COVID vs Geopolitical Risk vs EM Risk – Which Risk is Bigger?

September 2021 Monthly CiN-sights

Major global equities extended their winning streak, setting fresh all-time highs despite ongoing concerns on the delta wave of Covid-19 variant and increasing geopolitical risk. Appetite for risk assets particularly in the US, continued unabated through August, with S&P500 and Nasdaq gaining 3.0% and 4.0% respectively.

Domestically, economic activity has been weighed down by the destructive delta dynamics. The length and severity of restrictions in New South Wales combined with the delayed vaccination roll-out and subsequent closure of state borders, has led many to expect that the Australian economy will report a sharp contraction in the third quarter. However, with re-opening momentum continuing to build, medium-term growth rates are expected to be less affected.

The Australian reporting season remains in balance in beats vs misses, with recently reported results softer than earlier trends. However, the reflation trade remains the dominant theme. In contrast, the second-quarter U.S. earnings season has been remarkably strong, reflected in major US indices’ prices. Of the companies reported so far, 87.7% have reported earnings above analysts’ estimates with 87.1% are beating revenue estimates. Consensus estimates for 2022 remain strong based on the continued economic re-opening and continue to support currently high market valuations.

In the near term, we see Covid-19 related headwinds stemming from the continued impact of supply chain disruptions, semiconductor shortages, as well as rising wages and input costs on profit margins. Overall, global supply-side indicators remain tight: Covid-19 induced supply chain disruptions have pushed the price of shopping to the highest level seen in more than a decade; commodity markets are also facing growing supply challenges in light of growing global geopolitical tensions, including the higher risk premium warranted in oil prices due to US-Iran conflict.

A geopolitical development that has negatively impacted equity markets earlier in the month was the changing regulatory landscape in China, particularly in the technology and education sectors. These policy developments though are idiosyncratic in nature, raise questions surrounding the potential for further regulatory actions and highlight the regulatory risk associated with emerging markets and especially China. In conjunction with questions on the Chinese credit policy and PPI pressures, we remain vigilant.

We continue to remain underweight Emerging Markets versus Developed Markets equities heading into the month of September, as highlighted in our latest quarterly market view.

This view has been re-affirmed by the US financial markets’ muted reaction to Fed Chair Powell’s Jackson Hole speech, which indicates that asset prices already reflect investors’ expectation that the Fed will taper asset purchases before year-end. Emerging-market assets are more vulnerable to a negative shock from the Fed’s move towards less accommodative monetary policy. Emerging market credit growth has decelerated, inflation is more muted, the trade balance is in surplus, and foreign currency debt accumulation has slowed considerably.

Fed Tapering Comes with Collateral Damage For Emerging Markets

Source: BCA Research

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