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.

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:

With pension reform, Poland joins the sell-off. More to come

If the backdrop for global emerging markets (GEM) were not already challenging enough, there are, these days, some authorities that step in and try to make things even worse, writes Societe Generale strategist Benoit Anne. He speaks of course of Poland, where the government this week announced plans to transfer 121 billion zlotys ($36.99 billion) in bonds held by private pension funds to the state and subsequently cancel them. The move, aimed at cutting public debt by 8 percentage points,  led to a 5 percent crash yesterday on the Warsaw stock exchange, while 10-year bond yields have spiralled almost 50 basis points since the start of the week. So Poland, which had escaped the worst of the emerging markets sell-off so far, has now joined in.

But worse is probably to come. Liquidity on Polish stock and bond markets will certainly take a hit — the reform removes a fifth of  the outstanding government debt. That drop will decrease the weights of Polish bonds in popular global indices, in turn reducing demand for the debt from foreign investors benchmarked to those indices. Citi’s World Government Bond Index, for instance, has around $2 trillion benchmarked to it and contains only five emerging economies. That includes Poland whose weight of 0.55 percent assumes roughly $11 billion is invested it in by funds hugging the benchmark.

According to analysts at JPMorgan:

The most significant local market impact of the Polish pension reforms is likely to come from index-related selling as the weight of Polish government local currency debt in major global bond indices, including Citi’s WGBI and the Barclays Global Aggregate index, is likely to fall. Our base case scenario sees $3.5 billion worth of index-related selling, with risks skewed to the upside

Turkey’s central bank — a little more action please

In the selloff gripping emerging markets, one currency is conspicuous by its absence — the Turkish lira. But this will change unless the central bank adds significantly to its successful lira-defensive measures.

Hopefully at today’s policy meeting.

Like India or Indonesia which have borne the brunt of the recent rout, Turkey has a large current account deficit, equating to over 5 percent of its economic output. But what has made the difference for the lira is the contrast between the Turkish central bank’s decisive policy tightening moves and the ham-fisted tactics employed by India and Brazil.  (We wrote here about this).  See the following graphic (from Citi) that shows the central bank has effectively raised the effective cost of funding by 200 basis points to around 6.5 percent since its July 23 meeting.

 

Guillaume Salomon, a strategist at Societe Generale calls Turkey the “success story” given the relatively stable lira and expects the bank to raise the upper band of its interest rate corridor by another 50 basis points at least. He says:

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.

Turkey’s (investment grade)bond market

We wrote here yesterday on how Turkish hard currency bonds have been given the nod to join some Barclays global indices as a result of the country’s elevation to investment grade. Turkish dollar bonds will also move to the Investment grade sub-index of JPMorgan’s flagship EMBI Global on June 28.

Local lira debt meanwhile will enter JPM’s GBI-EM Global Diversified IG 15 percent Cap Index —  the top-tier of the bank’s GBI-EM index. But the big prize, an invitation into Citi’s mega World Government Bond Index, is still some way off. Requiring a still higher credit rating, WGBI membership is an honour that has been accorded to only four emerging markets so far.

Still, the Turkish Treasury is not complaining.  Even before last week’s upgrade to investment grade by Moody’s, it was borrowing from the lira bond market at record cheap levels of around 5 percent for two-year cash. Ten-year yields are down half a percentage point this year. One reason of course is the gush of liquidity from Western central banks. But most funds (at least those who were allowed to do so) had not waited for the Moody’s signal before buying Turkish bonds. So the bond market was already trading Turkey as investment grade.

Show us the (Japanese) money

Where is the Japanese money? Mostly it has been heading back to home shores as we wrote here yesterday.

The assumption was that the Bank of Japan’s huge money-printing campaign would push Japanese retail and institutional investors out in search of yield.  Emerging markets were expected to capture at least part of a potentially huge outflow from Japan and also benefit from rising allocations from other international funds as a result.  But almost a month after the BOJ announced its plans, the cash has not yet arrived.

EM investors, who seem to have been banking the most on the arrival of Japanese cash, may be forgiven for feeling a tad nervous. Data from EPFR Global shows no notable pick-up in flows to EM bond funds while cash continues to flee EM equities ($2 billion left last week).

Weekly Radar: Question mark for the ‘austerians’

One of the more startling moves of the week was the fresh rally in euro government debt – with 10-year Italian and Spanish borrowing rates falling to their lowest since late 2010 when the euro crisis was just erupting and 2-year Italian yields even falling to 1999 euro launch levels. The trigger? There’s been a slow build up for weeks on the prospect of new Japanese investor flows  seeking liquid overseas government bonds  – but it was signs of a sharp slowdown in Germany’s economy that seems to have had a perversely positive effect on the region’s asset markets as a whole. The logic is that German objections to another ECB rate cut will ebb, as will its refusal to ease up on front-loaded fiscal austerity across Europe. If its own economic engine is now suffering along with the rest, significantly just five months ahead of German Federal elections, then a tilt toward growth in the regional policy mix may not seem so bad for Berlin after all. And if euro economies are more in synch, albeit in recession rather than growth, then perhaps it will lead to a more effective regional policy response.

All that plays into the intensifying “growth vs austerity” debate, which had already shifted at the Washington IMF meetings last week and was sharpened this week by by EU Commission chief Barroso’s claim that the high watermark of EU’s austerity push had passed. On top of the Reinhart/Rogoff research farrago, it’s been a bad couple of weeks for the “austerians”, with only a UK Q1 GDP bounceback of any support for case of ever deeper fiscal cuts,  and investors smell a change of tack. Their reaction? Not only have euro government borrowing costs fallen  further, but euro equities too rallied for 4 straight days through Wednesday. Those arguing that investors would run screaming at the sight of a more growth-tilted policy mix in Europe may have some explaining to do.

Next week is back on monetary policy watch however. The ECB takes centre stage amid rate cut talks hopes for help for credit-starved SMEs. The FOMC meets stateside aswell just ahead of the critical US April employment report.

Turkey: ceasefire with PKK may bring economic gains

Turkey’s ceasefire last month with the Kurdish militant group PKK could boost its trade partnerships multilaterally, as increasing prospects for stability in the region bring economic opportunities in the Middle East and Africa.

The halt in the decades-long armed campaign came on March 21 after the leader of the Kurdistan Workers’ Party, Abdullah Ocalan, sent a letter with the announcement from the island prison cell where he has been held since 1999 when he was arrested for treason.

Although the main pro-Kurdish party has recently poured doubt on the veracity of Ocalan’s statement, the prospect of greater stability in the troubled border region with Iraq could pave the way for greater trade security and pay dividends for investors.

There’s cash in that trash

There’s cash in that trash.

Analysts at Bank of America/Merrill Lynch are expounding opportunities to profit from the burgeoning waste disposal industry, which it estimates at $1 trillion at present but says could double within the next decade. They have compiled a list of more than 80 companies which may benefit most from the push for recycling waste, generating energy from biomass and building facilities to process or reduce waste. It’s an industry that is likely to grow exponentially as incomes rise, especially in emerging economies, BofA/ML says in a note:

We believe that the global dynamics of waste volumes mean that waste management offers numerous opportunities for those with exposure to the value chain. We see opportunities across waste management, industrial treatment, waste-to-energy, wastewater & sewage,…recycling, and sustainable packaging among other areas.

There is no denying there is a problem. Around 11.2 billion tonnes of solid waste are produced by the world’s six billion people every day and 70 percent of this goes to landfill. In some emerging economies, over 90 percent is landfilled.  And the waste mountain is growing. By 2050, the earth’s population will reach 9 billion, while global per capita GDP is projected to quadruple. So waste production will double by 2025 and again from 2025 to 2050, United Nations agencies estimate.