Global Investing

Russia’s starting blocs – the EEU

The course is more than 20 million square kilometers, and covers 15 percent of the world’s land surface. It’s not a new event in next month’s IAAF World Championships in Moscow but a long-term project to better integrate emerging Eurasian economies.

The eventual aim of a new economic union for post-Soviet states, known as the Eurasian Economic Union (EEU), is to “substitute previously existing ones,” according to Tatiana Valovaya, Russia’s minister in charge of development of integration and macroeconomics, at a media briefing in London last week.

That means new laws and revamping regulation for “natural monopolies” in the member states, streamlined macroeconomic policy, shared currency policy, new rules on subsidies for the agricultural and rail sectors and the development of oil markets.

Kazakhstan and Belarus are the two other members of what is known as the Single Economic Space (SES), that is, the existing economic partnership between the three bordering countries established in 2012. So far Kyrgyzstan and Tajikistan  are co-operative members, Ukraine, Armenia and Moldova have been given observer status.

Since 1995, the SES3 and observer states have been moving ever closer to a shared set of structures under the EEU umbrella.

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.

“Contrarian” Deutsche (a bit) less bearish on emerging stocks

For an investor in emerging equities the best strategy in recent years has been to take a contrarian stance, says John-Paul Smith at Deutsche Bank.

Smith, head of emerging equity strategy at Deutsche, has been bearish on emerging stocks since 2010, exactly the time when bucketloads of new cash was being committed to the asset class. Investors who heeded his advice back then would have been in the money — since end-2010 emerging equities have underperformed U.S. equities by almost 40 percent, Smith pointed out a couple of months ago.

Things have worsened since then and MSCI’s emerging equity index is down around 12 percent year-to-date, almost the level of loss that Deutsche had predicted for the whole of 2013. June outflows from emerging stock funds, according to EPFR Global last week, were the largest on record. But true to form, Smith says he is no longer totally bearish on emerging equities.  Maybe the presence or absence of those he calls “marginal international investors” — people who joined the EM party too late and are quick to take fright — is key. Many of these positions appear to have been cleaned out. Short positions or high cash balances dominate the books of dedicated players,  Smith writes:

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)

A drop in the ocean or deluge to come?

Glass half full or half empty? For emerging markets watchers, it’s still not clear.

Last month was a record one in terms of net outflow for funds dedicated to emerging equities, Boston-based agency EPFR Global said.  Debt funds meanwhile saw a $5.5 billion exodus in the week to June 26, the highest in history .

These sound like big numbers, but in fact they are relatively small. EM equity funds tracked by EPFR  have now reversed all the bumper year-to-date inflow registered by end-May, but what of all the flows they have received in the preceding boom decade?

Russians and the city: consumer led growth

Speculation is growing that new central bank governor Elvira Nabiullina will cut rates to help stimulate faltering growth soon after takes up her job later this month, but the resilience of the Russian consumer may be another important factor in giving the economy a lift.

Retail sales figures have been lower than expected for the first quarter of 2013, leading economists to revise downwards their prediction for this driver of growth, though performance in the construction and cement sectors is improving, according to Morgan Stanley research:

Overall, we estimate that household consumption growth has accounted for 65 percent of Russian growth over the last decade.

Weekly Radar: A ‘sudden stop’ in emerging markets?

Turkey’s lira, South Africa’s rand and South Korea’s won have all lunged, local currency debt yields have suddenly surged, there’s an intense investor focus on domestic political risks again and governments like Brazil who were taxing what they feared were excessive foreign investment over the past couple of years have U-turned as those flows evaporate. 

