Excel Emerging Markets Blog

Excel Funds Newsletter

2010-09-17T16:44:00.000-04:00

Recent developments in China suggest a soft-landing is indeed a likely outcome of the latest round of policy tightening aimed at slowing the property sector. After activity peaked in recent months, it appears to be picking up again. The market has responded accordingly with the MSCI Barra China Index appreciating 16% in US dollar terms since bottoming on May 25th. That said, policy rates are very loose and real policy rates (adjusted for inflation) remain negative, meaning that the cost of borrowing is highly stimulative to the economy.

Interestingly, the currency is also starting to appreciate, and there is good reason to expect policymakers to allow the RMB to move higher over the next year. After locking the currency to the dollar since the credit crisis began roughly two years ago, it has been allowed to move up 1.5% since the official policy on the currency changed to one that would allow for gradual appreciation. Policymakers are responding to two forces.

Firstly, US Congress has been agitating for a trade war with China if the RMB does not appreciate sufficiently to appease the more than 15% of the U.S. population that is either unemployed or underemployed according to U.S. Bureau of Labor Statistics. National Economic Council Director Larry Summers reiterated these points on a recent official visit to China.

Secondly, inflation in China continues to rise. China’s August CPI data showed inflation accelerating to 3.5% over the past year, which is up from a low of 1.8% in July 2009. Food inflation is the main culprit, but it is a real problem that warrants a continued rise in the currency. Analysts suggested that currency appreciation was largely off the table after China’s economy slowed in recent months, but we suggested otherwise and we continue to make this case.

Excel Funds Newsletter

2010-08-26T15:23:00.004-04:00

Investors looking for signs that the emerging middle class is truly emerging need look no further than emerging Asia and especially China where there have been significant gains over the past fifteen years in the population of the middle class. Investors should note that the middle class is defined by a much lower income level in the emerging markets because the price of domestic services are far lower than in the developed world. With that in mind, the emergence of a middle class in China is astounding based on a recent report from the Asian Development Bank.

In China, the share of the population with daily incomes between US$6 to US$20, i.e. the middle class, increased from just over 5% of the population in 1995 to over 44% of the population in 2007. In other words, millions of people emerged from poverty in China over the past fifteen years providing a feel good factor offering justification for investing in the emerging markets.

Of course, investors are looking to capture above-average returns for their risk capital and the emergence of a middle class is leading to the development of consumer markets in these developing nations.

In India, the share of middle class is much smaller than in China, but it is growing too, having increased from 29% of the population in 1993-94 to 38% in 2004-05 and amounting to over 400-million people out of a population of 1.1-billion roughly five years ago.

Extrapolating these trends forward, the absolute buying power of the middle class in the developing world will rival that of the developed world by 2030, but it is no secret that foreign multinational companies are already exploiting the emerging middle class to enhance profitability. Investors who own domestic companies in the emerging markets, in retail, finance, and health care sectors for example are enjoying the most direct exposure to this trend.

Excel Funds Newsletter

2010-08-09T13:06:00.001-04:00

Russia appears the most compelling near term investment opportunity in the BRIC for the following reasons:

1. Low government debt.
2. Accelerating GDP growth rate.
3. Low inflation.
4. Strong relative growth in EU.
5. Oil revenues and associated current account surplus.
6. Compelling stock market valuations.

In this new era of hostile capital markets where government stimulus is being countenanced by bond vigilantes looking to punish unsustainable GDP/debt ratios, Russia is a standout for its very low level of government indebtedness. The country’s ratio of gross public indebtedness relative to GDP is well below the emerging market and/or global average by a wide margin (see chart). The implication here is that Russia can tap bond markets to finance its generous bout of government stimulus without having to contend with the bond vigilantes that have been plaguing Greece and Spain this past summer, for example.

Of the four BRIC nations, Russia’s economy was hit hardest by the global credit crisis and was slowest to rebound— yet GDP growth could hit 5.5% in 2010. That means that the central bank has yet to embark on a tightening cycle whereas central banks in China, India and Brazil are already contending with rising inflation through rate hikes in India and Brazil and various policy measures taken in China. Inflation has stopped falling in Russia but the economic cycle is clearly lagging the other three BRIC nations.

