Global Investing

No BRIC without China

Jim O’ Neill, creator of the BRIC investment concept, has been exasperated by repeated calls in the past to exclude one or another country from the quartet, based on either economic growth rates, equity performance or market structure. In the early years, Brazil’s eligibility for BRIC was often questioned due to its anaemic growth; then it was the turn of oil-dependent Russia. Over the past couple of years many turned their sights on India due to its reform stupor. They have suggested removing it and including Indonesia in its place.

All these detractors should focus on China.

China’s validity in BRIC has never been questioned. Aside from the fact that BRI does not really have a ring, that’s not surprising. China’s growth rates plus undoubted political and economic clout on the international stage put  it head and shoulders above the other three. And after all, it is Chinese demand which drives a large part of the Russian and Brazilian economies.

But its equity markets have not performed for years.

This year, Russian and Indian stocks are up around 20 percent in dollar terms while China has gained 9 percent and Brazil 3 percent. In local currency terms however China is among the worst performing emerging markets, down 5 percent. Brazil has risen 9 percent.

Over the past five years, MSCI China. which makes up 40 percent of the BRIC index, has lost 18 percent, Thomson Reuters data shows.  That has pushed the broader BRIC into a negative return of almost 10 percent in this period.

The BRIC equity losses and BRIC funds’ poor returns are now causing many to question the validity of the BRIC concept itself, a topic we explored in this recent article.  But clearly the problem with BRIC equities lies with China and as the economy slows, more losses are likely in the short-term.  The Shanghai market has taken little cheer from the Fed’s money printing-announcement, focusing instead on falling property prices locally and potential problems at Chinese banks.

Put down and Fed up

Given almost biblical gloom about the world economy at the moment, you really have to do a double take looking at Wall Street’s so-called “Fear Index”. The ViX , which is essentially the cost of options on S&P500 equities, acts as a geiger counter for both U.S. and global financial markets.  Measuring implied volatility in the market, the index surges when the demand for options protection against sharp moves in stock prices is high and falls back when investors are sufficiently comfortable with prevailing trends to feel little need to hedge portfolios. In practice — at least over the past 10 years — high volatility typically means sharp market falls and so the ViX goes up when the market is falling and vice versa. And because it’s used in risk models the world over as a proxy for global financial risk, a rising ViX tends to shoo investors away from risky assets while a falling ViX pulls them in — feeding the metronomic risk on/risk off behaviour in world markets and, arguably, exaggerating dangerously pro-cyclical trading and investment strategies.

Well, the “Fear Index” last night hit its lowest level since the global credit crisis erupted five-years ago to the month.  Can that picture of an anxiety-free investment world really be accurate? It’s easy to dismiss it and blame a thousand “technical factors” for its recent precipitous decline.  On the other hand,  it’s also easy to forget the performance of the underlying market has been remarkable too. Year-to-date gains on Wall St this year have been the second best since 1998. And while the U.S. and world economies hit another rough patch over the second quarter, the incoming U.S. economic data is far from universally poor and many economists see activity stabilising again.

But is all that enough for the lowest level of “fear” since the fateful August of 2007? The answer is likely rooted in another sort of “put” outside the options market — the policy “put”, essentially the implied insurance the Fed has offered investors by saying it will act again to print money and buy bonds in a third round of quantitative easing (QE3) if the economy or financial market conditions deteriorate sharply again. Reflecting this “best of both worlds” thinking, the latest monthly survey of fund managers by Bank of America Merrill Lynch says a net 15% more respondents expect the world economy to improve by the end of the year than those who expect it to deteriorate but almost 50 percent still believe the Fed will deliver QE3 before 2012 is out.  In other words, things will likely improve gradually in the months ahead and if they don’t the Fed will be there to catch us.

South African equities hit record highs, doomsayers left waiting

Earlier this year it seemed that an increase in global bullishness meant the end of the road for risk-off investment strategies and, by extension, the rise in South African equities. However, 6 months later, the band is still playing, and the ship is refusing to go down.

South African equities have flourished in the face of the doomsayers, with returns this year doubling the emerging market benchmark equity performance. Both the all-shares index and the top-40 share have hit fresh all time highs this week, and prophecies of gloom for South African stocks appear to have missed the mark somewhat.

Part of the reason for this is that, when it comes to risk attitudes, much of the song remains the same. South Africa has certainly benefitted from its continued attractiveness to risk-off investors, as global bullishness has receded from whence it came. For instance, as it is relatively well sheltered from euro zone turmoil, and as major gold exporter, firms based in the gold sector are ostensibly an attractive investment for the globally cautious.

Devil and the deep blue sea

Ok, it’s a big policy week and of course it could either way for markets. An awful lot of ECB and Fed easing expectations may well be in the price already, so some delivery would appear to be important especially now that ECB chief Mario Draghi has set everyone up for fireworks in Frankfurt.

But if it’s even possible to look beyond the meetings for a moment, it’s interesting to see how the other forces are stacked up.

Perhaps the least obvious market statistic as July draws to a close is that, with gains of more than 10 percent, Wall St equities have so far had their best year-to-date since 2003. Who would have thunk it in a summer of market doom and despair.  Now that could be a blessing or a curse for those trying to parse the remainder of the year. Gloomy chartists and uber-bears such as SocGen’s Albert Edwards warn variously of either hyper-negative chart signals on the S&P500, such as the “Ultimate Death Cross”, or claims that the U.S. has already entered recession in the third quarter.

