Global Investing

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.

GS relies instead on so-called “trade in value-added” data that allows it to separate direct exports to China and indirect trade connections. Measured this way and using industrial output as a proxy for growth, emerging Asia’s effective exposure to China turns out to be half of that measured using gross trade data:

In terms of levels, a one standard deviation shock to China’s industrial production  (roughly equivalent to a 4 percent annualised growth shock) would lower the level of industrial output in non-Japan Asia by some 0.6 percent on average in 12 months from the time of the shock, so roughly by as much as the fall in China’s industrial production in that period, as per our model estimates. The average impact would be smaller for the CEEMEA countries (some 0.5 percent on average) and the LatAm countries (0.43 percent).

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”:

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)?

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:

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.

Route 312 – China’s Route 66

The world’s largest car market, China, with a population of 1.3 billion people and an emerging middle class, holds great potential for investors and consumers alike with annual growth rates in the auto sector expected to hold at around 23 percent to 2017, according to Alliance Bernstein Asset Managers.

Joint ventures (JV), the most popular structure for foreign firms investing in the automobile sector in the world’s largest car market, are set to capitalise on a growing consumer base in a country with 3.3 million kilometres of asphalt. Traversing the so-called ‘mother’ road 312 (China’s route 66) is becoming more of an attainable dream for the Chinese consumer.

VW has a JV with Changchun-based FAW, Dongfeng with Nissan, GAC with Toyota and  Honda. There are many investment opportunities, though a constantly changing sectoral environment and risks of mechanical recalls can cause sharp fluctuations as in any market, according to Bernstein Research, a subsidiary of Alliance Bernstein holdings.

Brazil grinds out a result

The South Americans are dominating possession. And it’s not only on the football pitch.

Net flows at Brazilian equity mutual funds have been positive for 11 out of the 12 months to end-May, according to estimates from Lipper, leading to total net inflows over the period of about $13 billion. That stands in stark contrast to the other three BRIC emerging market powerhouses.

China equity funds have waved goodbye to almost £3 billion in that time, Russia a similar amount and India $4 billion. India equity funds have seen 12 straight months of net outflows, Russia 10 out of 12 and China nine out of 12. The graphic below makes the trend clear, with Brazil the only BRIC to show net inflows to equity funds in eight of the 12 months examined. (A brief note on India: the reporting timetable of locally-domiciled funds means that these numbers are largely from funds based outside the country, which account for about half of assets)