Global Investing

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.

Call it a contrarian trade but clearly now Russia has actually become everyone’s favourite market. The Moscow stock market is up more than 8 percent so far in September, its best monthly performance in two years. Oil has helped of course — Brent crude prices rose around $117 a barrel at one point and still remain well over $100 a barrel. Another inducement is valuations — on a price-book basis Russia trades at 0.7 times, a a 50 percent discount to its own 10-year average and the cheapest of all big emerging markets. Such low prices surely take into account any looming upheavals.

Another plus. For most emerging markets, the big fear is rising U.S. Treasury yields as the Fed starts to cut off liquidity. But BofA has compiled a list of 30 companies in emerging Europe, Middle east and Africa whose shares are positively correlated with Treasury yields — in other words, companies that benefit most from a recovering U.S. economy. Fifteen of the companies on that list are in Russia and that’s why, Harris points out, Russian equities tend to outperform following a spike in U.S. yields.  His graphic above is a good illustration.

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.

“Contrarian” Deutsche (a bit) less bearish on emerging stocks

For an investor in emerging equities the best strategy in recent years has been to take a contrarian stance, says John-Paul Smith at Deutsche Bank.

Smith, head of emerging equity strategy at Deutsche, has been bearish on emerging stocks since 2010, exactly the time when bucketloads of new cash was being committed to the asset class. Investors who heeded his advice back then would have been in the money — since end-2010 emerging equities have underperformed U.S. equities by almost 40 percent, Smith pointed out a couple of months ago.

Things have worsened since then and MSCI’s emerging equity index is down around 12 percent year-to-date, almost the level of loss that Deutsche had predicted for the whole of 2013. June outflows from emerging stock funds, according to EPFR Global last week, were the largest on record. But true to form, Smith says he is no longer totally bearish on emerging equities.  Maybe the presence or absence of those he calls “marginal international investors” — people who joined the EM party too late and are quick to take fright — is key. Many of these positions appear to have been cleaned out. Short positions or high cash balances dominate the books of dedicated players,  Smith writes:

Weekly Radar: A ‘sudden stop’ in emerging markets?

Turkey’s lira, South Africa’s rand and South Korea’s won have all lunged, local currency debt yields have suddenly surged, there’s an intense investor focus on domestic political risks again and governments like Brazil who were taxing what they feared were excessive foreign investment over the past couple of years have U-turned as those flows evaporate. 

What some have feared for many months may well be materializing – a ‘sudden stop’ in financing flows to emerging markets as the makings of a perfect storm gathers. With the Fed mulling some reduction in the amount of dollars it’s pumping into the world, the prospect of a rare and protracted rise in the dollar and U.S. Treasury yields potentially changes entire EM investment metrics for U.S. funds (who make up almost half of the world’s private institutional investors) and from markets which have willingly or not been some of the biggest beneficiaries of QE in recent years but also to where where , by some estimates, nearly $8 trillion of FDI and portfolio flows have flowed over the past decade. It doesn’t even have to mean a reversal of capital already in emerging markets, but even a sudden stop in new flows there could seriously undermine the currency and debt markets of countries heavily dependent on rolling foreign financing – those with large current account gaps to finance. As emerging and global economic growth has eased and return on equity sinks, emerging equity markets have already underperformed for three years now. But the biggest wave of recent investment in EM had been into its bond markets, most recently to higher-yielding local-currency debt markets. And it’s these flows that could dry up rather quickly and shockingly, with all the attendant pressure on currency rates and vice versa. For context, a record of more than $410 billion new sovereign and corporate bonds from emerging economies were sold last year alone, according to JPMorgan, and Morgan Stanley estimates show emerging companies alone have sold some $130 billion worth of new debt so far this year – up 30 percent on last year and more than twice the same period in 2011.
               Already we’re seeing big hits to big current account deficit countries Turkey and South Africa in this region and, as is so often the case in emerging markets, the withdrawal of capital leads to an intense focus on domestic and political risks. These are two of the five biggest destination for bond flows over the past four years, a list –measured on flows as share of GDP – also includes Poland and Czech Republic. Mexico is top of the list, but many see its geographic and financial proximity to the US insulating it.

               So, is this a 1997/1998 redux? That’s certainly a big fear. The similarities are obvious – building dollar strength, higher US Treasury yields and a repatriation of US investment to a domestic ‘emerging market’ (Silicone Valley and the dot.coms in the late 1990s); a sharp drop in Japan’s yen which upset the competitive landscape in Asia; narrowing global growth differentials; some signs of excessive monetary easing in emerging economies and concern about credit bubbles in China and elsewhere; the sudden magnifying of domestic political, social and policy risks etc etc.

The Sub-Saharan frontier: future generations

As growth in Sub-Saharan Africa is set to post a steady 5-6 percent per annum to 2017 according to IMF estimates,  investors will be taking notes on the region’s growth story not least with the financial sector.

Growth projections have rebounded from forecasts of around a 3 percent rise in 2009 after falling commodity prices have hit one of the region’s main revenue sources. Yet, according to the World Bank’s recent Global Development Finance report, stronger commodities will firm growth prospects in the coming years. In recent weeks, commodities have dipped, dampening the outlook for some resource-rich countries, but as 76 percent of the region’s population do not have access to a bank account, lenders are set to grow their presence in the region.

Julius Baer notes the region’s market potential:

Since 2002, resource-hungry China has swept across a by-and-large grateful African continent, taking oil and minerals in exchange for debt relief, low-interest loans, or much needed infrastructure, such as roads, ports and housing.

Weekly Radar: Draghi returns to London

ECB chief Mario Draghi returns to London next week almost 10 months on from his seminal “whatever it takes” speech to the global financial community in The City  – a speech that not only drew a line under the euro financial crisis by flagging the ECB’s sovereign debt backstop OMT but one that framed the determination of the G4 central banks at large to reflate their economies via extraordinary monetary easing. Since then we’ve seen the Fed effectively commit to buying an addition trillion dollars of bonds this year to get the U.S. jobless rate down toward 6.5%, followed by the ‘shock-and-awe’ tactics of the new Japanese government and Bank of Japan to end decades.

And as Draghi returns 10 months on, there’s little doubt that he and his U.S. and Japanese peers have succeeded in convincing financial investors of central bank doggedness at least. Don’t fight the Fed and all that – or more pertinently, Don’t fight the Fed/BoJ/ECB/BoE/SNB etc… G4 stock markets are surging ever higher through the Spring of 2013 even as global economic data bumbles along disappointingly through its by now annual ‘soft patch’.  Looking at the number tallies, total returns for Spanish and Greek equities and euro zone bank stocks are up between 40 and 50% since Draghi’s showstopper last July . Italian, French and German equities and Spanish and Irish 10-year government bonds have all returned about 30% or more. And you can add 7% on to all that if you happened to be a Boston-based investor due to a windfall from the net jump in the euro/dollar exchange rate. What’s more all of those have outperformed the 25% gains in Wall St’s S&P 500 since then, even though the latter is powering to uncharted record highs. And of course all pale in comparison with the eye-popping 75% rise in Japan’s Nikkei 225 in just six months!! Gold, metals and oil are all net losers and this is significant in a money-printing story where no one seems to see higher inflation anymore.

But with both Fed and BoJ pushes getting some traction on underlying growth and the euro zone economy registering it’s 6th straight quarter of contraction in the first three months of 2013, maybe Draghi’s big task now is to convince people the ECB will do whatever it takes to support the 17-nation economy too and not only the single currency per se. Last year’s pledge may have been a necessary start to stabilise things but it has not yet been sufficient to solve the economic problems bequethed by the credit crisis.

Weekly Radar: Watch the thought bubbles…

Far from the rules of the dusty old investment almanac, it’s up, up and away in May after all. And judging by the latest batch of economic data, markets may well have had good reason to look beyond the global economic ‘soft patch’ – with US employment, Chinese trade and even German and British industry data all coming in with positive surprises since last Friday. Is QE gaining traction at last?

Well, it’s still hard to tell yet in the real economy that continues to disappont overall. But what’s certain is that monetary easing is contagious and not about to stop in the foreseeable future – whether there’s signs of a growth stabilisation or not. With the Fed, BoJ and BoE still on full throttle and the ECB cutting interest rates again last week, monetary easing is fanning out across the emerging markets too. South Korea was the latest to surprise with a rate cut on Thursday, in part to keep a lid on its won currency after Japan’s effective maxi devaluation over the past six months. But Poland too cut rates on Wednesday. And emerging markets, which slipped into the red for the year in February, have at last moved back into the black – even if still far behind year-to-date gains in developed market equities of about 16%!

Not only have we got new records on Wall St and fresh multi-year highs in Europe and Japan, there’s little sign that either this weekend’s meeting in London of G7 finance chiefs or next weekend’s G20 sherpas gathering in Moscow will want to signal a shift  in the monetary stance. If anything, they may codify the recent tilt toward easier austerity deadlines in Europe and elsewhere. But inevitably talk of unintended consequences of QE and bubbles will build again now as both equity and debt markets race ahead , even if the truth is that asset managers have been remarkably defensive so far this year in asset, sector and geographical choices …  one can only guess at what might happen if they did actually start to get aggressive! Perhaps the next pause will have to come from the Fed thinking aloud again about the longevity of its QE programme — so best watch those thought bubbles!

Weekly Radar: May days or Pay days?

So, it’s May and time for the annual if temporary equity market selloff, right? Well, maybe – but only maybe.  A fresh weakening of the global economic pulse would certainly suggest so, but central banks have shown again they are not going to throw in the towel in the battle to reflate. The ECB’s interest rate cut today and last night’s insistence from the Fed that it’s as likely to step up money printing this year as wind it down are two cases in point. And we’re still awaiting the private investment flows from Japan following the BOJ’s latest aggressive easing there.

So where does that all leave us? A third of the way through 2013 and it’s been a good year so far for nearly all bulls – both western equity bulls and increasingly bond bulls too! Not only have developed world equities clocked up some 13 percent year-to-date (the S&P500 set yet another record high this week while Europe’s bluechips recorded a staggering 12th consecutive monthly gain in April) , but virtually all bond markets from junk bonds to Treasuries, euro peripherals to emerging markets are now back in the black for the year as a whole. For the most eyebrow-raising evidence, look no further than last week’s debut sovereign bond from Rwanda at less than 7 percent for 10 years or even newly-junked Slovenia’s ability this week to plough ahead with a syndicated bond sale reported to already be in the region of four times oversubscribed. For many people, that parallel rise in equity and bonds smells of a bubble somewhere. But before you cry “QEEEEE!” , take a look at commodities — the bulls there have been taken a bath all year as data on final global demand hits yet another ‘soft patch’ over the past couple of months.

So is this just an idiosyncratic random walk of asset markets (itself no bad thing after years of stress-riven hyper correlation) or can we explain all three asset directions together? One way to think of it is in terms of global inflation. If QE-related inflation fears have been grossly exaggerated then pressure to remove monetary stimulus or wanes again and there may even be arguments – certainly in Europe – for more. This would intuitively explain the renewed dash for bonds and fixed income in general even in the face of the still-plausible, if long term, “Great Rotation” idea. You could argue the monetary free-for-all is buoying equities regardless of demand concerns. But why wouldn’t commodities gain on that basis too?

Deutsche’s emerging markets bear sticking to his guns

Emerging markets bear John-Paul Smith first made his call to underweight emerging equities at the end of 2010. In a note released late on Monday he points out that such a position would have paid off handsomely — since end-2010 emerging equities have underperformed MSCI’s World index by 27.5 percent and U.S. MSCI by 37.6 percent.

 

Smith, who is head of emerging equity strategy at Deutsche Bank, sees no reason to change his call. Reckoning that the cyclical heyday of emerging markets is past, he is advising clients to hold on to developed and U.S. equities at the expense of emerging markets. The reason? China, pivotal for the rest of the EM world for commodities, trade.

Smith writes:

We are maintaining our existing underweight recommendations for GEM versus DM/US and current country weightings within GEM because the ongoing structural deterioration in the sustainable growth rate of the Chinese economy will continue to be the dominant narrative for the GEM equity asset class, in our view. Since the start of the year it has been increasingly evident at the micro level that the massive increase in total corporate financing has not as yet fed through into anything resembling a commensurate pickup in final demand.

Weekly Radar: Second-guessing Japan flows as global growth slows

Figuring out what was driving pretty violent market moves this week was trickier than usual – and that says something about how much the herd has scattered this year, with ‘risk on-risk off’ correlations having weakened sharply. Just as everyone puzzled over a potential “wall of money” from Japan after the BOJ’s aggressive reflation efforts, the bottom seemed to fall out of gold, energy and broader commodity markets – dragging both equity markets and, unusually, peripheral euro zone bond yields lower in the process.  As dangerous as it may be to seek an overriding narrative these days, you could possibly tie all up these moves under the BOJ banner – something along these lines: the threat of a further yen losses pushes an already pumped-up US dollar ever higher across the board and undermines dollar-denominated  commodities, which have already been hampered by what looks like yet another lull in global demand. Developed market equities, whose Q1 surge had been reined in by several weeks of disappointing economic data and an iffy start to the Q1 earnings season, were then hit further by a lunge in heavy cap mining and energy stocks. The commodities hit may also help explain the persistent underperformance of emerging markets this year. What’s more the lift to Italian and Spanish government bonds comes partly from an assumption any Japanese money exit will seek U.S. and European government bonds and relatively higher-yielding euro government paper may be favoured by some over the paltry returns in the core ‘safe havens’ of Treasuries or bunds. The confidence to reach for yield has clearly risen over the past six months as wider systemic fears have receded – something underlined in dramatic style this week by a huge lunge in gold,  now lost almost 20 percent in the year to date.

While all that logic may be plausible, there have been dozens of other reasons floating around for the seemingly erratic twists and turns of the week.

The only truth so far is that everyone is still just guessing about the likely extent of a Japanese outflow and confidence about global growth has received another setback.