Global Investing

Baton passing to the emerging markets consumer

Is there a change of sector leadership underway within emerging markets?

For years, commodities and energy delivered world-beating returns to emerging market investors. Yet in recent years there are signs of a shift, says Todd Henry, equity portfolio specialist at T.Rowe Price.

With the China tailwind no longer as strong as before demand for oil and metals will not be as robust as in the past decade, Henry says. But in China as well as elsewhere, disposable incomes have risen as a result of the fast economic growth these countries experienced in the past decade.

Check out the following two graphics from T.Rowe Price.

The first figure shows that in the ten years to December 2007, just before the global financial crisis erupted, emerging equities returned 300 percent in dollar terms. The two sectors that won the returns race in this period were energy and commodities, with dollar-based returns of around 650 percent. This is not surprising, given the enormous surge in Chinese demand for all manner of commodities, from oil to steel, as it fired up its exporters’ factories and embarked on a frenzy of infrastructure improvements.

The chart shows that consumer discretionary shares (comprising of auto or luxury goods makers)  didn’t actually do too badly either,  returning more than 300 percent. But they sat 5th in the rankings, beaten also by financials and healthcare in terms of returns. Shares in consumer staples (essential goods) came in sixth.

But take a look at the second chart showing sector returns between January 2008 and June  2012.  What a turnaround. Now it is indeed the EM consumer who started to deliver,  with consumer staples returning around 70 percent in this period while discretionaries provided returns of around 40 percent.

Shadow over Shekel

Israel’s financial markets had a torrid time on Monday as swirling rumours of an imminent air strike on Iran caused investors to flee. The shekel lost 1.4 percent, the Tel Aviv stock exchange fell 1.5 percent and credit default swaps, reflecting the cost of insuring exposure to a credit, surged almost 10 percent.

There has been a modest recovery today as the rumour mills wind down. But analysts reckon more weakness lies ahead for the shekel which is not far off three-year lows.  Political risks aside, the central bank has been cutting interest rates and is widely expected to take interest rates, currently at 2.25 percent, down to 1.75 percent by year-end. Societe Generale analysts are among the many recommending short shekel positions against the dollar. They say:

Expect the dovish stance of the Bank of Israel to remain well entrenched for now.

Lower rates give no respite to Brazil stocks

In normal times, an aggressive central bank campaign to cut interest rates would provide fodder for stock market bulls. That’s not happening in Brazil. Its interest rate, the Selic, has fallen 350 basis points since last August and is likely to fall further at this week’s meeting to a record low of 8.5 percent. Yet the Sao Paulo stock market is among the world’s worst performers this year, with losses of around 4 percent. That’s better than fellow BRIC Russia but far worse than India and China.

Brazil’s central bank and government are understandably worried about a Chinese growth slowdown that would eat into Brazilian commodity exports. They are therefore hoping that rate cuts will prepare the domestic economy to take up the slack.

But the haste to cut interest rates appears to have spooked some foreign investors, with many seeing the moves as evidence of political pressure on the central bank. A closely-watched survey from Bank of America/Merill Lynch showed that fund managers had swung into a net 14 percent underweight on Brazil in May from a net overweight of over 20 percent in April (See graphic). This is the first time investors have turned negative on Brazil since February 2011, BofA/ML said.

Three snapshots for Wednesday

On Friday 283 companies in the S&P 500 had a dividend yield higher than the 10-year Treasury yield, at yesterday’s close this had fallen to 266 but remains very high compared to the last 5-years.

Italian consumer morale plunged to its lowest level on record in May as Italians’ pessimism over the state of the economy plumbed new depths.

Germany set a zero coupon on its new Schatz, the first time it has done so on debt of such maturity. The bid to cover ratio for the new bond at the auction was 1.7, compared with 1.8 at a sale of two-year debt on April 18.

Research Radar: Greek gloom

Greek gloom dominates the start of the week as new elections there look inevitable and talk of Greek euro exit, or a Grexit” as common market parlance now has it, mounts. All risk assets and securities hinged on global growth have been hit, with China’s weekend reserve ratio easing doing little to offset gloomy data from world’s second biggest economy at the end of last week. World stocks are down heavily and emerging markets are underperforming; the euro has fallen to near 4-month lows below $1.29; safe haven core government debt is bid as euro peripheral debt yields in Italy and Spain push higher; and global growth bellwethers such as crude oil and the Australian dollar are down – the latter below parity against the US dollar for the first time in 5 months.

