Emerging Markets Radar (May 11, 2013)

Monday, May 13th, 2013

Emerging Markets Radar (May 11, 2013)

Strengths

• The eurozone as a whole has posted two consecutive quarters of substantial current account surpluses with the rest of the world. Initially it was thought only a sustained boost in domestic consumption in Germany could pull the peripheral and eastern European countries back into a strong growth trajectory. The current situation bodes well for eastern European nations’ exports while retaining the optionality of a strong recovery in German inter-European imports.
• The Central Bank of Peru kept its benchmark interest rate unchanged at 4.25 percent for the 24th straight month while highlighting the historically low inflation, as well as the Bank’s view of the economy operating near its full potential. The mining industry, which dominates the local stock market, should be able to benefit from the low inflation and give a strong boost to the markets when commodities strengthen. As for this week, the Lima stock exchange is closing in positive territory, ahead of its main Latin American peers.
• China’s April money supply (M2) was up 16.1 percent, higher than the market expectation of 15.5 percent, while bank loans were RMB 792.9 billion, more than the estimated RMB 755 billion. Total social financing was RMB 1.75 trillion versus the market estimate of RMB1.5 billion and RMB2.5 billion in March. With faster credit expansion, the economy should grow well in the second and third quarters.
• China’s April CPI was still low at 2.4 percent, though a little higher than the consensus of 2.3 percent and 2.1 percent in March.
• China’s April exports went up 14.7 percent year-over-year versus the consensus 9.2 percent and 10 percent in March; imports were up 16.8 percent versus the consensus 13 percent and 14.1 percent in March. Although many analysts and journalists don’t believe the better-than-expected export numbers, citing lower exports to the U.S. and Europe and discrepancies between what China said it exported to Taiwan and what Taiwan said it had bought from Mainland China; the stock market reacted positively to the trade statistics. This might prove the point that the wisdom of crowds comes from general population or investors other than “informed” specialists.
• China’s State Council had two-day policy meetings in Beijing. The results are a list of reforms for 2013, e.g., interest rate liberalization, capital account convertibility and hukou reform. Those reforms are aimed at releasing the potential for industrial growth quality and efficiency, and to facilitate consumption and urbanization.
• China’s power generation improved in April as average daily power production was up 7.2 percent versus 2.4 and 5.2 percent for February and March, respectively, due to improved industrial demand, according to CICC.
• ; China’s April passenger vehicle sales went up 15 percent year-over-year, driven by new models. Domestic auto makers should be winners when government thrifty spending policies and anti-corruption policies are enforced by the central governments, while luxury brands are having short-term downside impact.
• Korea cut its benchmark interest rate by 25 basis points to stimulate the housing market and exports.
• Malaysia kept its benchmark rate unchanged at 3 percent, which economists and investors think is an appropriate rate after Malaysia’s ruling coalition, Barisan Nasional (BN), won the election to remain in control. Investors like that the economic policy will be in status-quo under the new government.

Weaknesses

• Turkey lost some ground this week relative to its eastern European peers as speculation that the possible sovereign credit re-rating by Moody’s would not take place until the end of the year. It appears the market was expecting the review to take place earlier in the year following the advancements highlighted by the agency in recent weeks.
• Venezuelan inflation soared to 4.3 percent month-over-month in April, significantly exceeding analysts’ expectations of a 3.0 percent rise. The central government, the sole provider of foreign currency, has only held one U.S.-dollar auction following the March elections, effectively making fewer dollars available for importers. This is especially problematic for a country that imports most of its consumption goods. In fact, the scarcity index, which tracks the amount of goods that are out of stock on the market, rose to 21.3 percent, the highest since the central bank began tracking the measure. Shortages of basic goods risk worsening both the fragile economy as well as the deteriorating social tensions.
• China’s April Producer Price Index (PPI) was down 2.6 percent versus down 1.9 percent in March, which showed weak downstream production demand for midstream materials and products. It also is the reason we believe inflation will stay low for a while, which would keep the People’s Bank of China (PBOC) accommodative.
• Malaysia’s March exports contracted 2.9 percent year-over-year, but better than a contraction of 7.7 percent in February this year. For the first quarter, exports fell 2.4 percent, mostly due to lower palm oil prices; imports were up 6.2 percent due to strong domestic demand. The decline in March industrial production eased to -0.2 percent year-over-year from -5.2 percent in February, but below consensus expectations for +0.2 percent.
• Indonesia’s GDP growth moderated to 6 percent in the first quarter of 2013, down from 6.1 percent in the fourth quarter of 2012, and consensus was 6.1 percent. The slower growth rate was due to weak exports and slower growth in gross fixed asset formation and domestic consumption.

Opportunities

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• As shown in the graph above, money supply (M2) was up 16.1 percent in April. The PBOC has recently stayed in an easing monetary stand by injecting liquidity into the system, and the bank systems are lending out faster than the market expectation. This bodes well for the economy in the second and third quarters, particularly helping fixed asset investments and domestic consumption.
• Speculation of more monetary easing in the Czech Republic has been gaining momentum among policymakers in the past week. After four months with the benchmark rate at 0.05 percent, members of the Central Bank’s board have expressed their intention to increase monetary stimulus through foreign exchange intervention.
• Mexico had its sovereign debt rating raised to BBB+ from BBB by Fitch Ratings on Wednesday. The agency cited strong macroeconomic fundamentals, credibility in the inflation targeting and flexible exchange rate regimes, and greater commitment of the new administration in order to pass structural reforms. In addition, the Citibank Latin America Strategy team issued a positive report highlighting opportunities in the country’s staples, financials, and consumer discretionary sectors despite the recent earnings weakness.
• Mexico recently reported a $3.27 billion fiscal surplus for the first three months of 2013, as well as $6 billion in Japanese foreign direct investment over the last eight quarters. It can only be expected for this strength to give momentum to the economy and build on the competitiveness platform President Pena Nieto is submitting to Parliament. In addition, President Obama is on an official visit to Mexico this week and, despite the fact that the President is visiting mainly to discuss immigration and security, the trip presents an opportunity to touch on other bilateral items in the agenda such as immigration and trade.

Threats

• China’s April PPI was down 2.6 percent, showing weak demand for midstream products and fragile economic growth recovery. Particularly, the weak PPI statistics might reflect the fact that the small- to medium-sized firms, which are the driving forces in China’s exports, are facing weak external demand and headwind from the appreciating Yuan.
• Business Monitor International issued a report highlighting the current trend of the Russian current account balance and its implied rapid erosion of export competitiveness. The report demonstrates how lower oil prices, very low levels of export diversification, as well as ineffective measures to address the uncompetitive nature of non-oil exports are likely to bring Russia into a current account deficit scenario within the next five years.
• The government of President Dilma Rousseff appears to have lost coordination with Brazil’s congress at a pivotal time for approving structural reforms. Earlier this week the federal government pulled its proposed value-added tax reform, allegedly following multiple modifications introduced by congress which disfigured the original reform. In addition, the lower house failed to vote on a decree, backed at the federal level, to increase private investment in the ports, which are running at overcapacity and worsening the cost structure of export-driven industries.