What some have feared for many months may well be materializing – a ‘sudden stop’ in financing flows to emerging markets as the makings of a perfect storm gathers. With the Fed mulling some reduction in the amount of dollars it’s pumping into the world, the prospect of a rare and protracted rise in the dollar and U.S. Treasury yields potentially changes entire EM investment metrics for U.S. funds (who make up almost half of the world’s private institutional investors) and from markets which have willingly or not been some of the biggest beneficiaries of QE in recent years but also to where where , by some estimates, nearly $8 trillion of FDI and portfolio flows have flowed over the past decade. It doesn’t even have to mean a reversal of capital already in emerging markets, but even a sudden stop in new flows there could seriously undermine the currency and debt markets of countries heavily dependent on rolling foreign financing – those with large current account gaps to finance. As emerging and global economic growth has eased and return on equity sinks, emerging equity markets have already underperformed for three years now. But the biggest wave of recent investment in EM had been into its bond markets, most recently to higher-yielding local-currency debt markets. And it’s these flows that could dry up rather quickly and shockingly, with all the attendant pressure on currency rates and vice versa. For context, a record of more than $410 billion new sovereign and corporate bonds from emerging economies were sold last year alone, according to JPMorgan, and Morgan Stanley estimates show emerging companies alone have sold some $130 billion worth of new debt so far this year – up 30 percent on last year and more than twice the same period in 2011.
               Already we’re seeing big hits to big current account deficit countries Turkey and South Africa in this region and, as is so often the case in emerging markets, the withdrawal of capital leads to an intense focus on domestic and political risks. These are two of the five biggest destination for bond flows over the past four years, a list –measured on flows as share of GDP – also includes Poland and Czech Republic. Mexico is top of the list, but many see its geographic and financial proximity to the US insulating it.

               So, is this a 1997/1998 redux? That’s certainly a big fear. The similarities are obvious – building dollar strength, higher US Treasury yields and a repatriation of US investment to a domestic ‘emerging market’ (Silicone Valley and the dot.coms in the late 1990s); a sharp drop in Japan’s yen which upset the competitive landscape in Asia; narrowing global growth differentials; some signs of excessive monetary easing in emerging economies and concern about credit bubbles in China and elsewhere; the sudden magnifying of domestic political, social and policy risks etc etc.

Not all emerging currencies are equal

The received wisdom is dollar strength = weaker emerging market currencies. See here for my colleague Mike Dolan’s take on this. But as Mike’s article does point out, all emerging markets are not equal. It follows therefore that any waves of dollar strength and higher U.S. yields will hit them to varying degrees.

ING Bank says in a note sent to clients on Tuesday that emerging currency gains in recent years have been closely tied to foreign investments into domestic bond markets. Recent years have seen a torrent of inflows into local debt, driving down yields on the main GBI-EM index and significantly boosting its market value. Hence, it makes sense to examine how the GBI-EM’s biggest constituents might fare under a scenario of a surging dollar and Treasury yields (In the two years before a Fed tightening cycle commences, 5-year Treasury yields can trade 120-150 basis points higher, ING analysts point out).

In almost every one of the emerging markets examined by ING, spreads over U.S. Treasuries have tightened dramatically since the start of 2012. Ergo, they are vulnerable to correction.

It’s all adding up – emerging markets to drive global spending

The world’s leading ad agencies are positioning themselves  in Brazil, Russia and China — countries that are expected to provide almost a third of the growth in global advertising over the next three years. That’s according to a report by S&P Capital IQ Equity Research, a unit of publishing giant McGraw Hill.

Most major advertisers already have a foothold in these BRIC economies, where the advertising market is projected to grow by an average 10.7 percent  a year over the next three years — more than three times the growth rate in  the developed world.  Over the next 15 years,  big emerging markets will add $200 billion to the global ad spend, S&P Capital IQ reckons.

Hopes, unsurprisingly, are pinned on the soccer World Cup in 2014 and the 2016 Olympics, both hosted by Brazil. Russia hosts the 2014 Winter Games in Sochi and Football World cup in 2018 and both these events are expected to boost ad spending. The behemoths of the ad world have prepared for this, says Alex Wisch, an analyst at S&P Capital IQ: