Market report January 2021

day 29.01.2021 * Reading time: 10min.


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Market Report January 2021

Emerging markets compared to developed markets, a few words about the current situation, the longer term and the charms of emerging markets

In 2020, the MSCI Emerging Markets Index rose 19.1% in local currencies, ahead of developed markets’ returns:

Historical results do not guarantee future results. As of December 31, 2020. Index returns presented in local currency.
Source: Bloomberg. MSCI, RCieSolution Research

Emerging market equities, especially in the wake of the continuing pandemic, have some odium from previous years’ performance. Emerging market equities rose in 2016 and for much of 2017. During the remainder of the period, they were unlikely to be in the favor of investors, fueled by intensified US-China trade tensions, costly technology warfare and a global pandemic. In 2020, for example, India’s GDP contracted by almost 11 percent. Some emerging countries, such as China and South Korea, may bounce back faster than developed economies because they were relatively well prepared to absorb the economic effects of the COVID-19 crisis. And while countries like India and Indonesia are struggling, emerging countries together experienced a much milder decline in the PMI index – a key economic outlook index – suggesting they may have an advantage in rebuilding economic potential. The possible shift in attitudes in global trade policy bodes well for emerging-market stocks, and the new US policy under Biden could help defuse trade tensions between the US and China. A shift in tone would certainly restore stability and predictability to the benefit of trade, technology development and exports throughout Asia. Whether this will happen, however, the future will show.

Chart: Emerging markets lead the economic recovery

Historical results do not guarantee future results. As at December 31, 2020 Industry
PMI: EM: Markit Emerging Markets Composite PMI SA. DM: Markit Developed Markets Composite PMI SA
Source: Bloomberg

There are numerous signs that emerging countries are better able to deal with the economic and health crisis than developed regions. China was a leader in the recovery, and the world’s second-largest economy quickly developed plans as growth accelerated. Industrial production has already reached pre-crisis levels and the new five-year plan (“The Fifth Plenum”) includes measures to reduce dependence on US technology. We believe this will benefit Chinese technology innovators and many companies across the country and in Taiwan.

The lower level of relative debt gives EM another fundamental advantage. Developed markets, led by the US, have entered a pandemic with much higher indebtedness than many emerging nations. The US debt-to-GDP gap is expected to grow further relative to emerging markets. This is likely to help EM currencies gain against the US dollar. If history could be a forecaster, a weaker US dollar would benefit emerging market companies and increase their return potential.

The climate of low interest rates is another catalyst for restoring the potential of emerging markets. Historically low rates should boost key industries such as mortgage lending and possibly the automotive industry, but the economic benefits should extend across the asset class.

Chart: Emerging-market stocks are significantly cheaper than developed market stocks

Historical results and ongoing analysis do not guarantee future results. As of December 31, 2020, in US dollars, based on earnings per share estimate consensus.
Source: FactSet MSCI

Progress towards recovery from COVID-19 can increase Investor confidence by refocusing them on fundamental strengths and the growth potential of select emerging market companies.

The situation on the global credit market

Enforced economic blockades increased the level of loan defaults and led to a wave of downgrades in investment ratings from investment to high yield. The structure of credit markets has changed, the weakest borrowers have been removed from both the investment and high-yield levels, while increasing the size and depth of the high-yield market. Both markets offer greater opportunities across the credit spectrum for Investors looking for a balance.

The migration of Fallen Angels from the investment level has significantly increased the size of the US and European high-income markets by approximately US $ 200 billion and € 50 billion, respectively. Among these Fallen Angels are some of the most famous and respected names in the business world, including Ford, Rolls-Royce, and Carnival. Their arrival significantly improved the overall quality of the High Yield Index, increasing the share of BB rated loans in the US from around 48% pre-COVID-19 to 54%. In Europe, this new inflow of debt also deepens the market and consists mainly of “non-maturing” bonds, the issuer of which cannot be redeemed early (“non-callable” bonds). These factors are attractive to long-term investors such as pension funds and insurance companies and therefore increase the demand for high yielding assets.

The US high yield index is rated higher due to the influence of fallen angels – the share of BB-rated debt in the structure of the high-yield debt index is the highest in 10 years.

Chart: Structure of the US high-yielding market by rating (%)

Historical and current analyzes do not guarantee future results. As of December 31, 2020
Source: US High-Yield Bloomberg Barclays Index.

I believe the probability of loan defaults is around 6-7% in the US and 4-5% in Europe, which is in line with the forecast consensus. During last year’s lockdowns, weaker loans were removed from the indices due to defaults. It is possible that the current situation is an escalation of accumulated negative factors and that future default rates will decline as economies recover.