Economic growth in continental Europe— most notably Germany— appears more robust than in the U.S. and Japan, and that also has important near term implications for trade and investment in Russia.

Another important fillip to the investment outlook is the strength in oil prices. The associated current account surplus means the Russian ruble is well supported and could even be allowed to appreciate given the recent spike in wheat prices and the effects rising food prices will have on overall inflation in Russia.

Finally, the stock market is relatively better valued than the other three BRIC nations as mentioned in a recent posting. The P/E ration on the MSCI Russia market was a svelte 9 back in May-- far below its average level of 15 according to data from MSCI Barra.

Russia may be the most maligned or as the very least overlooked of the BRIC nations; for the very same reason, it may also be the most compelling.

Excel Funds Newsletter

2010-07-16T09:08:00.002-04:00

Investors fearing a housing bubble turned crash in China can find relief in the latest data showing a slowdown in the housing sector and the economy on the whole. Policy makers in China have effectively taken the air out of the housing market over the past few months as evidenced by a major slowdown in housing transactions and now a slight decline in property prices, achieved mostly through direct policy measures rather than indirectly through interest rate hikes.

The latest housing boom/bubble was fueled by very aggressive monetary expansion in 2009 that has pushed house prices up roughly 30% over the past year. This is the same credit and fiscal easing that has revived economic growth with expectations of GDP growth of 10.5% in 2010 according to IMF estimates.

The good news is that efforts by policymakers to lean against the wind, to slow the housing market, are working, and they reduce the probability of a hard landing for China’s economy. The economy slowed to 10.3% growth in the second quarter of 2010 versus 11.9% growth in the January to March quarter. Moreover, inflation slowed too— to a 2.9% annual rate in June from a 3.1% rate of increase in May.

Consider the difference between this proactive policy aimed at cooling a frothy housing market from the laissez faire approach to monetary policy in the U.S. as popularized by former Fed Chairman Alan Greenspan over the last decade. His once widely admired approach to monetary policy, now discredited by the collapse of the U.S. Housing market and banking sector, is contrasted with attempts in China to prick asset bubbles before they get too big to burst thus avoiding the major negative repercussions for the economy.

Similarly, the U.S. banking sector was allowed to grow unchecked to the extent that an overleveraged banking sector carrying very low-quality assets nearly self-destructed. Contrast that approach with one in China whereby banks have been ordered to raise capital through new equity issuance to ensure that banks remain well-capitalized after a significant lending spree in 2009. In this case, authorities are anticipating a rise in loan defaults and are protecting the banking sector and the greater economy against future loan defaults.

Excel Funds Newsletter

2010-07-06T08:36:00.005-04:00

Russia’s stock market appears undervalued again after a significant correction to the price-to-earnings (PE) ratio over the past month. While all markets have corrected and offer better valuation on a trailing PE basis, Russia’s stands out as trading below its long term historical average.

The PE ratio on the MSCI Russia Index is a trim 9 to the end of May which is significantly below its long term average of roughly 15 according to data from MSCI Barra. At the end of the day, Russia appears to be one of the cheapest places on earth to access energy production—both oil and natural gas and the recent environmental crisis in the Gulf of Mexico should increase the value of Russian energy assets over the long term as energy regulation tightens in North America in response to BP’s leaking Macondo oil well.

Russia’s economy has rebounded from a terrible hangover associated with the global credit crisis and appears to be growing strongly. “All components of demand are increasing,” according to a recent IMF report and growth is being led by consumption in thanks to a 45 boost to pensions. GDP could increase 5.5% this year and 5.1% in 2011 according to OECD estimates. Moreover, inflation is well contained and the central bank is still in loosening mode.

The government needs to tackle a significant budget deficit (non-oil) that hit 13.4% of GDP in 2009. Structural reforms are recommended by the IMF to improve productivity and the country’s long term growth potential. These are important points for investors to monitor over the long term; however, in the interim, Russia currently appears to offer investors cheap access to the energy assets and a long term emerging market growth story.

