Emerging-market equities beckon

Published October 5, 2011

Institutional investors are taking to emerging markets after a long losing streak in the segment


By MICHAEL PATTERSON AND WEIYI LIM


THE longest losing streak for developing-market equities in more than a decade is turning investors who shunned the stocks a year ago into buyers, after valuations fell to the lowest levels since March 2009.


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TCW Group Inc's Komal Sri-Kumar, who advised purchasing options as insurance against emerging-market declines in October 2010, now recommends shares of consumer companies after inflation slowed in China and central banks in Brazil and Turkey cut interest rates. HSBC Private Bank's Arjuna Mahendran is adding Chinese stocks with dividend yields of more than 4 per cent. Harris Private Bank's Jack Ablin said he may boost emerging-nation shares to 10 per cent of holdings from 3 per cent.

Index slumps

MSCI Inc's emerging-market gauge sank 30 per cent from its May 2 high and slumped 23 per cent in the three months to Sept 30, trailing the advanced-nation index for four straight quarters for the first time since Russia's 1998 default, as Europe's debt crisis and concern the US economy may contract led investors to flee riskier securities. The drop sent shares in the MSCI Emerging Markets Index to 1.5 times net assets, the lowest level versus the MSCI World Index in 30 months.

'It may be time to start getting your toes wet,' Mr Sri-Kumar, who helps oversee about US$120 billion as chief global strategist at TCW in Los Angeles, said in a phone interview last week. 'The emerging markets are not going to have the recession of the kind I anticipate for the US and Europe.'

MSCI's developing-stock gauge trailed the MSCI World index by 6.1 percentage points last quarter, the most since the third quarter of 2008. Brazil's Bovespa index fell 16 per cent, Russia's Micex Index lost 18 per cent, the BSE India Sensitive Index slid 13 per cent, and China's Shanghai Composite Index retreated 15 per cent.

Emerging-market equity funds have posted nine straight weeks of outflows, with investors withdrawing US$2.6 billion in the seven days ended Sept 28, according to data compiled by Cambridge, Massachusetts-based research firm EPFR Global. Industrial companies and raw-materials producers led declines during the past three months on concern falling demand from advanced countries will erode profits.

The drop in energy and food prices that dragged the S&P GSCI Spot Index of commodities down 12 per cent last quarter has given central banks room to reverse interest-rate increases that had turned emerging-market stocks into laggards the previous three quarters. Brazil's central bank cut its benchmark interest rate for the first time in two years in August, while Turkey reduced borrowing costs to a record low. China has kept its lending rate unchanged since July after three increases this year.

'Maybe all of this mess is going to help them because it will bring the peak in inflation earlier than it otherwise would have been,' Jim O'Neill, chairman of Goldman Sachs Asset Management in London, said in a Sept 23 interview on Bloomberg Television. Mr O'Neill coined the term BRIC in 2001 to describe Brazil, Russia, India and China.

Emerging-market stocks began the fourth quarter with losses. MSCI's gauge of developing equities slid 1.3 per cent to 841.38 as of 1:32pm in Hong Kong, extending Monday's 3.2 per cent slump. The MSCI World Index has declined 3 per cent in the past two days.

Barton Biggs, the founder of hedge fund Traxis Partners LP in New York, says it's too early to invest in emerging markets because government leaders haven't found solutions for Europe's sovereign-debt crisis or the faltering US economic recovery.

Seventy-four per cent of global investors surveyed by Bloomberg last month said the euro-area economy will fall into recession in the next 12 months. US Federal Reserve chairman Ben S Bernanke said on Sept 29 that the US is facing a 'national crisis' with a jobless rate at or above 9 per cent since April 2009. German Finance Minister Wolfgang Schaeuble opposed moves on Monday to increase the scale of a euro rescue fund, dampening speculation of a breakthrough in talks to quell the debt crisis.

'When there is clarity, when the authorities move and do something, emerging markets will be a fabulous place to invest,' Mr Biggs, the former chairman of Morgan Stanley Asset Management, said in a recent interview on Bloomberg Television. 'I am not ready to make that bet yet.'

