Global Investing

In defence of co-investing with the state

It’s hard to avoid state-run companies if you are investing in emerging markets — after all they make up a third of the main EM equity index, run by MSCI. But should one be avoiding shares in these firms?

Absolutely yes, says John-Paul Smith at Deutsche Bank. Smith sees state influence as the biggest factor dragging down emerging equity performance in the longer term. They will underperform, he says, not just because governments run companies such as Gazprom or the State Bank of India in their own interests (rather than to benefit shareholders)  but also because of their habit of interfering in the broader economy.  Shares in state-owned companies performed well during the crisis, Smith acknowledges, but attributes emerging markets’ underperformance since mid-2010 to fears over the state’s increasing influence in developing economies. (t

Jonathan Garner at Morgan Stanley has a diametrically opposing view, favouring what he calls “co-investing with the state”.  Garner estimates a basket of 122 MSCI-listed companies that were over 30 percent state-owned outperformed the emerging markets index by 260 percent since 2001 and by 33 percent after the 2008 financial crisis on a weighted average basis. The outperformance persisted even when adjusted for sectors, he says (state-run companies tend to be predominantly in the commodity sector).

Past performance and state support aside, Garner sees two inducements to buy shares in state-run companies. Firstly, they tend to trade relatively cheaply to their private sector peers (almost certainly because of the risks that state involvement is perceived to bring). Morgan Stanley calculates these companies are a fifth cheaper than the broader index, both on a forward price/earnings basis and on a price/book basis.

Secondly, many of these companies now pay decent dividends. Garner’s sample group of companies exhibits a dividend yield of 3.2 percent versus 2.7 percent for the MSCI index. That’s up from 1 percent in 2007 and should rise to 4 percent in 12, Morgan Stanley predicts. 

Eight days could point to a correction

Morgan Stanley has been crunching some numbers about Europe and come up with something that (not surprisingly) fits their scenario of  a near-term stock correction but only within a longer-term cyclical bull market for equities. It all comes down to eight days in March, apparently.

Here is the gist:

During 8 days in March, MSCI Europe was up (more than) 50 percent year-on-year.  This is a rare event, has happened on only 80 individual days since 1919.  It is a bullish signal on a 12-month view, a cautious signal on a 6-month view.  On average, the next 12 months  the market has been up 10 percent, up 96 percent of the time, the next 6 months down 4 percent, down 77 percent of the time

As for timing of the correction, MS says it will be when good economic news becomes bad market news sometime in Q2. That is to say, when a string of positive economic data prompts  central banks into a policy reaction or when markets react by sending bond yields and inflation expectations up.