While the global impact of Brexit remains highly uncertain and concerns mount over the potential domino effect of other countries leaving the EU, Emerging Markets appear to have been handed a surprise boost following the recent period of underperformance. This follows Brexit’s reinforcement of a low interest rate world, which has led to global investors having to look towards Emerging Markets in their search for yield.
According to Rian le Roux, Chief Economist at Old Mutual Investment Group, the fallout from Brexit will result in central banks leaning even more towards policy easing, which will involve either additional easing or the prolonged maintaining of existing easier stances. “The Fed has already backed off and the minutes of the June meeting before the Brexit referendum specifically referred to Brexit risks as a reason to postpone the next hike, which is now commonly only expected in December,” says le Roux.
He goes on to point out that forecasts continue to vary widely, the global impact of Brexit is still highly uncertain and as such drawing specific conclusions at this stage is a hazardous exercise. “However, a rather evident longer term threat of Britain leaving the EU is the risk of other countries following suit, or at least threatening to leave the EU. As a result, the EU will likely be quite hard on Britain so as to put paid to any thoughts of similar moves by other countries,” le Roux explains.
While markets initially sold off, then recovered sharply, le Roux warns that uncertainty will likely filter back in as negotiations get under way and/or pressures in other countries mount to also leave the EU. “Markets will also focus on the actual impact of Brexit on global growth and earnings as the situation continues to unfold,” he says.
“But a key point to note in the markets is still the positive impact that Brexit has had on Emerging Markets. The aftermath of Brexit has reinforced, somewhat strongly, the realities of a low return world,” says le Roux. “With this in mind, Emerging Markets with beaten down currencies and high-yielding assets may experience renewed interest from global investors as they go on the hunt for yield.”
Siboniso Nxumalo, co-head of OMIG’s Global Emerging Markets (GEM) boutique backs up the view that Brexit has been constructive in influencing the search for yield in Emerging Markets. “The decision to leave the EU has increased risk in developed markets and in turn, this has led to increased caution from central bankers, resulting in a decreased likelihood of developed market interest rates rising,” he says. “The ‘lower for longer’ rates environment therefore encourages investors seeking higher returns to go into Emerging Markets.”
Nxumalo also points to the low growth/low return world that we are currently experiencing. “Against the current global market backdrop, the highest potential for returns and yields can now be found in Emerging Markets and recently we’ve seen increasing appetite for Emerging Markets assets in pursuit of these higher yields and returns.
“The highest yields we’re seeing are in commodity producing countries like Brazil, Russia, Turkey and South Africa. Incidentally these are the countries that have also resulted in strong market performance year to date,” he adds. “The Old Mutual Global Emerging Markets Fund’s biggest positions were predominantly in great companies in Brazil and Russia, which has resulted in strong outperformance and further driven by the exceptional performance of our stock selection in these countries.”
When considering the question of whether Emerging Markets are facing pain further down the line as a result of Brexit, Nxumalo believes that the current Emerging Markets rebound doesn’t have to continue for the GEM Fund to continue its outperformance. “We seek to invest our clients funds in quality business models with sustainable a sustainable competitive advantage at attractive valuations, and therefore we only need the fundamental performance of the companies we invest in to continue.”
The impact on South Africa, according to le Roux, will be predominantly through financial markets, with capital inflows a potential benefit, as the UK accounts for only about 4 percent of SA’s export market. “However, one specific area that could be negatively affected in SA is tourism given that the UK makes up some 17% of SA’s tourists.”