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'While the country has been hit hard from a strong second wave of Covid, we believe the markets are willing to look through that.'
In an interview with Ashley Coutinho, Alex Tedder, CIO, Head of Global & Thematic Equities, Schroders Investment Management says the near-term outlook for emerging markets is clearly driven by Covid-19.
What is your outlook for US equities for CY2021? What are the key risks that could impact the bull run?
Despite optically stretched valuation, we believe there are a number of factors that can drive the US and global markets higher over the next 12 months. As lockdown is eased in key economies, confidence is returning and the momentum for economic recovery is building strongly.
Given the inventory run-down in many industries during Covid, we expect a very powerful inventory re-build cycle across most industries.
The Biden administration has announced three major stimulus programmes that are already providing significant support to the economy.
This includes the $1.9 trillion American Rescue Plan that put stimulus checks directly in the hands of US households during the Covid lockdown period.
Then you have the $2.3 trillion American Jobs plan and the $1.9 trillion American Family plan.
Not all the measures proposed by President Biden will be approved.
However, in all likelihood major components of each package will make it through both Houses.
This would provide a substantial tailwind to US economic recovery.
The US equity risk premium has fallen to its lowest levels of the past decade by some measures. Do your valuations look stretched at this point in time?
Valuations certainly appear extended based on a number of headline multiples.
And while rising bond yields have been a near-term headwind for growth stocks, and undeniably contributed to the de-rating of long duration stocks, a period of rising rates does not necessarily mean that equities will struggle to perform.
Empirically, equities have performed well in a rising rate environment, largely reflecting the beneficial impact of earnings growth which has typically served to offset an inverse relationship between equity valuations and real yields.
So while it is reasonable to expect some contraction in valuation multiples, improving revenue and earnings fundamentals should serve to more than offset this.
What is your view on India vis a vis other emerging markets in the aftermath of the second wave of the pandemic?
Indian equity markets have been laggards this year vis a vis global markets due to the severity of the second wave.
While the country has been hit hard from a strong second wave of Covid, we believe the markets are willing to look through that.
We do expect some impact in the near term earnings in the region.
But the base case expectation remains that the economy had been recovering strongly before the second wave hit and once this wave peaks out, we expect the growth to come back and the recovery to begin again, as it did earlier.
What are your views on emerging markets, especially Brazil and China?
The near-term outlook for emerging markets is clearly driven by Covid-19.
The human cost aside, the virus will limit the full economic potential of these markets for some time to come.
Vaccine supply and distribution continues to lag developed markets, which may hinder near term economic recovery in certain countries, but this should continue to improve and provide some much needed respite with some resumption of normality at some point.
New variants have shown that the virus is not easily eradicated and is still best controlled through restrictions on social mobility.
This has implications for consumption and the domestic economy more broadly.
Emerging markets in theory perform well during periods of cyclical recovery and economic expansion and should therefore benefit from the recovery in the global economy post the pandemic.
China, for example, should be a beneficiary of both industrial expansion and, the recovery in consumption given it is much further ahead in its control and recovery from the virus.
Will inflationary pressures have a bearing on global equities going forward?
Inflationary pressures are already starting to emerge, most notably through the sharp rise in commodity prices experienced during the past 6-9 months feeding into high intermediate inflation.
Although the Consumer Price Index remains subdued in most developed economies we believe that this is a lagging indicator since it includes many items such as rent which are slow to recover from a downturn.
We believe that companies utilising raw materials will pass these on rapidly to their end customers, causing final goods and service sector prices to rise rapidly in the latter part of the year and going into 2022.
Bond yields are likely to respond quite substantially to this development in our view, something that has already put the valuations of long duration stocks under pressure.
Historically, equities have been positively correlated with inflation expectations, and gradual increases in rates have coincided with positive equity returns.
Sharp moves can, however, pose a threat.