America Inc. share of GDP – 12 or 3 pct?

Wall Street has been doing pretty well in recent years. Just how well is illustrated by the steady rise in corporate profits as a share of the national economy. Look at the following graphic:

Of it, HSBC writes:

The profits share of GDP in the United States must rank as one of the most chilling charts in finance.

 
What this means is that around 12 percent of American gross domestic product is going to companies in the form of after-tax profits. A year ago that figure was just over 10 percent and in 2005 it was just 6 percent. In contrast, the share of wages and salaries in the U.S. GDP fell under 50 percent i n 2010 and continues to decline. Comparable figures for the UK or Europe are harder to come by but analysts reckon the profits’ share is within historical ranges.

SocGen poll unearths more EM bulls in July

These are not the best of times for emerging markets but some investors don’t seem too perturbed. According to Societe Generale,  almost half the clients it surveys in its monthly snap poll of investors have turned bullish on emerging markets’ near-term prospects. That is a big shift from June, when only 33 percent were optimistic on the sector. And less than a third of folk are bearish for the near-term outlook over the next couple of weeks, a drop of 20 percentage points over the past month.

These findings are perhaps not so surprising, given most risky assets have rallied off the lows of May.  And a bailout of Spain’s banks seems to have averted, at least temporarily, an immediate debt and banking crunch in the euro zone. What is more interesting is that despite a cloudy growth picture in the developing world, especially in the four big BRIC economies,  almost two-thirds of the investors polled declared themselves bullish on emerging markets in the medium-term (the next 3 months) . That rose to almost 70 percent for real money investors. (the poll includes 46 real money accounts and 45 hedge funds from across the world).

See the graphics below (click to enlarge):

Signals are positive on positioning as well with 38.5 percent of investors reckoning they were under-invested in emerging markets, compared to a quarter who felt they were over-invested. Again, real-money investors appeared more keen on emerging markets, with over 40 percent seeing themselves as under-invested. SocGen analysts write:

In Brazil, rate cuts but no economic recovery

Brazil’s central bank meets today and almost certainly will announce another half point cut in interest rates, the eighth consecutive reduction since last August. But so far there is little sign that its rate-cutting spree – the longest and most aggressive  in the developing world – is having much success in resuscitating the economy.

HSBC’s closely watched emerging markets index (EMI), released this week, shows Brazil as one of the weak links in the EM growth picture,  with sharp declines in manufacturing and export orders in the second quarter.

The government is expected to soon revise down its 4.5 percent growth projection for 2012; the central bank has already done so.  Industrial output is down, and automobile production has slumped 9 percent in the first half of 2012. Nor  it seems are record low interest rates encouraging the middle classes to take on more debt — the number of Brazilians seeking new credit fell 7.4 percent in the first half of this year, the biggest fall on record, according to credit research firm Seresa Experian.

European equities finding some takers

European equities are getting some investor interest again.

As the ongoing debt crisis erodes consumer spending and corporate profits, the euro zone’s share  in investors’ equity portfolios has fallen in the past year –Reuters polls show holdings of euro zone stocks at 25 percent versus over 36 percent a year back.  Cash has fled instead to U.S. stocks, opening up a record valuation gap between the European and U.S. shares. (see graphics below from my colleague Scott Barber). In fact no other region has ever been considered as cheap as the euro zone is now,  a monthly survey by Bank of America/Merrill Lynch found in June.

That could offer investors a powerful incentive to return, especially as there are signs of serious efforts to tackle the crisis by deploying the euro zone’s rescue fund.

Pioneer Investments has moved to an overweight position on European stocks. While Pioneer’s head of global asset allocation research Monica Defend stresses the overweight is a small one compared to, say, its position in emerging markets, she says:

Emerging stocks: when will there be gain after pain?

Emerging equities’ amazing  first quarter rally now seems a distant memory. In fact MSCI’s main emerging markets index recently spent 11 straight weeks in the red, the longest lossmaking stretch in the history of the index.  The reasons are clear — the euro zone is in danger of breakup, growth is dire in the West and stuttering in the East. Weaker oil and metals prices are hitting commodity exporting countries.

But there may be grounds for optimism. According to this graphic from HSBC analyst John Lomax, sharp falls in emerging equity valuations have always in the past been followed by a robust market bounce.

What might swing things? First, the valuation. The  2008 crisis took emerging  equity prices to an average of 8 times forward earnings for the MSCI index, down from almost 14 times before the Lehman crisis. The subsequent rebound from April 2009 saw the MSCI emerging index jump 90 percent. Emerging equities are not quite so cheap today, trading at around 9 times forward 12-month earnings but that is still well below developed peers and their own long-term average.

Sell in May? Yes they did

Just how miserable a month May was for global equity markets is summed up by index provider S&P which notes that every one of the 46 markets included in its world index (BMI)  fell last month, and of these 35 posted double-digit declines. Overall, the index slumped more than 9 percent.

With Greece’s anti-austerity May 6 election result responsible for much of the red ink, it was perhaps fitting that Athens was May’s worst performer, losing almost 30 percent (it’s down 65 percent so far this year).  With euro zone growth steadily deteriorating, even German stocks fell almost 15 percent in May while Portugal, Spain and Italy were the worst performing developed markets  (along with Finland).

The best of the bunch (at least in the developed world) was the United States which fell only 6.5 percent in May and is clinging to 2012 gains of around 5 percent. S&P analyst Howard Silverblatt writes: