Global Investing

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.

The data comes from about 400 GEM funds for which Lipper has recent allocations data. At the last count they held combined assets of $175 billion. GEM funds offer a useful gauge of investor sentiment around emerging markets as they can generally allocate money across the sector.

China and India have seen the sharpest increase in average allocations during the year in percentage points terms, even as fears of a China slowdown have gathered momentum and stocks .MSCICN have barely eked out a gain. (Full Story)

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.

South Africa may need pre-emptive rate strike

Should South Africa’s central bank — the SARB – strike first with an interest rate hike before being forced into it?  Gill Marcus and her team started their two-day policy meeting today and no doubt have been keeping an eye on happenings in Turkey, a place where a pre-emptive rate hike (instead of blowing billions of dollars in reserves) might have saved the day.

The SARB is very different from Turkey’s central bank in that it is generally less concerned about currency weakness due to the competitiveness boost a weak rand gives the domestic mining sector. This time things might be a bit different. The bank is battling not only anaemic growth but also rising inflation that may soon bust the upper end of its 3-6 percent target band thanks to a rand that has weakened 15  percent to the dollar this year.

Interest rates of 5 percent, moreover, look too low in today’s world of higher borrowing costs  – real interest rates in South Africa are already negative while 10-year yields are around 2.5 percent (1.5 percent in the United States). So any rise in inflation from here will leave the currency dangerously exposed.

Chinese inflation – unreported retail

China’s inflation print for June at 2.7 percent, a four-month high, was higher than forecast, but part of the picture could be obfuscated by a lack of accounting for the ever-growing online retail sector.

Gross domestic product figures have been consistently revised down this year from 8 percent to around 7.4 percent by July, with significant doubt over the reliability of official data. Some analysts forecast the more likely GDP print is around 5 percent, given the lack of punishment for falsifying local data and incentives for better growth figures for regional prints.

With an increasing share of shopping carried out online through websites such as Taobao, Tmall and Paipai, there is an increasing argument for online retail numbers -which had lifted one metric of inflation  closer to 7 percent in April –  to be included in the headline CPI. That metric is the retail sector’s internet shopping price index (iSPI).

“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:

A drop in the ocean or deluge to come?

Glass half full or half empty? For emerging markets watchers, it’s still not clear.

Last month was a record one in terms of net outflow for funds dedicated to emerging equities, Boston-based agency EPFR Global said.  Debt funds meanwhile saw a $5.5 billion exodus in the week to June 26, the highest in history .

These sound like big numbers, but in fact they are relatively small. EM equity funds tracked by EPFR  have now reversed all the bumper year-to-date inflow registered by end-May, but what of all the flows they have received in the preceding boom decade?

Russians and the city: consumer led growth

Speculation is growing that new central bank governor Elvira Nabiullina will cut rates to help stimulate faltering growth soon after takes up her job later this month, but the resilience of the Russian consumer may be another important factor in giving the economy a lift.

Retail sales figures have been lower than expected for the first quarter of 2013, leading economists to revise downwards their prediction for this driver of growth, though performance in the construction and cement sectors is improving, according to Morgan Stanley research:

Overall, we estimate that household consumption growth has accounted for 65 percent of Russian growth over the last decade.

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.

Guarding against the inflation dog in emerging markets

The dog that didn’t bark was how the IMF described inflation. But might the fall in emerging market currencies reverse the current picture of largely benign inflation?

Nick Shearn, a portfolio manager at BlueBay Asset Management, sees the rise in inflation as not an if but a when, which makes inflation-linked bonds (linkers in common parlance) a good idea. These would hedge not only against EM but also G7 inflation — he calculates the correlation between the two at around 0.8 percent. He says linkers outperform as inflation uncertainty increases, hence:

As a result of the loose monetary policies of recent years that have been implemented to promote growth within emerging market economies, we believe rising as well as persistent inflation should become a trend….. Currently we are seeing the early signs of an inflation dynamic in isolated countries such as in Brazil. But, as inflation begins to rise across the region, inflation uncertainty will also begin to rise and consequently inflation-linked bonds should perform well.

No more currency war. Mantega dumps the IOF

Brazil’s finance minister Guido Mantega, one of the most shrill critics of Western money-printing, has decided to repeal the so-called IOF tax, he imposed almost three years ago as a measure to fend off  hot money flows.

Well, circumstances alter cases, Mantega might say. And the world is a very different place today compared to 2010. Back then, the Fed was cranking up its printing presses and the currency war (in Mantega’s words) was raging; today the U.S. central bank is indicating it may start tapering off the stimulus it has been delivering. Nor is investors enthusiasm for emerging markets what it used to be.  Brazil’s currency, the real, is plumbing four-year lows against the dollar and local bond yields have risen 30 basis points since the start of May. Brazil’s balance of payments situation meanwhile, is deteriorating, which means it needs all the foreign capital  it can get, hot money or otherwise. And currency weakness spells inflation — bad news for Brazil’s government which faces voters next year.

The IOF did work — Brazil’s local debt markets received just over $10 billion last year, Bank of America/Merrill Lynch calculates — a third of 2010 levels, and much of the cash that was already invested, preferred to stay put (given the IOF is paid upon exiting the country).