Excel Funds Newsletter

2010-06-21T15:59:00.002-04:00

In the ongoing tale of two markets, emerging versus developed, another important point of difference is the better access to capital in the emerging market vis-à-vis the developing world in recent months. The high profile initial public offering slated to take place in China and the multi-billion dollar equity issuance in Brazil in the very near term versus the virtual shutdown in these parts of capital markets in the United States and Europe recently speaks to this difference.

In China, the world’s largest bank by customers, the Agricultural Bank of China, with 350-million plus customers, is planning an initial share offering pegged at US$20-billion in the near term. This is the last of China’s big banks to come to market over the past decade and it garnering significant attention from global investors. Next in line is Petrobras, Brazil’s national oil company, with a planned US$25-billion equity capital issuance to finance the development of its “pre-salt” deepwater oil fields. The company is planning roughly US$200-billion in capital spending over the next five years which will catapult Petrobras to the top of oil investing companies. These planned capital raises are enormous in their own right but all the more impressive given the state of capital markets in the developed world— which are struggling. Ever since investors began obsessing about a possible debt default in Greece, companies in the developed world have been largely shut out of capital markets, and M&A and IPO activity has been very weak to non-existent over the past few months.

The ability of companies to tap capital markets is crucial for the achievement of their growth plans. That is why revenues were hit so hard during the credit crisis in 2008 and 2009. Investors are clearly differentiating between companies in the developed and emerging markets giving those companies that can attract tens of billions of dollars from the global investment community a significant advantage in a very tense market.

Excel Funds Newsletter

2010-06-14T09:09:00.002-04:00

Problems in Europe’s credit markets are not working their way to the real economies of the emerging markets judging by the latest economic data. Brazil’s economy showed no signs of slowing in the first quarter of 2010 and China’s economy also looks hot. As a result, strong earnings expectations due to rapid economic growth and falling share prices are leading to better valuations affecting both the numerator and denominator of market P/E ratios.

Brazil’s rate of economic growth is white flaming hot based on the 9% quarter-on-quarter number announced this week. This rate of growth is more than double the non-inflationary trend rate of economic growth suggesting that more policy tightening will take place in the very neat term.

Brazil’s central bank lifted interest rates by 75 basis points to 10.25% this week in response to inflation pressures—as expected by the market and the real strengthened.

In China, industrial production and fixed asset investment expanded strongly- each rising by more than 10% on a quarter-on-quarter basis and both accelerating from earlier this year despite efforts by authorities to slow the economy through policy measures aimed at the housing sector. That factor alongside a large print for the trade surplus—with exports leaping by 48.5% in May over the previous year—is bringing currency appreciation in China back on the agenda of the U.S. Treasury Secretary and Congress. Expect currency analysts to begin refocusing on RMB appreciation in the coming weeks as suggested in this newsletter last week.

Excel Funds Newsletter

2010-06-09T10:53:00.008-04:00

Last February, we echoed popular economic sentiment in this newsletter by calling for an imminent appreciation of the Chinese RMB against the US dollar due to domestic overheating in China. As the story went, rising inflation and property price appreciation coupled with US dollar reserve accumulation led to the obvious conclusion that monetary policy needed to be tightened and exchange rate appreciation was an obvious means for achieving those goals. That was before capital markets went into a tizzy over potential debt defaults in the European periphery and the Euro started its rapid descent.

Now analysts are questioning the need or desire on the policy front in China for a stronger currency. They argue that the RMB has undergone a de facto appreciation vis-à-vis the Euro over the past few months because it is pegged to an appreciating US dollar. It is also argued that the case for currency appreciation has diminished due to the rapidly shrinking Chinese trade surplus in recent months with the nation posting a rare trade deficit in March for the first time in six years. Finally, policymakers are thought to be vindicated for taking a cautious approach to currency appreciation given the gyrations in global capital markets.

That is all well and good, but one would think that currency appreciation will return to the agenda as soon as capital market volatility subsides. China’s economy appears to be slowing, and one might expect the trade surplus to reflate once the effects of commodity restocking and the government stimulus spending subsides.