Although corporate leverage hit record levels of 2.9x in US investment markets, 5.3x in US high-yield markets and 6.3x in European euro high-yield markets (as of June 30, 2020), the risk of high absolute lending levels can be mitigated by several important factors. First, there was a record new issue in 2020, which strengthened liquidity buyers and postponed their bond maturities. This should give companies more time to run out of debt and help them weather the rest of the crisis. Second, debt servicing costs have fallen, despite an increase in actual debt, thanks to record low interest rates. Third, I expect profits to increase in most economies. While several business sectors will continue to struggle, most issuers should be able to generate additional cash flow after paying interest on their bonds – despite deteriorating performance due to further lockdowns.

Constructing a socially responsible investment portfolio, i.e. about sustainable investing

Investors turn to sustainable equity funds and their revenues break new records in 2020. However, choosing a sustainable capital manager remains a challenge. Socially responsible investing is becoming more and more popular. According to CNBC, by the end of 2020, global assets managed by open-ended equities and equity funds reached 33% of US assets under management *.


Growing awareness of environmental, social and strictly management issues, combined with lessons learned from the pandemic, is driving the urgency of sustainable investment programs.

What does sustainability mean?

Not every sustainable portfolio clearly explains how it integrates sustainability into its investment process. Investors should look for managers with a clear and consistent definition of sustainability to understand what they are getting. Many investment managers have the United Nations Sustainable Development Goals (SDGs) as their roadmap. But because it is a broad set of concepts, Investors need a practical plan to translate the SDGs into investment ideas that can be realized. In my opinion, the SDGs are a set of forward-looking opportunities that can influence investment topics and help define the investment universe.

How are ESG factors taken into account in the investment process?

ESG has become synonymous with responsible investing. But a catchy acronym doesn’t create a clear process. ESG factors should be seen as an integral part of the value proposition for any enterprise. Simply put, you cannot price a company without taking ESG factors into account. From the risk related to climate change, through diversity, to good management, ESG factors can have a significant impact on the company’s financial results and should be significantly taken into account in the valuation process carried out by the Investor. Many Investors rely on external ESG ratings to assess the company’s sustainability. However, ESG ratings by themselves cannot define durability or serve as a true proxy for responsible investment impact. These ratings can play an important role in the sustainable investment process, but they are also somewhat fleeting. For example, ESG ratings do not have standard methodologies, so company ratings can vary greatly from agency to agency. While issuer credit ratings are approximately 90% correlated between suppliers, ESG Equity Ratings are less than 50% correlated between agencies. And because ESG ratings are based on publicly available information, they reward companies that can meet reporting criteria, rather than best practice. Therefore, a balanced portfolio should demonstrate an independent ability to quantify ESG factors at enterprise level. Investors should look for sustainable managers that go beyond third party ratings and conduct their own research to evaluate the relevant ESG factors of investment candidates and holdings.

Are engagement initiatives part of the strategy?

Commitment to the company’s leadership is a key tactic used by active capital managers to promote positive change. Engagement strategies vary. Some portfolio managers may think that sending an email to the company counts as engagement points even if no response is received. In my opinion, commitment is to create a productive partnership with management aimed at making progress in various areas over the long term. This does not mean sympathy with the management, it is rather about developing relationships that will allow investors to exert influence and foster positive changes, often in controversial issues, from the position of mutual respect.
This type of commitment takes time, patience and many years. Investors need to understand that real change doesn’t happen overnight. I believe playing an active role in promoting positive change ultimately helps companies perform better and supports long-term payback potential.

Volatility accompanying stock markets recovering

Volatility continued into 2020, even after stock markets rebounded. The daily volatility of the MSCI ACWI index was 28% – almost three times more than in 2019. The index increased or decreased by at least 1% in 90 days in 2020 – more than three times more often than in 2019.

Chart: Volatility of the MSCI ACWI Index

Historical results do not guarantee future results. Data as of December 31, 2020 Volatility is the annual standard deviation of daily returns.
Source: Morningstar, MSCI, AllianceBernstein (AB), RCieSolution Research.

Restoring global economic growth will be an uneven process that will be determined by fiscal policy, public health concerns and consumer confidence. These are some of the risks that may continue to drive volatility this year. In this environment, it is important to consider investment strategies that can help Investors obtain good sources of long-term return potential, but that are also designed to help reduce risk during deeper market corrections.

Rafal Ciepielski

Rafal Ciepielski

CEO RCieSolution

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The views expressed in this document do not constitute research, are not investment or commercial advice, and do not necessarily reflect the views of all management teams. They change over time.