Financial research reports on Monday and over the weekend were just as gloomy, but plenty of interesting takes:

Bank of New York Mellon’s Simon Derrick’s view of the Greek political impasse concluded “there is at least an evens chance that the latter part of this summer will see what had officially been seen up until last November as an impossibility: a nation leaving the EUR.”

Hungary can seek IMF aid now. But can it cut rates?

The European Union has given Budapest the green light to seek aid from the IMF. (see here)  In fact, the breakthrough after five months of dispute does not let Hungary completely off the hook  — to get its hands on the money, Viktor Orban’s government will have to backtack on some controversial recent legislation, starting with its efforts to curb the central bank’s independence.  It remains to be seen if Orban will actually cave in.

But markets are reacting as if the IMF money is in Hungary’s pocket already. There have been sharp rallies in Hungarian dollar bonds,  CDS and currency markets (see graphic below from Capital Economics). The Budapest stock market has posted its best one-day gain since last November while the yield on local 10-year bonds have collapsed almost 100 bps. Hungarian officials are (a bit prematurely)  talking of issuing bonds on world markets.

What investors are hoping for now is a cut to the 7 percent interest rate. Hungary’s central bank jacked up rates by 100 bps in recent months to defend the forint as cash fled the country. Now there is a chance those rate rises can be reeled back in. After all, the moribund economy could really use a dash of monetary easing. Thanasis Petronikolos, head of emerging debt at Baring Asset Management has been overweight Hungary and  recalls that after 2008 crisis, the central bank was able to quickly take back its 300 bps of currency-defensive rate hikes.

from MacroScope:

Foreign investors still buying American

Overseas investors have yet to sour towards U.S. assets despite high government debt levels, according the latest figures on capital flows.

Including short-dated assets such as bills, foreigners snapped up $107.7 billion in U.S. securities in February, following a downwardly revised $3.1 billion inflow for January. At the same time, the United States attracted a net long-term capital inflow of just $10.1 billion in February after drawing an upwardly revised $102.4 billion in the first month of 2012.

The data showed China boosted purchases of U.S. government debt for a second month in February, but also some waning of demand for longer-dated securities.

No hard landing for Chinese real estate

The desperate days when Chinese property developers offered free cars as an inducement to homebuyers look to be over.

Sales and earnings figures indicate some of the gloom is lifting as developers have enjoyed a second straight month of rising sales. Vanke, China’s biggest developer by sales, said last week that March sales had risen 24 percent year on year, while  2011 profits rose 30 percent. Another firm, China Overseas Land, posted a 21.5 percent profit rise last year.

The mood is reflected in stock prices. While the Shanghai shares index has risen less than 5  percent this year,  a sub-index of Chinese property companies has risen 13 percent. Shares in Vanke and COL are up 13 percent and 22 percent respectively. A Reuters poll of fund  managers showed that investors had upped their weighting for property stocks to 10.9 percent at the end of March, the highest level in two years.

All in the price in China?

It’s been a while since Chinese stocks earned investors fat profits. Last year the Shanghai market lost 22 percent and the compounded return on equity investments there since 1993 is minus 3 percent. This year too China has underwhelmed, rising less than 3 percent so far. Broader emerging equities on the other hand have just concluded their best first quarter since 1992, with gains of over 13 percent.

Given all that, bears remain a surprisingly rare breed in China. A Bank of America/Merrill Lynch’s monthly survey found it was fund managers’ biggest emerging markets overweight in March and that has been the case for some months now.  Clearly, hope dies last.

Driving many of these allocations is valuation. China’s equity market has always tended to trade at a premium to emerging markets but in recent months it has swung into a discount, trading at 9.2 times forward earnings or 10 percent below broader emerging markets.  MSCI’s China index is also trading almost 25 percent below its own long-term average, according to this graphic from my colleague Scott Barber (@scottybarber):

March world equity funk flattered by Wall St

It was all about the United States last month as far as equity markets were concerned. S&P’s world equity index may have ended the month with a small gain of just 0.3 percent but that was down to a 3 percent rise on  U.S. markets, data from the index provider shows. Strip out the U.S. contribution and it would have been a pretty poor month for world equities. Beyond Wall St, there was a decline of 1.7 percent and $285 billion lost in market value. Instead, the $418 billion added to U.S. market capitalization dragged the global aggregate up by $132 billion.

Behind the robust U.S. equity performance was a steady flow of strong economic data which also pushed up U.S. 10-year yields 20 bps last month. S&P index analyst Howard Silverblatt writes:

The overall rationale for the U.S. outperformance is the perception that several parts of the world have re-entered a recession, while the U.S. continues to show a slow, but steady recovery.