As one can see in the accompanying chart from the OECD Outlook, China’s deficit in trade mushroomed to nearly 8% of GDP in the fourth quarter of 2009, nearly double the average rate early this decade. Under reasonable expectations, commodity imports will return close to the five year average by the end of 2010 and the trade surplus will increase as a result. This development will remove a major near term argument for keeping the RMB pegged to the dollar at current levels (and for taking a cautious stance on commodity prices).

For more information, contact Excel Funds at 1-888-813-9813 or visit our website at www.excelfunds.com

Emerging Markets Weekly

2010-05-20T13:29:00.003-04:00

The recent correction in global equity markets that has led to a 15% fall in the MSCI China Index since April 9th could be an outright buying opportunity in the near term. Valuations make poor timing indicators, but investors should note that the China’s stock market is now reasonably valued and economic growth remains strong; that should translate to robust earnings growth and momentum in investment spending.

Investors concerned that they are witnessing the bursting of a second equity market bubble in as many years should note the change in the value of China’s stock market relative to GDP from the top of the market in 2007 to April 2010. Note that the MSCI China Index remains at less than half its peak value as a percentage of GDP. In 2007, at the height of the market bubble, the capitalization of China’s stock market was worth 131.8% of GDP, admittedly a high number by emerging market standards. Fast forward three years and China’s stock market is worth only modestly more than half of its current output. There are two reasons for this fact.

Firstly, China equities have recovered only part of the ground lost since the credit crisis. In fact, MSCI China Index remains down by roughly 44% since its 2007 peak. And lets not forget that China’s recovery has been growing strongly since the crisis hit the global economy. It is worth reminding investors that China’s GDP expanded 9.6% in 2008, 8.7% in 2009, and is expected to grow 10% in 2010 according to the IMF. Therefore, China’s economy will likely be roughly one-third bigger since the onset of the credit crisis by the end of the year.

Emerging Markets Weekly

2010-05-06T23:07:00.000-04:00

After months of narrowing, spreads on emerging market bonds have started to widen over the past week, and the strong rally in emerging market debt has ended. This is important for emerging market equity investors because it represents a reversal in capital flows to the region after a record year. In fact, capital flows to EM in the first four months of the year exceeded total flows over the entire previous record year, 2005, and spreads on emerging market government bonds have shrunk from a peak of 865 basis points in October 2008 to 285 basis points only last week. Today yields spiked crossed over 316 basis point spreads over U.S. Treasury yields and stock markets fell.

What were investors reacting to with these in and out flows over the past year? At first a revulsion to risk when spreads blew out in the thick of the credit crisis and then a return to risk with the subsequent fall in spreads— crucially, a recognition that the BRIC nations represented lower sovereign default risk than the PIGS (Portugal, Italy, Greece and Spain) in Europe that roiled global markets over the past week. Now the risk trade has come off and even emerging markets are getting hit.

So it is worth revisiting the reasons investors have been attracted to the emerging markets— the paradigm shift that we have been highlighting over the past three of four year. We point to low debt, high foreign exchange reserves, and current account balances that are in surplus or small deficits that are easily financed by global capital flows and/or covered by foreign exchange reserves in the event of crisis.

So what are investors to make of the jump in yield spreads and fall in equity prices across emerging markets? These near term market gyrations should be viewed as buying opportunities. The better fundamentals and strong economic growth in the emerging markets are the reasons why.

Emerging Markets Weekly

2010-04-23T20:47:00.003-04:00

The opportunity in infrastructure in emerging markets is an ongoing theme in these weekly updates with the greatest emphasis so far being on China due to the absolute size of these projects. However, India should not be overlooked for infrastructure investment opportunities given the opportunity for public/private sharing on these deals. Billions of dollars is being spent on extending power capacity, roads, railways, ports, and airports over the next decade for sure.

India will see projected annual growth in passenger traffic of 12% and cargo traffic of 15% over the next few years. To accommodate the flagging infrastructure in these areas, tens of billions of dollars will need to be spent to build out the road network across the country. The government is planning a roughly 50% increase in spending on roads to US$23-billion between 2011 and 2012 according to PWC Capital.

