EM equities: wary of second-round effects
The covid-19 outbreak has put significant pressure on oil prices, straining the OPEC+ agreement and leading Saudi Arabia to open the floodgates. Beyond oil prices – which may remain low over the coming months – this shock further weakens a world economy that was already on the brink of recession.
Producers will now have to cope with much lower revenues than anticipated. This will impact balance sheets, notably in the highly leveraged US shale oil industry, which may in turn hurt US growth. The public finances of commodity producing countries will also be impacted as many heavily rely on high oil prices to balance their budgets. Central banks are likely to be strong-armed into injecting further liquidity to avoid systemic chain reactions.
While developed economies, especially in Europe, are still bracing for the epidemic’s full impact, China could be the first to emerge from the crisis. The virus seems to be under control or receding in other major Asian economies too. On the economic front, business activity is gradually being rebooted. The industrial sector seems to be recovering faster than services. Daily coal usage by major power generators suggests industrial production reached 80% of its normal level on 10 March, but daily property sales volumes are only 40% of the historical average.
However, given the significant uncertainty surrounding covid-19’s further spread, additional negative effects on the world economy should not be ruled out. We recently revised down our 2020 Chinese GDP forecast to 4.8% (from 5.6% previously). Nonetheless, we expect production to accelerate now that the virus appears to be under control and local governments are shifting their priority to boosting growth. In addition, we expect the Chinese central bank to continue its easing policy and more fiscal stimulus from the central government, especially in the infrastructure space. After the Q1 slump, Chinese growth should pick up in Q2 and throughout the rest of the year.
We remain comfortable with our current positioning: underweight EM equities overall, but with a preference for EM Asia, and particularly China. To change our stance, we would need a slowdown in the virus’s propagation, and coordinated fiscal and monetary responses, notably in developed economies.
We maintain our year-end target of USD 1,080 for the MSCI EM index, assuming that forward earnings will recover by then and that valuations will remain supported by very accommodative conditions worldwide. Risks to our target are still tilted to the downside in the short term as policy mistakes or domino effects from the current shocks could still materialise.
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