Global Investing

Emerging Markets: the love story

It is Valentine’s day and emerging markets are certainly feeling the love. Bank of America/Merrill Lynch‘s monthly investor survey shows a ‘stunning’ rise in allocations to emerging markets in February. Forty-four percent of  asset allocators are now overweight emerging market equities this month, up from 20 percent in January — the second biggest monthly jump in the past 12 years. Emerging markets are once again investors’ favourite asset class.

Looking ahead, 36 percent of respondents said they would like to overweight emerging markets more than any other region, with investors saying they would underweight all other regions, including the United States. Meanwhile investor faith in China has rebounded  with only 2 percent of investors believing the Chinese economy will weaken over the next year, down from 23 percent in January. China also regained its crown of most favoured emerging market in February.

Last year, the main EM index plummeted more than 20 percent as emerging assets fell from favour. So what is the reason for this renewed passion in 2012?

Firstly December’s LTRO — a multi-billion euro liquidity arrow from the cupids at the ECB has revived investor appetite for riskier emerging assets, boosting the index to around six-month highs since the start of the January. A second significant factor behind the resurgence in  risk sentiment is that the market is daring once again to hope for an improvement in global growth, says Gary Baker,  BofAML Global Research head of European equities strategy.

The big beneficiaries of all this have been emerging markets.  It’s not just about liquidity. Clearly the actions of the ECB have been vitally important… but what you’ve also seen is an improvement in global growth optimism. If optimism over growth is improving  then there may well be a more fundamental underpinning to the movement.

Interest rates in emerging markets – - harder to cut

Emerging market central banks and economic data are sending a message — interest rates will stay on hold for now.  There are exceptions of course.

Indonesia cut rates on Thursday but the move was unexpected and possibly the last for some time. Brazil has also signalled that rate cuts will continue.  But South Korea and Poland held rates steady this week and made hawkish noises. Peru and Chile will probably do the same.

The culprit that’s spoiling the party is of course inflation. Expectations that slowing growth will wipe out remaining price pressures have largely failed to materialise, leaving policymakers in a bind. Tensions over Iran could drive oil prices higher. Growth seems to be looking up in the United States.

Currency rally drives sizzling returns on emerging local debt

Emerging market bonds denominated in local currencies enjoyed a record January last month with JP Morgan’s GBI-EM Global index returning around 8 percent in dollar terms. Year-to-date, returns are over 9.5 percent.

 

 

This is mainly down to spectacular gains on emerging currencies such as the Mexican peso and Turkish lira which have surged 7-10 percent against the dollar and euro this year.  Analysts say the currency component of this year’s returns has been around 7 percent, meaning any portfolio hedged for currency risk would have garnered returns of just 2.5 percent.

The gains come as good news to investors licking their wounds after the index ended 2011 in negative territory. A mid-year rout on emerging markets pushed up local bond yields, often by hundreds of basis points and sent many currencies to multi-year lows.

Emerging markets facing current account pain

Emerging markets may yet pay dearly for the sins of their richer cousins. While recent financial crises have been rooted in the United States and euro zone, analysts at Credit Agricole are questioning whether a full-fledged emerging markets crisis could be on the horizon, the first since the series of crashes from Argentina to Turkey over a decade ago. The concern stems from the worsening balance of payments picture across the developing world and the need to plug big  funding shortfalls.

The above chart from Credit Agricole shows that as recently as 2006, the 34 big emerging economies ran a cumulative current account surplus of 5.2 percent of GDP. By end-2011 that had dwindled to 1.7 percent of GDP. More worrying yet is the position of “deficit” economies. The current account gap here has widened to 4 percent of GDP, more than double 2006 levels and the biggest since the 1980s. The difficulties are unlikely to disappear this year, Credit Agricole says,  predicting India, Turkey, Morocco, Tunisia, Vietnam, Poland and Romania to run current account deficits of over 4 percent this year.

Some fiscally profligate countries such as India may have mainly themselves to blame for their plight. But in general, emerging nations after the Lehman crisis were forced to embark on massive spending to buck up domestic consumption and offset the collapse of Western export markets. For this reason, many were unable to raise interest rates or did so too late. As the woes of the Turkish lira and Indian rupee showed last year, the yawning funding gap leaves many countries horribly exposed to the vagaries of global risk appetite.