Valuations fall

Emerging-market stocks trailed advanced-nation shares during times of financial stress that sparked global losses in the past two decades, including Latin America's so-called Tequila Crisis in 1994 after a devaluation of the Mexican peso, Russia's 1998 default on US$40 billion of debt, and the 2008 crisis sparked by the bankruptcy of Lehman Brothers Holdings Inc. The peak-to-trough drop in the emerging-market index was 12 percentage points bigger on average during the six retreats, according to data compiled by Bloomberg.

'The likelihood that people continue to take money out of risky asset classes continues to be there,' said Lee King Fuei, a fund manager at London-based Schroders plc, which oversaw about US$330 billion as of June 30. 'In the shorter term, I don't see any particular catalyst that will reverse this.'

A year ago, Harris Private Bank's Mr Ablin told Bloomberg News that emerging-market shares were 'stretched'. Now the Chicago-based chief investment officer says valuations have fallen 'back in line with reality' and investors should consider adding to holdings.

TCW's Mr Sri-Kumar advises buying in the consumer industries of India and Brazil, where the unemployment rate was 6 per cent in August, a record low for the month. Mr Mahendran, who helps oversee about US$499 billion as the Singapore-based Asian head of investment strategy at HSBC Private Bank, favours Jiangsu Expressway Co, a Chinese toll-road operator, and China Mobile Ltd, the world's largest mobile-phone company by users.

Faster growth in emerging markets means investment returns will be higher, said Takahiro Mitani, president of Japan's Government Pension Investment Fund. The world's largest public pension fund, which oversees 114 trillion yen (S$1.95 trillion), will start investing in emerging-market stocks by the end of the year, Mr Mitani said in an interview in Tokyo last week.

Emerging economies may expand 6.4 per cent in 2011, four times quicker than the 1.6 per cent rate for developed nations, the Washington-based International Monetary Fund forecast in September.

Developing-nation government debt will probably amount to 35 per cent of emerging-market gross domestic product this year and budget deficits will be 2.7 per cent, compared with levels of 102 per cent and 6.8 per cent in advanced nations, according to the fund's Fiscal Monitor in June.

The MSCI emerging-market index's price-to-book ratio is 25 per cent lower than its average of 2 during the past five years, according to data compiled by Bloomberg. The gauge trades at a 2.5 per cent discount to the MSCI World Index, compared with a 17 per cent premium a year ago.

Profits at companies in the emerging gauge jumped 23 per cent on average in the second quarter, about three times faster than the 7.8 per cent growth in MSCI World index earnings, the data show.

Rising yields

The MSCI Brazil Consumer Staples Index trades at 2.5 times book value, or assets minus liabilities, 19 per cent less than its five-year average. Hypermarcas SA, the Sao Paulo-based maker of consumer products and medicines, tumbled 40 per cent last quarter to the lowest level since April 2009.

The benchmark gauge for Indian makers of discretionary consumer products has retreated to 3.8 times book value from 6.4 times a year ago, data compiled by Bloomberg show. Tata Motors Ltd, the Mumbai-based maker of the world's cheapest car, tumbled 22 per cent in the three months through September.

Brazil's central bank cut its benchmark Selic interest rate by 0.5 percentage point to 12 per cent on Aug 31 after raising borrowing costs eight times since April 2010. While the Reserve Bank of India increased interest rates on Sept 16, traders of interest-rate swaps are pricing in the possibility of cuts in the next year.

One-year interest-rate swaps in India, which reflect the cost of receiving the overnight money-market rate, traded at 7.91 per cent on Monday, below the 8.25 per cent repurchase rate, according to data compiled by Bloomberg.

China Mobile's dividend yield has climbed to 4.2 per cent from an average 2.6 per cent since 2003, data compiled by Bloomberg show. The Hong Kong-based company has about US$50 billion of cash available to invest or return to shareholders, more than Apple Inc, the world's biggest technology company by market value, according to data compiled by Bloomberg.