Undervalued assets – Feature
them to avoid a default or implement a “light” debt re-profile that leads to higher recovery value than today. The recent currency depreciation in Nigeria and the appoint- ment of a market friendly finance minister and central bank governor in Turkey are encouraging steps for these countries. Argentina is again in a perilous position, but the presidential elections may lead to a transition of power to a market friendly government which will focus on implementing fiscal consoli- dation and gradually removing capital controls which are “chocking the economy”, a scenario far from being priced on Argentina’s bond valuations today. This amounts to a big list of undervalued opportunities in emerging markets. Why is this the case? Medeiros’ research reveals that emerging market assets have struggled to attract significant and consistent flows during the past 10 years.
End of US exceptionalism
In this context, the balance of payment adjustment of 2013 to 2016 was followed by pro-cyclical policies by the US govern- ment that led to an exceptional amount of inflows to US capi- tal markets, primarily stocks, explaining why the US has a $17trn (£13.3trn) net external liability to the rest of the world, which underpins the US dollar overvaluation. Over this period, the dollar outperformed significantly, leading to lower invest- ments and GDP growth across emerging market countries. If Medeiros is right: the poor performance of US capital mar- kets in 2022 marked the beginning of the end of what has been termed US exceptionalism, which marks a massive develop- ment, way beyond that of market undervaluation. It will mean investors need to diversify their exposure to other parts of the world. This will drive the US dollar weaker and the gap between “exuberant US valuations versus depressed emerging market valuations to narrow”, Medeiros says. This gives investors much food for thought. It also reinforces the fact that the identification of undervalued assets can spread
far and wide and into unexpected areas. And the reasons can be beyond the recent market turmoil and focused on how an asset, or country, offers one of growth on its own terms. In this way, Richard Bullock, geopolitical strategist at BNY Mel- lon Investment Management, puts the case for investors to look at Vietnam. “The Vietnamese dong is heavily underval- ued, unit labour costs are exceptionally low, even by regional standards,” he says, adding: “With the tightness of the labour market and growth in activity, real wage growth will be strong over time, boosting consumption. GDP growth is resilient and sustainable – at around 5% plus. And it is one of the only coun- tries to avoid economic contraction during Covid.” Indeed, according to some estimates, Vietnam will become one of the 10 largest consumer markets in the world by 2030 – bigger than Germany or the UK.
Market divergence
We expect slowing growth and sticky inflation to bring greater dispersion between
companies. Helen Jewell, Blackrock
There is another dimension to the undervaluation argument in markets. This is simply that there can be a divergence of rea- sons for companies to be valued, with differences between stock markets justifying different valuations as well. The high valuation on the US market can be seen as driven largely because its market contains several huge companies producing solidly growing earnings in high-growth sectors – inevitably in technology. Those are things investors are happy to pay high valuations for – or traditionally they have. The UK, by contrast, is dominated by some sectors that are less highly prized, such as miners, energy companies and banks. These sectors have seen their valuations dip recently, contrib- uting to the cheapness of the UK market overall. Here numbers from Schroders show that valuations for com- panies in the UK materials sector are 22% below their 15-year average, which can also be thrown into the undervalues mix. Based on the same analysis, valuations on financials are 32% below and energy 33% below. Other indicators show a diver- gence between different areas of the market. Using an earn- ings-per-share measurement, for example, the FTSE100 is forecast to fall 2.9% in the coming year, while it is expected to grow 7.9% for the FTSE250 and 11.6% for the FTSE Small Cap. That could suggest it is Britain’s smaller companies that have the best chance to raise their valuations from here. But another view is the on-going economic environment will result in the undervalued trend continuing. Helen Jewell, dep- uty chief investment officer of EMEA at Blackrock, says: “We expect slowing growth and sticky inflation to bring greater dis- persion between companies. This presents opportunities for active stock pickers to generate attractive returns – even if the market overall remains flat.” So the search for undervalued assets is something investors should be considering, if they have not done so already.
Issue 125 | July-August 2023 | portfolio institutional | 23
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