CA-EN Advisors

Diverging vaccination rates a concern for emerging markets

The recovery in emerging markets has taken a turn for the worse over the last two months.
August 2021

The post lockdown boom has continued for most advanced economies. In the July update to the World Economic Outlook, the IMF upgraded the growth forecast for advanced economies by 0.5%. This was led by the U.S., which received a 0.7% upgrade resulting in expected GDP growth of 7% for 2021. Yet, there are signs that the rapid pace of the recovery in the first two quarters is cooling in the second half of this year. The primary reason for this is the spread of the Delta variant, but also expiring stimulus programs and persistent goods and labor supply shortages.

In the U.S., the $300 weekly unemployed benefits that supported consumption over the last year have now dropped off in 25 States. Personal disposable income, which grew by 33% in Q1, is now expected to return to single digit growth. Housing has been the biggest star of the recovery, however, peak growth may have been reached last month. New home sales contracted -6.6% versus an expected 3.5% gain. Median house prices increased by an impressive 6% in June, but still less than the double-digit gains of the previous months. When it comes to rents, many had anticipated a wave of evictions after the onset of the pandemic last year. This was postponed by a federal moratorium on evictions, a key relief policy that also expires at the end of this month. According to the U.S. Census Bureau an estimated 16% of renters are behind on their rent and could face eviction.

Eventually, the extravagant fiscal and monetary support that has propped up the recovery will come to an end. The negative impact on growth may come sooner and be more severe than many expect. The U.S. posted annualized GDP growth of 6.5% for Q2, considerably below the consensus of 8.5%. With unfavorable demographics as well as weak productivity growth the sad yet true story for most advanced economies is a trend rate of growth between 1-3%. A return to this world of low growth is what we expect. The challenge for policymakers is getting there in a relatively smooth fashion.

Unfortunately, the recovery in emerging markets has taken a turn for the worse over the last two months. The IMF downgraded its GDP forecast for emerging economies by 0.4%. ASEAN economies outperformed in the latter half of 2020 and the beginning of 2021 due to their handling of the pandemic. Now the region is the epicenter of the virus and specifically Indonesia which is reporting an average of 45,000 daily new cases. Similarly, in Malaysia the virus has prompted authorities to enforce a nationwide lockdown. In Thailand the virus has once again delayed the full-scale return of tourist activity, which has likely caused a contraction in the economy for the second quarter. Clearly, the key variable that is splitting the world economy in two is the rate of vaccination. Advanced economies on average have vaccinated roughly 40% of their population versus only 10% for emerging markets and 1% for lower-income countries.

The exception within the advanced economy group is Australia, where only 15% of the population have been fully vaccinated. This is surprisingly low when compared to its peers. The U.S. has fully vaccinated 50% of its population, the U.K. 57%, Canada, 59%, Germany 52% and France 48%. Even Japan (28%) is outpacing Australia, despite only beginning their vaccine rollout at the end of June. Supply shortages have been blamed for the disappointing progress, as well as public hesitancy and skepticism. Australia’s zero tolerance for any increase in cases has resulted in a four-week extension to the lockdown in New South Wales, despite only a minor outbreak. Private consumption expectedly took a hit with retail sales contracting by 1.8% in June and many are now forecasting a contraction in output for Q3.

China regulatory crackdown

Regulatory authorities in China have been busy. What has been accomplished in the span of a few months may have taken decades in the U.S. or any other developed economy for that matter. Notably, at the start of this month regulators cracked down on ride-sharing company Didi Chuxing, days after it went public on the NYSE. The Cyberspace Administration of China (CAC) banned Didi from registering new users until a comprehensive investigation of cybersecurity risks was concluded. Didi shares remain around 40% below their opening IPO price. More recently, action was taken against private companies in the education sector. Tutoring companies that teach the school curriculum have been banned from raising foreign capital, making profits or listing publicly on any exchange. Two of China’s biggest tutoring companies TAL Education Group and New Oriental fell nearly 70% after news of the ban was circulated. China’s regulators have made their presence felt across a number of sectors from tech to finance to real estate. Many of their concerns are legitimate and the swiftness and efficiency in decision-making likely draws some envy from regulators watching on overseas. However, for investors the actions taken in the last few months only serve as a reminder of the increasing political and regulatory risk that comes with investing in Chinese businesses.

Market sentiment cautious amidst rising cases

The market’s attention continues to focus on the US 10-year yield with competing views still in play. Should yields be moving down because the Delta variant will force localized shutdowns, forcing the hand of central banks to keep quantitative easing in place? Will banks remain buyers despite the yields on offer as they look to invest excess capital? Or should yields be rising and quantitative easing be tapered given demand is returning and, although some supply shortages have been resolved, shortages are persisting?

Key to this is market sentiment amidst concerns of the Delta variant. Yields moved lower over the month as the concern on the Delta variant came to the fore. The benchmark U.S. 10-year hitting 1.20% at its lowest point on the 19 July before ending the month at 1.47%. The move lower saw growth and quality stocks rewarded over the month while value lagged. The pattern of a move lower in yields aiding growth outperforming value has been a regular theme of the market for a few years now.

The Fed announced that progress has been made towards its goal of reaching full employment which will ultimately mean a higher U.S. 10-year yield. However, the timing of Fed tapering remains uncertain given the surge in Delta cases and a slowing uptake of vaccines. Similarly, the Bank of England is expected to strike a cautiously optimistic note at the upcoming meeting in early August.

Valuations remain elevated despite the derating following strong reported earnings last quarter. Earnings in the U.S. have been stronger than outside the U.S. given the U.S. started reopening earlier than most other developed countries. That said, expectations are for earnings growth outside the U.S. to be higher than inside the U.S. as more economies remove lockdown restrictions.

Disclosures

Pyrford International Ltd is authorized and regulated by the Financial Conduct Authority, entered on the Financial Services Register under number 122137. In the USA Pyrford is registered as an investment adviser with the Securities and Exchange Commission. In Australia Pyrford is exempt from the requirement to hold a financial services license under the Corporations Act in respect of financial services it provides to wholesale investors in Australia. In Canada Pyrford is registered as a Portfolio Manager in Alberta, British Columbia, Manitoba, Ontario and Quebec. Pyrford is a wholly-owned subsidiary of BMO Financial Group, a company listed on the Toronto Stock Exchange (ticker BMO).

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