Global equities to be volatile before US Presidential polls: Mustafa Sagun

The CIO of Principal Global Equities says more than 20 per cent of companies and industries represented in international indices face significant long-term structural risks

India is our largest overweight given its structural growth and long-term favourable fundamental trends, says Mustafa Sagun, chief investment officer, Principal Global Equities. In an interview with Ashley Coutinho, he says more than 20 per cent of companies and industries represented in international indices face significant long-term structural risks. Edited excerpts:
 
Technology stocks have led the market rally in the US amid the pandemic. Do you see a bubble building up in the space?
 
Valuations may look stretched for the technology and e-commerce titans in the US. But for most companies, those equity market gains have been supported by powerful earnings growth, expanding profit margins and high returns on capital or ROEs. Further, many technology business models will likely emerge stronger after Covid as it has accelerated prior trends, including towards more e-commerce, digital payments, digital gaming and cloud computing adoption. Conversely, cyclical value remains structurally challenged in many industries, particularly for brick-and-mortar retail, the energy sector, and with limited upside potential for many financial institutions amid the era of continuing record low interest rates.

 

The S&P 500 has given double-digit returns annually for the past 11 years. What are your expectations for equity returns in the US for the next decade?
 
Based on the strength of performance in the past decade and corresponding valuations, lower levels of return are likely in the coming decade. However, equities may likely deliver better returns than many other asset classes, including fixed income. In the near term, unprecedented stimulus should help support global equity markets, while in the longer term the strength of the consumer should be supportive.
 
Which are the sectors or pockets of the market that you like in the aftermath of the pandemic?

 
The pandemic has pulled forward a couple of years’ worth of demand in a span of several months. Our research analysts have identified many international businesses that have benefitted from the Covid-19 environment. Examples include online retailing, e-payments, home improvement and renovation (more time spent at home will drive increased spending on home projects), automation, both in manufacturing and warehouses, renewable energy, etc. Other trends like reshoring will also pick up.
 
Has the pandemic made the job of active fund managers more difficult, given the heightened economic uncertainty globally and disruption in near-term earnings growth?
 
The year 2020 has taught us to prepare for the unexpected. With unexpected disruption comes opportunity, especially in those segments of the global equity market that are less closely followed and more structurally fragmented. Our team is looking to invest in businesses that will be beneficiaries of disruption, accelerated trends and ones that focus on sustainability. The pandemic has demonstrated how we cannot just avoid disaster but rather prepare for it. Many of the pandemic recovery plans are focusing on that through renewable energy, less pollution, and ensuring all stakeholders are heard.

 
Our analysts estimate more than 20 per cent of companies and industries represented in international indices face significant long-term structural risks. Many companies and some industries are not adapting to the rapidly changing environment. While some will remain on government life support, some others will become insolvent.
 
Which countries do you fancy right now among emerging markets?
 
We are most bullish on India, Indonesia, Taiwan and Mexico. India is our largest overweight given its structural growth and long-term favourable fundamental trends. Indonesia also has multiple attractive characteristics, including structural reforms and favourable demographics, growth in middle-class participation resulting in increased demand for financial services, and consumer purchases. We continue to like how Taiwan is positioned within the technology value chain and believe there are attractive prospects related to the 5G transition, data centres and cloud computing. Mexico is closely linked to the US and is well-positioned for a cyclical recovery as Covid concerns fade away. We see value here and believe the equities have been underappreciated by the market for a while now.

 
What about Brazil and China?
 
Brazil is experiencing a challenging financial situation with public-debt-to-GDP ratio approaching 90 per cent, driven primarily by the Covid situation. While Brazil remains a promising market, it continues to have challenges, including those related to its currency.
 
China remains in transition from being the world’s factory to being more of a consumer-driven economy. We prefer consumer- and IT-related investment opportunities here and are cautious regarding the ongoing geopolitical tensions and debt levels. We believe China may experience a turnaround in its economy due to its disciplined public health tracking and management. Domestic consumption is expected to recover faster with better visibility, while export-related sectors like manufacturing would recover more slowly depending on external demand.

 
Could you tell us more about your views on India, especially given the impact of the pandemic?
 
Despite being among countries hit most by Covid, attractive demographics reflect rising consumer trends and structural reforms intended to build a foundation for future economic growth support our positive views. Additionally, India remains outside of the China-centred manufacturing supply chain and may likely continue to deliver its steady compounding economic growth rate, which would make it a standout among EM countries in an environment of ongoing trade disputes and economic uncertainty.
 
Central banks worldwide have resorted to large stimulus measures amid the Covid-19 pandemic. What are the likely pitfalls of this move and will this lead to bubbles?

 
Overall, the policy prescriptions for the pandemic seemed timely and reasonable. Potential negative consequences could include the risk of asset-class inflation that is well ahead of inflation for goods and services and substantial increases in home prices as there is a positive link between financial conditions and home prices which makes it worse for lower income groups because housing rents are a significant proportion of household incomes. We could also see socialism in policy making allowing those companies to survive which are not generating returns above their fair cost of capital resulting in zombie companies. Finally, low interest rates would deny opportunities for new savers to deploy their savings at meaningful expected returns.

 
What are the key global cues to watch out for in the months ahead?
 
Equity markets are likely to remain volatile leading up to the US Presidential elections. Continued swings in market leadership between the longstanding new economy leaders and the out-of-favour cyclical value opportunities is expected. However, for many value sectors to sustain performance improvement, tangible evidence of broadening economic recovery is needed. The key economic implications of Donald Trump’s re-election would be continuation of low tax policies and deregulation, including a potentially antagonistic stance on ESG investing and climate policy. A Joe Biden win would likely revert to the era of more progressive policies, including higher taxes, health care reform and more alignment with European climate policies and ESG support.