markets as to ongoing monetary accommodation. Investors should remain cautious as we see possible fallout from a slow China hurting German export-led growth, alongside remaining structural debt problems. Despite this, there are attractive fundamental and event- driven opportunities in the region with many companies facing existential issues, while others flourish.
Africa – with its supportive demographics – continues to look relatively attractive, even considering a Chinese slowdown. With a broad array of individual economies, the commodity dependant will not fare as well, while others benefitting from increased consumerism and opening of financial markets offer more potential. Asset flows to Africa have been relatively significant recently, but are still not overly concerning given the size of the economies, capacity for growth and valuations relative to historical levels and considering that most of the flows we’ve seen are chasing the largest and most liquid names. There are plenty of exciting stories around stocks where there is no research coverage and significant growth.
Whilst pitfalls remain, relative growth rates and directional biases of monetary policy will provide numerous opportunities for those with independent ideas and strong risk management.
Scott Gibb is portfolio manager and partner at Cube Capital
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