Global Investing

Revitalised West knocks Brazil, Russia off global growth Top-30

By Shadi Bushra

Yet another sign of the growth convergence between developed and emerging markets. Two  of the “BRIC’ countries have dropped out of the Top-30 in a growth index compiled by political risk consultancy Maplecroft, while several Western powerhouses have nudged their way onto the list.

Maplecroft’s 2014 Growth Opportunities Atlas showed that Brazil and Russia — the B and R of the BRIC bloc — had dropped 26 and 41 places, respectively – due to slow economic reforms and diversification.  The United States, Australia and Germany meanwhile broke into the top 30 on the  index, which evaluates 173 countries on their growth prospects over the next 20 years.

The study’s results are indicative of the broader pattern this year of an emerging markets slowdown after years of robust growth fuelled by cheap money from the West and a decade of booming trade. But the two other BRIC countries — India and China — have retained their top spots, albeit with lower absolute scores. And India overtook China for first place due to its “catch-up growth potential,”  Maplecroft’s report said.

The index also highlights a view that has been gaining increasing currency in recent times — that the term emerging markets is a actually a convenient catch-all phrase that masks the diversity within the group it supposedly describes. So although the report disparages Brazil and Russia’s failure to use a decade-long commodity boom to invest in long-term growth, it offers Indonesia (3rd), Turkey (13th) and Nigeria (18th) as possible alternatives.

Meanwhile the significant improvement in key Western economies, including France and Britain, appears to signal that Europe is ready to join the global recovery.

Emerging equities: out of the doghouse

Emerging stocks, in the doghouse for months and months, haven’t done too badly of late. The main EM index,  has rallied more than 11 percent since its end-August troughs, outgunning the S&P 500′s 3 percent rise in this period. Bank of America/Merrill Lynch strategist Michael Hartnett reminds us of the extreme underweight positioning in emerging stocks last month, as revealed by his bank’s monthly investor survey.  Anyone putting on a long EM-short UK equities trade back then would have been in the money with returns of 540 basis points, he says.

Undoubtedly, the postponement of the Fed taper is the main reason for the rally.  Another big inducement is that valuations look very cheap (forward P/E is around 9.9 versus a 10-year average of 10.8) .

According to Mouhammed Choukeir, CIO , Kleinwort Benson:

Looking at valuations we think emerging markets are in an attractively valued zone, hence we think it’s a good investment. EMs are in negative momentum trend but have good valuations. We’re sitting on the positions we’ve built but if it hits a positive (momentum) trend we will add on it…. You wait for value and value will translate into returns over time.

The hit from China’s growth slowdown

China’s slowing economy is raising concern about the potential spillovers beyond its shores, in particular the impact on other emerging markets. Because developing countries have over the past decade significantly boosted exports to China to offset slow growth in the West and Japan, these countries are unquestionably vulnerable to a Chinese slowdown. But how big will the hit be?

Goldman Sachs analysts have crunched the numbers to show which markets and regions could be hardest hit. On the face of it non-Japan Asia should be most worried — exports to China account for almost 3 percent of GDP while in Latin America it is 2 percent and in emerging Europe, Middle East and Africa (CEEMEA) it is just 1.1 percent, their data shows.

But they warn that standard trade stats won’t tell the whole story. That’s because a high proportion of EM exports are re-processed in other countries before reaching China which in turn often re-works them for re-export to the developed world. In other words, exports to China from say, Taiwan, may be driven not so much by Chinese demand but by demand for goods in the United States or Europe. So gross trade data may actually be overstating a country’s vulnerability to a Chinese slowdown.

Bernanke Put for emerging markets? Not really

The Fed’s unexpectedly dovish position last week has sparked a rally in emerging markets — not only did the U.S. central bank’s all-powerful boss Ben Bernanke keep his $85 billion-a-month money printing programme in place, he also mentioned emerging markets in his post-meeting news conference, noting the potential impact of Fed policy on the developing world. All that, along with the likelihood of the dovish Janet Yellen succeeding Bernanke was described by Commerzbank analysts as “a triple whammy for EM.” A positive triple whammy, presumably.

Now it may be going too far to conclude there is some kind of Bernanke Put for emerging markets of the sort the U.S. stock market is said to enjoy — the assumption, dating back to Alan Greenspan’s days, that things cant go too wrong for markets because the Fed boss will wade in with lower rates to right things. But the fact remains that global pressure on the Fed has been mounting to avoid any kind of violent disruption to the flow of cheap money — remember the cacophony at this month’s G20 summit? Second, the spike in U.S. yields may have been the main motivation for standing pat but the Treasury selloff was at least partly driven by emerging central banks which have needed to dip into their reserve stash to defend their own currencies. According to IMF estimates, developing countries hold some $3.5 trillion worth of Treasuries, of which just under half is in China. (See here for my colleague Mike Dolan’s June 12 article on the EM-Fed linkages)

David Spegel, head of emerging debt at ING Bank in New York says the decision reflects “an appreciation for today’s globalised world”:

Russian stocks: big overweight

Emerging stocks are not much in favour these days — Bank of America/Merrill Lynch’s survey of global fund managers finds that in August just a net 18 percent of investors were overweight emerging markets, among the lowest since 2001. Within the sector though, there are some outright winners and quite a few losers. Russian stocks are back in favour, the survey found, with a whopping 92 percent of fund managers overweight. Allocations to Russia doubled from last month (possibly at the expense of South African where underweight positions are now at 100 percent, making it the most unloved market of all) See below for graphic:

BofA points out its analyst Michael Harris recently turned bullish on Russian stocks advising clients to go for a “Big Overweight” on a market that he reckons is best positioned to benefit from the recovery in global growth.

Russia may not be anyone’s favourite market but in a world with plenty of cyclical headwinds, Russia looks a clear place for relative outperformance with upside risk if markets turn… we are overweight the entire market as we like domestic Russia, oil policy changes and beaten-up metals’ leverage to any global uplift.

Emerging markets: to buy or not to buy

To buy or not to buy — that’s the question facing emerging market investors.

The sector is undoubtedly cheap –  equity valuations are 30-50 percent cheaper than their 10-year average on a price-book basis; currencies have depreciated 15-20 percent in the space of 4 months and local bond yields have surged by an average 150 basis points. As we have pointed out before, cheapness is relative and the slowing economic and credit growth in many countries will undoubtedly manifest itself in falling EPS growth. Companies that cannot pass on high input costs caused by weak currencies, will have to take a further margin squeeze.

But many analysts have in recent days changed their recommendations on the sector. Barclays for instance notes:

Tapping India’s diaspora to salvage rupee

What will save the Indian rupee? There’s an election next year so forget about the stuff that’s really needed — structural reforms to labour and tax laws, easing business regulations and scrapping inefficient subsidies. The quickest and most effective short-term option may be a dollar bond issued to the Indian diaspora overseas which could boost central bank coffers about $20 billion.

The option was mooted a month ago when the rupee’s slide started to get into panic territory but many Indian policymakers are not so keen on the idea

So what are the merits of a diaspora bond (or NRI bond as it’s known in India)?

Russia — the one-eyed emerging market among the blind

It’s difficult to find many investors who are enthusiastic about Russia these days. Yet it may be one of the few emerging markets  that is relatively safe from the effects of “sudden stops” in foreign investment flows.

Russia’s few fans always point to its cheap valuations –and these days Russian shares, on a price-book basis, are trading an astonishing 52 percent below their own 10-year history, Deutsche Bank data shows.  Deutsche is sticking to its underweight recommendation on Russia but notes that Russia has:

“become so unpopular with the investor community that it is a candidate for the ‘it’s so bad it’s good’ club as evidenced by the very cheap valuations and long-term  underperformance.

Emerging markets funds shun Brazil, South Africa

Global emerging markets equity funds have cut average weightings to Brazil and South Africa for the fourth straight quarter, according to the latest allocations data from fund research firm Lipper.

You can see a full interactive graphic of the allocations data here or by clicking on the snapshot below.

The average allocation to Brazil has fallen by 1.75 percentage points over the past year to stand at 11.6 percent of portfolios by the end of the April-June 2013 quarter. South Africa’s average weighting has fallen to 6.0 percent from 7.3 percent in the second quarter of 2012.

BRIC shares? At the right price

Is the price right? Many reckon that the sell off in emerging markets and growing disenchantment with the developing world’s growth story is lending fresh validity to the value-based investing model.

That’s especially so for the four BRIC economies, where shares have underperformed for years thanks either to an over-reliance on commodities, excessive valuations conferred by a perception of fast growth or simply dodgy corporate governance. Now with MSCI’s emerging equity index down 30 percent from 2007 peaks, prices are looking so beaten down that some players, even highly unlikely ones, are finding value.

Societe Generale’s perma-bear Albert Edwards is one. Okay, he still calls the bloc Bloody Ridiculous Investment Concept but he reckons that share valuations are inching into territory where some buying might just be justified. Edwards notes that it was ultra-cheap share valuations in the early 2000s that set the stage for the sector’s stellar gains over the following decade, rather than any turbo-charged economic growth rates. So if MSCI’s emerging equity index is trading around 10 times forward earnings, that’s a 30 percent discount to the developed index, the biggest in a very long time. And valuations are lower still in Russia and Brazil.