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Emerging Markets Radar (April 29, 2013)

Monday, April 29th, 2013

Emerging Markets Radar (April 29, 2013)
Strengths

• The Hang Seng Index was up 2.43 percent this week, driven by better than expected first-quarter earnings announcements from H-share banks, IPP, auto, telecom, home appliances and property developers. Investors also may have been encouraged by attractive valuations of H-share stocks in general.
• Domestic airlines in China booked a combined profit of more than Rmb 500 million, compared with a loss of Rmb 130 million a year earlier.
• The Philippines cut the Special Deposit Account (SDA) rate by 50 basis points to 2 percent, while keeping the overnight benchmark rate and lending rate unchanged at 3.5 percent and 5.5 percent, respectively. This is the third-consecutive SDA rate reduction to help credit expansion. The Philippines stock market, PCOMP Index, established another milestone on Monday as it closed above the 7,000 mark. The stock market is also supported by higher GDP growth, growing remittance, growing business process outsourcing, double-digit earning growth, high-loan growth, private public partnership projects, loosening monetary policy, merger and acquisition activities, and rising assets under management of local funds. However, the popular stocks are no longer cheap.
• Hong Kong exports grew 11.2 percent in March, versus the consensus of 9.3 percent. Total exports to Asia grew by 15.8 percent on a year-over-year basis. While exports to the U.S. grew by a modest 0.4 percent, exports to the U.K. and Germany fell by 26.6 percent and 14.7 percent, respectively, showing weak markets in developed countries.
• Korea’s first-quarter real GDP grew 0.9 percent quarter-over-quarter and 1.5 percent year-over-year, stronger than market expectations of 0.7 and 1.4 percent, respectively. Manufacturing, construction and services sectors expanded sequentially.
• Thailand’s March exports rose 4.55 percent versus the consensus of 2.34 percent, and better than a 5.83 percent drop for the previous month.
• S&P upgraded the rating of Colombia’s sovereign debt from BBB- to BBB. Deutsche Bank reports the rating change is justified by an improved sovereign creditworthiness, explained by a stronger fiscal profile, deeper capital markets and favorable long-term prospects. The rating agency also commented on potential future upgrades as peace negotiations progress could result in significant decreases in violence, as well as improved security. This new rating places the country in line with its peers Brazil, Mexico and Peru. The news is expected to increase foreign direct investment into the country.
• Turkey continues to be a magnet for foreign direct investment. The country’s appeal was reiterated this week when in a surprising move, Texas-based Airport Development Corporation (ADC) and airport operator Houston Airport System (HAS) announced a joint bid for the New Istanbul Airport project to be tendered on May 3. ADC and HAS were responsible for the Ferenc Lizst Airport in Budapest, as well as the Lester B. Pearson Airport in Toronto. The bid for the 7 billion euros project will be submitted jointly with an unspecified Turkish partner.

Weaknesses

• HSBC’s April China flash PMI was 50.5 versus the market estimate of 51.5, indicating the economic growth recovery is in process, but is weak.
• The China Banking Regulatory Commission’s (CBRC) chairman Shang Fulin was quoted as saying non-performing loans will keep rising, but hidden loans are expected to pose a much bigger challenge for banks.
• The Taiwan March industrial output posted a 3.28 percent decrease in March due to a downside surprise in export orders of negative 6.6 percent year-over-year. March commerce sales were weak as well, at negative 0.7 percent.
• The Brazilian central bank came short of market expectations of a 50 basis point increase in the lending rate at its April meeting. Central bank chief Alexandre Tombini announced a 25 basis point increase to the SELIC rate, which did not satisfy analysts who remain highly concerned with March inflation breaking through the tolerance ceiling of 6.5 percent. Analysts are now focusing on the central bank’s policy meeting in May for the additional 25 basis point increase, while carefully monitoring for a spill-over economic slowdown effect on the already ailing economy.
• In Hungary it appears the Viktor Orban-induced record central bank rate cuts are no match for the weakening Hungarian labor market. Despite limited success on the PMI front, the Hungarian economy has begun to show stronger signs of European weakness contagion. Industrial production was down 1.1 percent, economic confidence dropped by 21.7 points, and the unemployment rate reached 11.8 percent, just shy of its all-time high in March 2010.

Opportunities

click to enlarge

• As shown in the graph above, Chinese investors are actively opening new accounts, which might indicate those investors’ intentions of bottom-fishing in the A-share market. The Shanghai Stock Exchange Composite Index is currently priced at multiples that are at its historical lows.
• Venezuelan President Nicolas Maduro announced Tuesday his decision to name National Assembly representative Calixto Ortega in charge d’affairs for Venezuela in the United States. The head of state said that the Venezuelan government wants to have the best possible relations with all governments around the world, including the United States. We believe the new appointment opens the opportunity to improve communications and trade relations among the two countries, while at the same time helping to heal the diplomatic relations that have been strained since 2008.
• Poland is likely to continue the monetary easing it started during the last quarter of 2012. The weak monthly activity data for March, a recent downward revision of the 2012 fourth-quarter GDP, as well as the weakening of growth expectations in Germany and the eurozone, have led analysts to suggest a 25 to 50 basis point cut during the monetary policy committee meeting next month. The chart below shows how the last 50 basis point cut in March finally aligned the Polish sovereign 10-year yield performance with the performance of its emerging market counterparts. We expect a May cut to provide more support to the economy and lead Poland to outperform its peers.

click to enlarge

Threats

• China is ending its 20-year cycle of fast growth, which is characterized by manufacturing expansion, international trade growth, and infrastructure build-up. While China will maintain an annualized GDP growth rate of 7 percent, the transition of a growth model toward value-added manufacturing, consumption and services can have many uncertainties for the equity market.
• On Wednesday, Mexican president Pena Nieto suspended the presentation of his financial reform to congress, citing differences with opposition parties. The office of the president noted a new negotiation phase would improve communication with other parties and reinforce the Pact for Mexico coalition. However, the truth behind the matter, according to Deutsche Bank, is not related to the reform itself, but rather to a corruption scandal tarnishing the political campaign ahead of the Veracruz state election next July where opposition parties have accused Pena Nieto’s government of using fiscal spending for electoral purposes. The impasse is likely to be resolved, but it will certainly strain relations within the coalition, cause political casualties, and involve greater execution risks and delays on the reform front.
• With the country struggling to rein in inflation and revive the economy, Russian president Vladimir Putin said he may limit rises in gas and power tariffs to 6 percent, instead of the previously planned 9 to 10 percent. The news is negative for state-owned gas company Gazprom and the Federal Grid Company (FSK), because the lower tariff growth would negatively affect margins and profitability. Furthermore, Putin implied that the Russian Federation will not cut rates to revive the economy; instead he will pressure banks to lower their lending rates, which he considers overexaggerated. The move will compress the banks’ net interest margins and erode their profitability.

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Emerging Markets Radar (April 15, 2013)

Sunday, April 14th, 2013

Emerging Markets Radar (April 15, 2013)

Strengths

• China’s March CPI was 2.1 percent year-over-year falling short of market expectations for 2.5 percent. The benign inflation number will allow China’s central bank, People’s Bank of China (PBOC), to stay on neutral monetary policy to support the government’s growth objective. PPI was down 1.9 percent, proving weaker industrial demand, further limiting the central bank’s ability to tighten the money supply.
• In March, China’s new bank loans were Rmb 1.06 trillion versus market expectation for Rmb 900 billion; and M2 money supply grew 15.7 percent versus market expectations for 14.6 percent. Total social financing grew Rmb 2.54 trillion versus the estimated increase of Rmb 1.81 trillion. Those money supply statistics showed a strong demand for credit and good liquidity in the system.
• China’s March passenger vehicle sales increased 17 percent year-over-year to 1.39 million units, showing robust consumption growth.
• H share stocks are traded at 8.75 times forward earning with 3.5 percent dividends yield, the cheapest valuation and highest yield among the markets in China’s neighboring countries.
• Mexico released very encouraging gross fixed investment numbers for the month of January. According to the National Institute of Statistics, gross asset fixed investment increased at a pace of 4.6 percent from last year, beating analysts’ expectations by 100 basis points. The greatest expanding subcategory was machinery and equipment which bodes well for bullishness in the construction sector for the remainder of the year.

Weaknesses

• China’s March exports grew 10 percent year-over-year, lower than consensus of 11.7 percent, while imports rose 14.1 percent, higher than market consensus of 6 percent, resulting in a trade deficit of $884 million. Nevertheless, both export and import growth accelerated for the first quarter, with exports up 18.4 percent and imports up 8.4 percent, logging in a trade surplus of $43.07 billion versus $220 million in the same period last year.
• Fitch ratings downgraded China’s long-term local currency IDR rating to “A+” from “AA-“, with a stable outlook. Fitch cited five reasons for the downgrade, including fast credit expansion, proliferation of shadow banking, local government debt, lower fiscal revenue base versus other A-rated peers, and less track record on inflation management versus same peers. Investors in Hong Kong and China had largely ignored the downgrading event since those reasons are debatable.
• The Philippines’ February exports dropped by 15.6 percent versus the consensus decrease of 4.8 percent, which saw broad-based external demand weakness.
• The Monetary Policy Committee (MPC) of the Bank of Korea (BOK) kept its policy rate on hold at 2.75 percent, while the market had expected a rate cut by 25 basis points. The MPC, however, increased a policy lending window earmarked for small and medium sized companies from 9 trillion won to 12 trillion won and cut its base rate from 1.25 percent to as much as 0.5 percent. BOK also lowered its 2013 GDP growth forecast to 2.6 percent from 2.8 percent released in January, but the market expects an upside from the lowered forecast.
• Malaysia saw its February industrial production fall 4.5 percent below the consensus decrease of 2.5 percent, mostly due to shortened working days during Chinese New Year holiday.
• Bank Indonesia, the central bank, kept its policy rate unchanged at 5.75 percent, but lowered GDP forecast to 6.2 – 6.6 percent from the previous range of 6.3 -6.8 percent. The risk is fuel price measures, which can inflate consumer goods prices if subsidies are removed.
• Brazilian news continues to show deterioration in the overall economic environment. Just this week the balance of trade started showing signs of declining exports on the back of sluggish global economic growth. The decline in inflation for the month of March relative to February was not enough to prevent the CPI to breach the annualized 6.5 percent tolerance threshold, and UBS reported it estimates first quarter GDP growth to disappoint by growing roughly at half the pace of its already conservative 1.4 percent original estimates.

Opportunities

click to enlarge

• As shown in the graph, the internet sector outperformed during the SARS period in 2003. After the SARS pandemic, the overall market rebounded and ended the year much higher. The current bird flu outbreak seemed well under control in the last couple of weeks, and social order in China is as normal as before.
• This Sunday, April 14, will mark the first time in 20 years that a presidential election in Venezuela will not have Hugo Chavez as a candidate. The consensus among local political analysts is that interim President Nicolas Maduro will win the elections by campaigning on Chavez’s platform. Despite the fact that the majority of the polls show Maduro will outvote opposition leader Henrique Capriles by a comfortable margin, we believe there is an opportunity for the opposition to narrow the 11-point gap of last year’s elections. A narrower win by the “chavismo” could lead to Maduro softening his party’s critical and debasing stance towards the opposition.
• Odds on Macau gaming revenue are rising as credit rating service Fitch raised its outlook, the latest in a string of upbeat reports on the Chinese gambling enclave. Fitch now expects Macau gambling revenue to rise 11.5 percent in 2013, up from its prior 8 percent forecast. Macau officials recently said gambling revenue jumped 25 percent in March, to nearly $4 billion, a new monthly record.

Threats

• For China, monetary policy directions are determined by inflation expectation and economic growth maintenance. Presently, neither of the two factors seems to cause any policy threat on the equity market, but other risk management measures in financial market, such as wealth management product regulations, could cause some short-term market volatility.
• Bank Indonesia may raise its benchmark some time over the year since CPI is threatened by trade deficit.
• The Peruvian government continues to do “whatever it takes” to tame a potential appreciation of its currency, the New Sol. This week, and for the third consecutive time this year, the central bank allowed an increase in pension funds’ cap on foreign investment. The measure, now at 36 percent after the last lift, is far above the 10.5 percent of 2006. While we welcome the move to allow greater investment flexibility, the estimated $1.7 billion of potential outflows estimated by Deutsche Bank could pose a threat to the already underperforming Peruvian stock market, and to the rallying local corporate bond market.

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Emerging Markets Radar (April 8, 2013)

Monday, April 8th, 2013

Emerging Markets Radar (April 8, 2013)

Strengths

• Macau generated record gaming revenue in March, up 25 percent year-over-year or 16 percent month-over-month.
• China’s major cities released their interpretations or implementations of the State Council’s “New Five-Point Property Measures.” On home price and home purchase restrictions, policies remained largely neutral, except for Beijing and Shanghai which are biased toward the tightening side. On the 20 percent capital gains tax, the policies mostly just simply repeated the exact wording of the State Council’s notice. The market had positively reacted to the announcements by the local governments.
• China March new loans may be RMB1 trillion based on an estimate that new lending by the four biggest banks was about RMB331 billion, Shanghai Securities News reports. Also in anther news by the Economic Information Daily, investments for China’s railways, roads, ports and airports may be almost RMB4 trillion for the three years through 2015.
• China PMI came in at 50.9, up from 50.1 in February, but lower than consensus 51.2, showing the expansionary Chinese economic activities. China’s March non-manufacturing PMI rose to 55.6 from 54.5 in February.
• Hong Kong February retail sales value was up 22.7 percent year-over-year versus the consensus of 15.7 percent.
• Bank of Thailand (BOT), the central bank, kept the policy rate on hold at 2.75 percent this week. BOT expects the Thai economy to moderate toward a normal trend, while the pace of fiscal stimulus is expected to rise gradually in second half of 2013, in line with the start of government spending on infrastructure projects. Thailand just reported February CPI that was 2.69 percent versus the consensus of 3 percent, and 3.23 percent in the previous month.
• The Korean government announced its property stimulus measures, which include capital gains tax reductions, tax and loan benefits for first-time home buyers, and a reduction in public housing supply.
• Mexico’s Finance Ministry submitted to Congress the so-called Pre-General Criteria of Economic Policy, which marks the first step of the reforms proposed by President Pena Nieto. The restructuring in the energy, telecommunications, and financial sectors will be carried together with a tax reform, which Pena Nieto assures will attract greater foreign direct investment, enhance productivity, and accelerate economic development.

Weaknesses

• China reported 16 cases of H7N9 (bird flu) with 6 dead. Officials said there are no human contagions found at the moment, but no vaccines are discovered either. Should the epidemic spread, it will negatively impact the social life and the economic activities.
• China’s home prices rose 1.06 percent in March or 3.9 percent year-over-year to Rmb9, 998 a square meter ($146.6 a square feet), Soufun Holdings Ltd said. Sharp price increases invite tightening government housing policy.
• Korean peninsula tensions are at the highest level in recent years with North Korea threatening to retaliate using nuclear bombs on U.S. military bases and its alliances in North East Asia.
• Indonesia’s exports contracted 4.5 percent in February, and the oil trade deficit stayed wide at $2.3 billion. The trade deficit widened to $327 million from $75 million in January, which indicates economic imbalance between consumption and manufacturing at the moment.
• Brazilian equities continue to underperform their BRIC and South American peers as companies post the longest streak of earnings misses in six years. For the fourth quarter of 2012 over 65 percent of the members of the Bovespa Index trailed analysts’ earnings estimates. The most recent quarter’s information is the fifth straight period in which more than 50 percent of the companies in the benchmark fell short of expectations.

Opportunities

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• As shown in the graph above, China March PMI was 50.9, which indicates a weak expansionary economy. With news report that China had found 16 cases of H7N9 (bird flu) and 6 people had died, the probability of tightening the economy by monetary and fiscal policies is extremely low.
• Brazil’s President Dilma Rousseff issued a decree on Thursday that will eliminate payroll taxes in the construction and transportation industries in favor of a 1 to 2 percent tax on gross revenue. In the previous months, similar measures were adopted across multiple sectors to incentivize economic growth and business hiring ahead of presidential elections in 2014.
• While positioning in consumer segments in emerging markets is an increasingly crowded trade that is beginning to stretch valuations, frontier markets generally look a lot more attractive. Higher dividend yields than in emerging markets offer better protection against inflation. Frontier markets also offer superior exposure to the developing world consumer than emerging markets in general, because of market composition, according to HSBC.

Threats

• Reported bird flu in China, if breaking out like the SARS in early 2003, can threaten the overall economic activities, especially tourism, entertainment, retail, and air and land transportation.
• The Colombian Finance Minister has voiced his discontent with commercial and personal lending rates in the country. After the central bank cut benchmark interest rates by 100 basis points so far in 2013, commercial banks have only decreased lending rates by approximately 50 basis points signaling issues in the monetary transmission mechanism. Banco de la Republica has stated its March cut would be the last in the current cycle, leading to speculation that commercial banks, not the central bank, now hold the key to bringing the economy closer to full potential.
• Amid concerns about ballooning G7 public debt, emerging market economies, still smarting from their own mistakes of previous regimes, have been much more disciplined and actually managed to keep debt-to-GDP levels largely stable since the outbreak of the credit crisis in 2007-08.

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Emerging Markets: Proceed with Caution (Gibley)

Thursday, April 4th, 2013

April 3, 2013

by Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research

Key points

• Emerging markets have great promise—but we see constraints on future growth in large EM economies, and stocks have underperformed recently.
• Meanwhile, inflation is stubbornly high in several large countries, which could result in monetary tightening that further slows growth.
• We are cautious on emerging markets as an asset class, and see better opportunities in developed markets such as Europe and Japan.

The large emerging-market economies of Brazil, China and India have run into growth, inflation, and structural challenges. Combine that with a potential peak in commodity prices that could damage heavy commodity exporters such as Brazil, South Africa, Russia, Indonesia and Chile, and we see reason to be cautious on emerging markets (EM) as an asset class.

High economic growth doesn’t assure strong stock performance

Just five years ago, emerging markets, including the BRIC sub-group (Brazil, Russia, India and China) showed great promise. Chinese and Indian incomes were growing; Brazil and Russia boasted abundant and valuable natural resources; and low government debt and high levels of foreign exchange reserves in many emerging markets seemed to pave the way for rapid growth.

Emerging-market growth steps down

Source: FactSet, IMF. Estimates used after vertical line are as of Oct. 2012, World Economic Report database.

Unfortunately, growth rates have taken a noticeable step down, and emerging-market stocks have underperformed over the past two years. Some investors have held on to emerging-market allocations on the premise that the growth outlook for these countries remains above that in the developed world.

Paradoxically, higher economic growth doesn’t always equate to the best investment returns—academic research suggests no clear correlation. While stronger economic growth creates the potential for greater sales growth, high earnings per share and dividend growth don’t necessarily follow. Profits can suffer if wages rise faster than productivity increases. Weak corporate governance can reduce returns when profits are expropriated rather than passed along to shareholders. Additional capital can be needed to sustain high growth, which can reduce shareholder returns.

The role of expectations and valuations is also very important. High growth expectations can be accompanied by high valuations, resulting in future underperformance—the good news is priced in. We believe that missed growth expectations in emerging markets are the likely culprit for the underperformance over the past two years.

Emerging market growth may have difficulty improving

So are expectations now low enough to get in? We view valuation as an important basis for future performance, but not the only factor. We are cautious on emerging markets (EM) as an asset class due to growth constraints for 60% of the weight in the universe, as defined by the MSCI Emerging Market Index. We believe addressing these constraints could involve difficult transformations or decisions by policymakers in the largest countries.

• A combination of stagflation and structural issues in the large emerging market economies of Brazil, China and India, which represent 40% of the MSCI Emerging Market Index.
• Commodities are potentially peaking, which represents roughly 20% of the MSCI Emerging Market Index, excluding Brazil (included above).

China: Still growing, but sources are suspect

Construction spending has been the primary driver of China’s economic growth in recent years, but it was fueled by a massive issuance of debt, which grew at 30% of GDP for four straight years. That rate of growth can’t continue forever, so we think property and infrastructure construction will likely slow from the rapid pace of the past. Additionally, the overhang of debt could result in a credit crunch that reduces growth for the overall economy.

China’s government is trying to transition to a more consumer-led economy, which will likely be an eventual positive for consumer spending—but we could see policy mistakes and uneven economic progress along the way. It’s much harder for a government to control consumer spending than it is to order new infrastructure construction or command a state-owned company to build another factory. Wages are rising, which benefits consumers, but sales and labor productivity are slowing, constraining corporate profits. Corporations have had difficulty with pricing power.

Additionally, China has a host of challenges related to the growth of its shadow banking sector. See more in “China’s Hidden Risks: Shadow Banking and US Delisting” and “Avoid China – Subprime-Like Bubble Brewing.”

China’s debt-fuelled growth potentially unsustainable

Source: FactSet, People’s Bank of China, Bloomberg. In current dollars using the December 31, 2012 exchange rate. Total credit as measured by total social financing. As of January 29, 2013.

Brazil: Stressed consumers and government bureaucracy

Brazil’s economy relies heavily on consumers, who represent 60% of GDP—and right now, consumers are challenged by inflation and high levels of household debt.

Inflation in Brazil accelerated to 6.3% in February and has exceeded the central bank’s 4.5% target for more than two years. The country’s tight labor market could further propel inflation. With flagging productivity gains and low unemployment, employers won’t find it easy to get more productivity out of the existing workforce or hire lower-wage workers—which means that rising wages may be next. This is good for workers, but often leads to accelerating inflation.

Additionally, the rapid growth in consumer credit that helped to fuel Brazil’s economy in recent years may now be waning. Brazil’s households spend roughly 20% of their disposable income servicing debt, compared to 14% at the peak for the US consumer in 2007, according to Capital Economics. With consumers spending so much money servicing debt, there’s little disposable income left over for new consumption.

Brazil’s consumers are tapped out on credit

Source: FactSet, Banco Central do Brasil, Bloomberg. As of March 15, 2013. *Household debt is the sum of consumer loans outstanding and housing loans outstanding.

On the business side, government bureaucracy and increased interference in the private sector has created a difficult operating environment—particularly for the two largest stocks in the Bovespa Index, as well as utilities and banks. For example, the government limited the price Petrobras could charge for petrol fuel in order to dampen inflation—but this reduced profits for the oil company. Meanwhile, Brazil’s central bank has pursued a somewhat volatile monetary policy. It has overshot at times, creating volatility in both growth and inflation, and has instituted controls that limit foreign investment.

India: Reforms needed, but hopes fading

Economic growth in India has roughly halved from the 9-10% range in the late 2000s to a 4.5% annualized rate as 2012 ended, well below the country’s 8% growth goal. From a funding perspective, India suffers from both a large fiscal deficit and the need for foreign investment due to low savings rates. Therefore, reforms to reduce fiscal spending and attract investment are important to reinvigorate growth.

India’s fiscal deficit expected to worsen before it improves

Source: FactSet, Bloomberg, India Central Statistical Organization. Estimates used after vertical line are provided by India Central Statistical Organization. As of March 15, 2013.

The fiscal budget released in February 2013 was a disappointment for investors hoping for reforms. The budget projected optimistic revenue increases and placed a greater tax burden on corporations, but lacked reforms to spending, preserving populist measures such as costly fuel, food and fertilizer subsidies. Reforms to open the economy to competition announced in 2012 were a positive first step, but momentum has stalled and the possibility of progress ahead of elections in April 2014 is fading.

Meanwhile, inflation is stubbornly high due to swings in food prices, which constitute a large portion of consumer spending. This volatility is the result of supply bottlenecks that stem from insufficient power and warehouse facilities, low agriculture yields, an inefficient public food-distribution system and dependence on the unpredictable monsoon season for irrigation.

Commodity prices may be peaking

As emerging-market economies continue to build out infrastructure and housing, they’ll support demand for commodities such as industrial metals and construction materials. However, the pace of demand growth is likely to slow. China constitutes 40% of demand for many commodities right now, and we expect slower growth in future demand from China as construction of infrastructure and property slow. We don’t see any countries that could replace China as a major commodities consumer—both Brazil and India are potential candidates, since they appear to need large investments in infrastructure, but government bureaucracies and lack of funding are barriers to progress.

Revenues for commodity producers are a function of both demand (where we expect slower volume gains) and prices. Prices of some commodities may have difficulty increasing, as demand growth in the past was met with significant increases in supply. Stagnant commodity revenues could be a challenge to economic growth for the commodity-oriented emerging economies of Brazil, South Africa, Russia, Indonesia and Chile.

Commodity prices have yet to gain traction

Source: FactSet, Commodity Research Bureau. As of March 15, 2013.

Monetary policy may tighten

In Brazil, central bank chief Alexandre Tombini said in February that he was “uncomfortable” with current inflation levels and that the bank will not hesitate to raise rates. At its March 6 meeting, the central bank removed the language (used since October) that it would maintain monetary policy for a “prolonged period of time,” suggesting it has shifted its priority from encouraging growth to fighting inflation. Brazil was the first major emerging-market country to ease in August of 2011, and its moves could be reflective of broader trends.

Inflation still a concern in Brazil and India

Source: FactSet, IBGE, Indian Ministry of Labor. As of March 15, 2013.

In China, Governor Zhou of the People’s Bank of China (PBoC) noted in March that China should be on “high alert” as inflation could accelerate later this year. As a result, monetary policy in China is now in “neutral” territory, and the next move for the PBoC is more likely to be tightening than easing.

Attractive valuations, but disappointing earnings
In a fourth straight quarter of disappointing results, more than 59% of companies in the MSCI BRIC Index reported quarterly earnings that trailed analyst estimates, while profits rose less than 1%, according to Bloomberg. Earnings estimates for emerging markets may still be overly optimistic, as economic growth continues to come in below expectations.

Consumers in some countries (such as Brazil) and other borrowers (such as local governments in China) appear tapped out on credit, and without credit to help fuel consumption we may see slower economic growth. Additionally, rising labor costs in many emerging markets could put a damper on corporate profits. While valuations appear attractive relative to historical averages, lower growth and potentially unmet estimates will likely necessitate lower valuations until these trends turn around.

Investment implications

As long as China’s economic reacceleration continues, emerging-market investments could benefit in the short term. However, we believe longer-term investors may want to consider re-orienting international exposure away from China and emerging markets and toward developed international markets. Earnings in non-US developed markets such as Europe and Japan have been cut quite dramatically, and economic data has shown steady (albeit modest) improvement. Additionally, valuations in Europe and Japan look low relative to historical averages, so stocks in these markets could be a relative bargain.

***

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.

The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

The MSCI BRIC Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the following four emerging market country indices: Brazil, Russia, India and China.

The Bovespa Indexis comprised of the most liquid stocks traded on the Sao Paulo Stock Exchange, and serves as the main indicator of the Brazilian stock market’s average performance.

Copyright © Charles Schwab and Co.

Tags: Brazil, BRIC, BRICs, China, Emerging Markets, India, Russia
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Emerging Markets Radar (April 1, 2013)

Saturday, March 30th, 2013

Emerging Markets Radar (April 1, 2013)

Strengths

• Fitch upgraded the Philippines’ sovereign debt rating from below investment grade BB+ to investment grade BBB- due to a current account balance surplus and a lower debt-to-government-revenue ratio. Moody’s and S&P have yet to follow through with an upgrade.
• China’s industrial profit growth soared to 17.2 percent in the first two months of the year to 709.2 billion renminbi, suggesting a further recovery of corporate earnings growth year-to-date. Also, based on 84 percent of H-share companies that reported their 2012 earnings, there has been a remarkable sequential improvement in earnings growth to 8.5 percent in the second half from negative growth of 2.8 percent in the first half of 2012. Analysts believe earnings growth recovery will continue in 2013, which should support the market.
• China will cut retail gasoline prices by 310 yuan per ton and diesel by 300 yuan per ton. It also announced it will adjust prices of oil products every 10 working days from 22 days to better reflect changes in the global oil markets.
• Chilean companies continue to sell record amounts of corporate debt overseas as yields on existing securities continue to reach record lows. From investment grade to junk-rate, companies of all sizes are lining up to take advantage of the unsatisfied demand for higher yielding offerings in attractive jurisdictions. In the first quarter, Chilean-dollar-denominated offerings reached $3.8 billion, more than double the amount issued in the same period last year.
• S&P upgraded Turkey’s sovereign rate to BB+, one notch below investment grade, with a stable outlook. S&P has been the most intransigent of the three rating agencies, with Fitch having already given Turkey investment grade. Moody’s is one notch below and is expected to move next.

Weaknesses

• China issued new regulations to limit credit securitization in wealth management products (WMP), capping it at 35 percent of total WMP assets and 4 percent of total bank assets. Bank industry analysts believe the regulations will not have a material impact on the earnings of large banks but may affect smaller banks. The market is concerned that this will in effect tighten liquidity for small business and property developers.
• Colombia reported official unemployment numbers for February this week. Urban unemployment came in at 12.3 percent, down 0.8 percent and in line with Bloomberg survey expectations. The rate is the largest among major Latin American economies and its inability to remain in the single digits shows signs of structural problems in the Colombian labor market. The Colombian central bank cut benchmark interest rates by 50 basis points last week to address its preoccupation with GDP expanding below potential.

Opportunities

click to enlarge

• As shown in the graph above, China’s power generators still run much under their capacity. This chart from BCA is based on the historical pattern between the policy interest rate and power generation utilization level, which shows no policy tightening when the sector has been at under-utilization. This technical relationship can be explained by the fact that if power demand is low, the monetary policy should either stay neutral or be easing. Currently, power consumption growth is improving from the 2012 low but still below the historical average.
• The deadline for Argentina to present its final proposal to estranged creditors led by Paul Singer will be this Friday, March 29. Argentine newspapers are reporting the country is likely to offer par bonds for the notional claim, while offering discount bonds to cover the past interest. Deutsche Bank reports this type of settlement would imply a repetition of the settlement reached in the 2005-2010 restructuring, and consider it possible that the government will present a better proposal. We believe this is a great opportunity for Argentina to finally put to rest the ghosts of the 2002 default, but we are certainly not holding our breath.
• The benefits of joining the euro outweigh any costs, said finance ministers of the three Baltic countries, rejecting economist Paul Krugman’s view that Europe’s common currency is a “trap.” Austerity plans that Krugman opposed have helped the Baltic nations recover from the debt crisis in 2008 to become the 27-nation bloc’s fastest growing region.
• While relative underperformance of emerging market equities versus developed markets is likely to continue in 2013, according to Merrill Lynch, any signs of Chinese stability would likely cause a trading bounce in BRIC resource stocks, trading at a ten-year low price-to-book multiple.

click to enlarge

Threats

• China’s new WMP regulation may curb financing for small- and medium-sized companies. Those are the companies that have benefited from WMP loans. Many banks have started to lend to small businesses since a year ago to look for loan growth, which might offset the WMP tightening impact.
• Brazilian fiscal spending jumped 13.9 percent in February compared to the prior month, while revenues jumped only 7.4 percent. The gap led the country to post about a $3.2 billion fiscal deficit for the month, reversing some of the January gains. The slower growth in government revenues is accounted for by several tax cuts implemented by the government to spur growth in the slowest-growing BRIC country. The considerable increase in government expenditures may threaten the central bank’s already poor control of the country’s high and unstable inflation.
• Amid Russian security forces shaking down non-governmental organizations, the Russian navy parading unannounced in Black Sea, and Pravda making a statement about Russian nuclear warheads being installed in Cuba, sentiment toward Russian equities is set to worsen.

Tags: Emerging Markets
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Matthews’ Mark Headley: “This Could be The Year of China”

Monday, March 25th, 2013

A rare television interview with Great Investor Mark Headley of Matthews Asia. The Asia investing pioneer will explain why this could be the year of China as it transitions to new leadership and a consumer driven economy.

Tags: Emerging Markets, mark headley
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Emerging Markets Radar (March 18, 2013)

Monday, March 18th, 2013

Emerging Markets Radar (March 18, 2013)

Strengths

• China’s residential floor space sales surged 55.2 percent year-over-year in the January to February period, the fastest pace since late 2009, reflecting pent-up demand after two years of stagnation. Residential investment rose 23.4 percent and residential starts increased 17.5 percent for the same period.
• China’s passenger vehicle sales rose 20 percent year-over-year in the January to February period to 2.84 million units, in stark contrast to India’s 11 percent decline in the same period.
• Fitch raised Thailand’s credit rating to BBB+ with a stable outlook four years after political turmoil in the country, a positive recognition of Prime Minister Yingluck Shinawatra’s ability maintain social stability.
• Stocks in Poland and Turkey are entering their annual dividend season, and payments look particularly attractive this year, with yields reaching double-digit percentage points
• The Latin American corporate debt market is seeing increased demand allowing borrowers to fund their expenditures at significantly lower interest rates. Investors are boosting their risk tolerance amid near zero U.S. and Europe benchmark interest rates. Last month Colombia’s Banco de Bogota issued $500 million in 10-year bonds at 5.375 percent. Earlier this month, Cosan SA Industria & Comercio, a Brazilian large cap sugar and ethanol producer, sold $500 million in 10-year bonds at 5 percent. This week, CEMEX, the largest cement maker in the Americas, sold $600 million of 6-year callable bonds at 5.87 percent.

Weaknesses

• China’s real retail sales expanded by a lower-than-expected 10.4 percent year-over-year in the January to February period, the slowest pace since September 2011, affected by the communist party’s campaign against corruption and extravagance. Revenue from large caterers including high-end restaurants declined 3.3 percent vs. 14 percent gain a year earlier.
• South Korea’s unemployment rate unexpectedly rose to 3.5 percent in February from 3.2 percent in January, the highest in the last 12 months, as a result of moderating export growth and expanding the labor force.
• Higher-than-expected February inflation in China and the government’s renewed focus on curbing speculation in the residential property market weighed on both Chinese and Hong Kong markets this week.
• Renaissance Capital estimates that the Russian economy will grow by 1.4 percent in the first quarter, and is forecasting second-quarter growth of only 1 percent year-over-year. If these yearly forecasts materialize, it would mean consecutive quarters of negative quarter-over-quarter growth, technically qualifying as a recession.
• Dollar bonds sold by Argentine consumer products companies are missing out on the biggest rally in Latin American debt on concerns a price freeze by supermarkets will squeeze profits. President Cristina Fernandez pressured supermarkets to fix prices until April in an effort to contain inflation that economists estimate at 26 percent, more than double the official rate. Candy maker Arcor’s bonds returned 0.9 percent since the price freeze was enacted, while Latin American companies in the same sector returned 2.9 percent over the same period.

Opportunities

• The Chinese regulator’s invitation of overseas institutions to reinvest their Chinese yuan on hand in mainland markets, coupled with the country’s robust trade surplus and lingering international expectation of appreciating yuan, should help sustain foreign capital inflows to China.  Ample liquidity lends support to domestic Chinese A-share equities, a strong sentiment indicator for Hong Kong traded Chinese names, amid an increasingly uncertain government policy environment.

• Over a 12- to 24-month horizon, earnings momentum within emerging Europe is strongest in Hungary and Turkey.  Polish companies’ earnings are not expected to accelerate until 2014.

• Mexico’s credit rating outlook was raised from stable to positive by Standard & Poor’s on increased confidence that President Enrique Pena Nieto’s proposed legislation will boost growth in Latin America’s second-largest economy. The news dropped yields on benchmark peso bonds to a record. The news follows the March 8 move by Fitch Ratings, which revised the rating outlook from stable to positive on Colombia’s BBB sovereign rating, and the upgrade of Uruguay’s sovereign ratings to investment grade.

Threats

• Market perception of potentially more strong-handed new administration in China could increase near-term volatility of its residential property sector.
• President Vladimir Putin named Elvira Nabiullina, his chief economic aide, to become the next head of the Central Bank of Russia (CBR). In a parting shot, outgoing CBR chairman Sergey Ignatiev said that the capital flight out of Russia is controlled by a criminal, “well organized group of individuals,” costing the country 2.5 percent of GDP, or $49 billion last year, a claim immediately disputed by a presidential spokesman. The appointment of Nabiullina, a Tatar, aims to appeal to ethnic and religious minorities, but will she manage to preserve the independence of CBR?

• Chile has posted some remarkable numbers over the first two months of the year; retail sales, manufacturing index, economic activity, exports, and trade balance have all beaten analyst expectations. Furthermore, inflation is the lowest in Latin America, and one of the lowest among Organization for Economic Co-operation and Development members at 1.3 percent year-over-year, and GDP grew at 6.7 percent in January. Such successful economic indicators have driven the country’s multilateral exchange rate against its major trading partners to a 20-year high. Chile’s commodity exports give the country little pricing power and are highly sensitive to exchange rate fluctuations, a situation that threatens to slow down its spectacular growth this year.

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Emerging Markets Radar (March 11, 2013)

Sunday, March 10th, 2013

Emerging Markets Radar (March 11, 2013)

Strengths

• China’s February export was up 22 percent, exceeding the market expectation of 8.1 percent. China export is highly correlated with industrial production (IP), and therefore, the market is looking for a better February IP number to be released this weekend.
• China raised the fixed asset investment target to 18 percent growth for 2013 from 16 percent in 2012 in order to meet a GDP growth target of 7.5 percent. China also increased the fiscal budget deficit by 50 percent to Rmb1.2 trillion from last year’s 0.8 trillion.
• National Development and Reform Commission (NDRC)  added 10 million kilowatts of solar power capacity to this year’s target. NDRC also said it will target expanding wind power capacity by 18 million kilowatts. The pollution reduction is clearly a policy priority in China.
• The Chilean economy expanded 6.7 percent in January benefiting both from increased commodity exports to China and growing internal demand. Exports were up 7.4 percent from a year earlier, while retail sales rose 9.5 percent over the same period. It is expected Chile will grow at the second-largest pace this year among Latin American countries; analysts estimate GDP will climb 4.8 percent for the year.

Weaknesses

• China’s February import was down 15.2 percent, lower than the market expectation of down 8.5 percent.
• China lowered the target for broad money supply growth from last year’s 15.9 percent to this year’s 13 percent, which suggests a possible shift towards a more proactive fiscal policy and a more prudent monetary stance. Total social financing may continue to grow, which has the effect to increase debt durations.
• The Indonesia rupiah is stabilizing below 10,000 rupiah per U.S. dollar.
• Despite a two-day rally in the Brazilian Bovespa Index, macroeconomic news continues to be discouraging for Brazil. A surprisingly low inflation reading published on Wednesday, together with an agreement in which BTG Pactual Group will provide $1 billion in liquidity to billionaire Eike Batista’s EBX group, helped boost the Brazilian market mid week. The EBX group controls OGX Oil & Gas, MMX Mining & Minerals, and LLX Logistics, a total 5 percent weight in the Bovespa Index. On Friday however, three CPI numbers were announced significantly above analyst expectations, further reducing the country’s capacity to advance economic growth through monetary easing.

Opportunities

• According to the graph above, China’s residential property value is 195 percent of GDP, which is in line with the U.S. and Japan, but below the U.K. and Ireland. After the Chinese government reinforced its housing tightening policies recently, the news media and China bears cooked up China ghost town stories again. In 2010, the most sensational story was Ordos city. A report in CBS’s 60 Minutes last weekend discovered another ghost city called Zhengzhou New Community within Zhengzhou, the capital city of Henan province. The story was actually made by a local Chinese TV crew last year before the building’s power and water connections were completed. CICC analysts had visited the community at the first report, and went back again last year after the community was completed and saw that people had started moving in. Zhengzhou has a population of nearly 9 million, and the Henan province is the most populated province in China, with more than 100 million people. Both Zhengzhou and Henan are growing much faster in recent years than coastal-developed China as this area is catching up in investment and consumption. In Henan, as everywhere in China, it is undeniable that people like properties for personal use and for investment savings, but most have made a large down payment, which is less risky if prices fall. Globally and historically, unleveraged housing investments for the long term have seen value increases.
• Mexico’s President, Enrique Pena Nieto, will advance a plan to congress that recommends an end to the monopoly of state-owned Pemex in the domestic oil industry. Oil output has fallen dramatically over the last decade as the Mexican central government tapped into the company’s earnings to finance its budget and to add U.S. dollar reserves. The move is set to open the industry to more competition, restore oil production levels and reduce the tax burden on Pemex. President Pena Nieto expects a boost in foreign direct investment and economic growth.
• A wide ranging energy deal is in the works that according to Financial Times, will see state-backed Turkish firms and Western oil majors plough money into Kurdish infrastructure and oilfields, connecting them to Turkey and the world beyond.  The deal would unlock the value of oil exploration companies operating in Northern Iraq. More broadly, the entire Turkish economy would benefit from greater energy independence, both through strong domestic demand and diversified export economy.

Threats

• China’s housing market tightening can hurt property stocks if local governments follow up with their own tightening measures. There are discontents in China from all walks of life towards the 20 percent capital gain tax, which eventually will cause property prices to go up when that levy is passed to the buyers.
• Following the death of Venezuelan President Hugo Chavez, a multitude of reports on the current state of the Venezuelan oil industry have surfaced. Despite being home to the largest heavy oil reserves in the world, the country is facing a pipeline capacity glut; massive delays in infrastructure spending over the past few years will weigh down the country’s ability to capitalize on oil exports. Furthermore, Vice-President Nicolas Maduro is widely expected to win the election that should follow, leaving little hope for structural changes that could reduce the country’s massive fiscal deficit, excessive inflation and precipitous productive capacity drop in its oil sector.
• An influential think tank warned that in the nearest future, president Putin will make replacements in the top echelons of Russia’s ruling class either by dismissing the government or by announcing early Duma elections. The measures would be a result of the perceived inability of the ruling elite to successfully respond to the challenges Russia is facing: growing popular dissatisfaction with corruption, the lack of growth opportunities for the country, and increased number of conflicts among various ruling clans.

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Emerging Markets Radar (February 24, 2013)

Sunday, February 24th, 2013

Emerging Markets Radar (February 24, 2013)

Strengths

• Finance Minister Xie Xuren says China will maintain positive fiscal policy and prudent monetary policy, Xinhua News reported.
• China jewelry sales over the Chinese New Year period grew 38 percent, according to the Ministry of Commerce.
• January car sales were up 49.4 percent in China due to extra working days and strong demand for local brands and luxury names, particularly Audi and BMW.
• More than 4 million people from China participated in overseas group tours, up 14 percent year-over-year. Over 90 percent of the travelers went to Asian tourist sites and the hottest destinations were Thailand, Korea, Hong Kong, Macau and Taiwan. This is the reason tourist businesses in those countries and regions are enjoying double digit sales and earnings growth, which is one of the Asia megatrends that investors can potentially benefit from.
• Thailand fourth quarter GDP growth was 18.9 percent, better than the market consensus of 15.3 percent. The accelerated growth was broadly based in domestic and external demand. For 2012, Thailand GDP grew 6.4 percent.
• Malaysia fourth quarter GDP grew 6.4 percent versus the estimate of 5.5 percent, and improved from 5.3 percent in the prior quarter. For 2012, Malaysia GDP grew 5.6 percent.
• Poland’s debt rating outlook was raised to positive from stable by Fitch, which cited the country’s narrowing budget deficit, stabilizing government debt, and economic growth. The budget deficit narrowed by about 4.5 percent of GDP since 2010 to an estimated 3.4 percent last year.
• The Central Bank of Turkey shifted the interest rate corridor down by 25 basis points, while simultaneously raising reserve rate requirements by an average of 20 basis points. The bank acknowledged the strong capital inflow to the country and intends to preserve the financial stability by maintaining the low interest rate environment supported by the macro prudential measures.
• Banco Daycoval, S.A. of Brazil rose 6.46 percent, leading the financial sector in the Brazilian market this week following a strong earnings report, the issuance of a dividend, and the announcement of a share buyback program. A small bank compared to regional giants Itau and Bradesco, Daycoval outperformed by reducing its credit portfolio as credit delinquencies rose across the country. The Bovespa Sao Paulo Stock Exchange Index declined 2.35 percent for the week ended February 22.

Weaknesses

• In the China State Council meeting, Premier Wen Jiabao called on local governments to “decisively” curb housing prices from rising. In the meeting, China decided to expand property tax trials to more cities. The market had reacted negatively at the rumor but positively when the policy directory was confirmed on Friday.
• In separate news, the People’s Bank of China (PBOC) had withdrawn Rmb910 billion ($146 billion in USD) in the week, which followed a commentary on the central bank’s website that said it was concerned with potential inflation risk. The market is afraid that PBOC may start tightening money supply by restraining the fast growth of total social financing, which again may not happen immediately at this stage of growth recovery.
• Retail and restaurant sales during the Chinese New Year rose 14.7 percent to Rmb539 billion, the lowest pace in four years, according to the Ministry of Commerce. The market speculated this was due to anti-corruption efforts by the new leadership which curbed government officials from spending public funds for gift-giving and entertainment.
• Macau stocks dropped in the week on disappointing month-to-date February revenue growth which was up 2 percent but below market expectation, though mainland visitor growth was up 20 percent during Chinese New Year.
• Russian inflation jumped to 7.1 percent in January from 6.6 percent in December, exceeding the target range and bolstering the International Monetary Fund’s case that the central bank must refrain from easing monetary policy. The government had urged policymakers to cut rates after economic growth slowed to 3.4 percent last year.
• Russian retail sales grew 3.5 percent in January, according to Rosstat, the slowest pace in almost three years as unemployment rose and inflation sapped household purchasing power.
• Peruvian exports tumbled 16 percent in December together with the domestic construction industry bringing economic growth down to 4.3 percent compared to 6.8 percent in November. The strength of Peru’s construction industry had previously shielded the country’s commodity dependent economy from international commodity price fluctuations. Despite missing economic growth expectations local economists believe the construction industry will regain strength in 2013 and foresee no need to alter benchmark rates in the short term.

Opportunities

• As shown in the Chart above, inventories of houses available for sales in the tier 1 cities are low, which indicates rapid sales growth and a supply shortage. The structural land shortage in tier 1 cities favors developers who had plenty of land reserves and growing project pipelines. For the overall real estate sector in China, it is showing inventories are regressing to the average historical levels due to slower start-ups since the beginning of 2012, and rapid sales growth since the second half of last year, which also indicates healthy fundamentals for developers.
• In the current environment, when global slowdown fears come back to the fore, Indonesia, Philippines, Thailand, and Turkey may outperform again as money flows follow growth.
• The Pacific Alliance trade bloc was established in 2012 by Chile, Colombia, Mexico and Peru to bolster free trade and economic integration with Asia. The founding members have vowed to lower the barriers to do business with Chile at the forefront of this initiative. Chile has passed a law that will allow people to instantly register companies for free, has opted to provide selected start-ups with equity-free seed capital, and has significantly eased the path to obtaining Chilean residency. No surprise Chilean President Pinera welcomed European leaders to the Economic Commission for Latin America and the Caribbean (ECLAC) summit two weeks ago saying “Welcome to a better world.”

Threats

• The HSI (Hang Seng Index) Index fell through the 50-day moving average in a profit-taking week. The market found an excuse in the weaker-than-expected sector growth numbers during the Chinese New Year to take profit gained since early September of last year.
• Brazil’s latest inflation reading came out higher than expected at 6.18 percent, making it the eighth consecutive month of rising inflation above economists’ forecasts. The rising inflation continues to put pressure on the central bank to raise interest rates at a time when economic growth is hovering at 1 percent, far below the other BRIC countries. In addition, the country reported a $11.4 billion current account deficit for the month of January, a measure that is likely to increase with an interest rate hike, thus making a monetary tightening more likely to dampen economic growth.
• Despite record high oil prices, free cash flow generation of Russian integrated oil companies is diminishing due to: (i) higher taxes for extraction and (ii) rising costs, driven by higher pipeline and railroad tariffs, as well as double digit increases in electric power prices.

Tags: Emerging Markets
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