Emerging consumers’ pain to spell gains for stocks in staples

Food and electricity bills are high. The cost of filling up at the petrol station isn’t coming down much either. The U.S. economy is in trouble and suddenly the job isn’t as secure as it seemed. Maybe that designer handbag and new car aren’t such good ideas after all.

That’s the kind of decision millions of middle class consumers in developing countries are facing these days. That’s bad news for purveyors of everything from jeans to iphones  who have enjoyed double-digit profits thanks to booming sales in emerging markets.

Brazil is the best example of how emerging market consumers are tightening their belts. Thanks to their spending splurge earlier this decade, Brazilian consumers on average see a quarter of their income disappear these days on debt repayments. People’s credit card bills can carry interest rates of up to 45 percent. The central bank is so worried about the growth outlook it stunned markets with a cut in interest rates this week even though inflation is running well above target

Venezuela — high risk, higher yield

Venezuela's Chavez with Lukashenko of Belarus

Which bond would you rather buy — one issued by a country with an unpredictable leader but huge oil reserves, or one with  a dictatorial president as well as empty coffers? The answer should be a no brainer. Not so. The countries are Venezuela and Belarus, and a basic comparison of their debt profiles shows how strangely risk can be priced in emerging markets.

Venezuela’s 2022 dollar bond yields 15.5 percent while the 2022 issue from state oil firm PDVSA trades at 17 percent yield. Venezuelan debt pays a 1200 basis point premium to U.S. Treasuries, according to the EMBI Global bond index.

Now check out Belarus. Dire public finances, a huge recent currency devaluation, and seeking an $8 billion bailout from the IMF, yet able to pay 11 percent on its 2018 issue. Its yield premium to Treasuries is 900 bps or three percentage points less than Venezuela.

Investors love those emerging markets

No question that investors are in the throes of passion over emerging markets. The latest Reuters asset allocation polls show investors pouring money into Asian and Latin American stocks in October to the detriment of U.S. and euro zone equities. Exposure to equities in emerging Europe, Asia ex-Japan, Latin America and Africa/Middle East rose to 15.6 percent of a typical stock portfolio from 14.3 percent a month earlier. untitled

from Reuters Investigates:

Enter stage left — Brazil’s next president?

BRAZIL-ELECTION/ROUSSEFFNot every president has a police mugshot, but it's not so surprising in Latin America.

A special report out of Brazil today sheds new light on Dilma Rousseff, a former guerrilla leader who is likely to be elected the booming country's next president. She spent nearly three years in jail in the early 1970s and was tortured by her military captors. She's come a long way since then.

The product of more than a dozen interviews with Rousseff and her top advisers, the story gives a glimpse of how Rousseff could govern at the helm of a country that, with India, Russia and China, is among the worlds few economic bright spots.

Not quite 99 emerging market beers on the wall

Should emerging market investors set aside their spreadsheets and crack open a cold one?

Their markets have zoomed higher from the March lows, with MSCI’s emerging markets stock index up 81 percent. Are they heading for a fall? Will investors soon be crying in their beer? And if so what kind?

Broker Auerbach Grayson held a rooftop fete this week showcasing emerging market versus developed market beers, with nary a Yankee brew in sight.

Talking inflation over coffee as oil falls

CoffeeInteresting juxtapositions at a Barclays Capital chat. On the day when oil prices were plunging below $106 a barrel — more than $40 below their July record peak — the investment bank held a lunch seminar to discuss trading strategies on inflation. ”It seems odd to have an inflation seminar when oil prices more or less collapsed,” said Tim Bond, head of global asset allocation. He added, however, that there is still structural upward pressure on inflation and this theme is further to run.

Rodrigo Valdes, Barclays’ chief Latin American economist and former head of research at Chile’s central bank, talked about the varying impact on inflation from food prices, as those gathered tucked into roasted sea trout with razor clams, carrot puree and sorrel velonte.

He said the surge in food and other resource prices hits emerging markets more than others, predicting Latin American inflation to peak in Q4 or Q1 with quite a lot of interest rate hikes to come. “If you buy a cup of coffee here, there’s not much coffee in it … In Brazil, it’s not the case,” he said.