On the port side, containerized cargo is expected to grow at a 15% annualized rate over the next 7 years and similarly, passenger air traffic will grow at that rate too according to recent government projections, and there are already several successful examples of Public Private Investment Programs (PPIP) in airports in India in recent years. Finally rail investments are projected at US$65-billion over the five year period ending 2012 with the private sector expected to stump up 40% of that money.

India has the third largest electricity grid in the world according to PWC yet it is woefully inadequate at supporting current electricity demand. The government projected US$167-billion investment in this infrastructure between 2007 and 2012 and will likely come up short in this area in part due to the credit crisis of 2008/2009.

Investors in Excel Funds are already participating in this opportunity. For example, Bharat Heavy Electricals and Larsen & Toubro are the third and sixth largest holdings in Excel India Fund giving investors exposure to this long-term infrastructure role out.

Projected spending from FY07-FY12 in selected infrastructure segments:

Electricity: US$167 billion
Railways: US$65 billion
Road and highways: US$92 billion
Ports: US$22 billion
Airports: US$8 billion

Emerging Markets Weekly

2010-04-16T13:54:00.000-04:00

The IMF released its semi-annual update to the World Economic Outlook this week and things are certainly improving especially for the emerging markets, according to the IMF. The emerging or developing economies are slated to grow 6.3% this year and 6.5% in 2011 on average with China leading the way advancing 10% this year and thereabouts in 2011. India will grow 8.8% this year and 8.4% in 2011 says the IMF; Brazil will advance in a lower gear— 5.5% in 2010 and 4.4% in 2011; slower still, Russia will grow 4.4% this year and only 3.3% in 2011. The advanced economies are out of neutral but will only putt along in first gear, growing 2.3% in 2010 and 2.4% in 2011.

It is worth noting that emerging markets are growing thanks to very strong domestic demand. Retails sales are booming in the emerging world and especially in emerging Asia. A strong job market and low interest rates are undoubtedly fuelling the demand. What’s more, China is contributing roughly half of global GDP growth this year and next with the rest of the developing economies contributing the balance of that growth. The US and other advanced economies are barely contributing to the mix.

So investors can fret about overheating and rising interest rates in China and India for example as reasons to not invest in emerging markets, but the positive growth outlook, strong domestic demand, and appreciating currencies are all good reasons to invest in these stock markets over the next eighteen months. Valuations based on forward earnings expectations are not high, and any corrections on policy tightening appear to be long term buying opportunities on an absolute basis.

Emerging Markets Weekly

2010-04-09T18:21:00.001-04:00

Investors may be overestimating the near term risk to investing in China and other emerging markets and underestimating the buying opportunity from a long term perspective. Valuations have rebounded from extremely oversold positions last year when earnings growth turned negative in most markets; however the strong GDP rebound in China for example bodes well for earnings growth over the next year or two. On that front, P/E ratios do not look high on a forward earnings basis. The forward P/E on the MSCI China Investables Index is a still reasonable 13 based on consensus earnings growth of roughly 20% over the next year and far below the peak forward PE reached in 2007.

Investors concerned about excessive loan growth in China and the possibility of bubbles should consider that loan growth slowed dramatically in March. Commercial bank lending slowed to US$75-billion for the month down from $103-billion in the previous month. Authorities are clamping down firmly on lending and investors should expect interest rates and the currency to rise over the next six months.

The MSCI China Index (USD) has lagged global index performance this year rising only 1.8% according to MSCI Barra suggesting that from a long term perspective the current timing appears to be a good buying opportunity.

Emerging Markets Weekly

2010-03-26T19:42:00.005-04:00

One of the more interesting aspects of foreign direct investment into emerging markets is the technology transfer from foreign multinational companies to domestic nationals, most notably in China. One of the prerequisites of investing in various Chinese industries over the past decade has been government mandated partnerships with domestic companies, in the automotive industry for example. This has allowed domestic manufacturers to gain a leg up in their ability to produce manufactured goods and compete on industrial projects at developed market standards. Now we are seeing the emergence of domestic companies starting to compete on the international stage.

China is home to the largest car market in the world, and the recent acquisition of Swedish auto manufacturer Volvo by Geely in China takes this technology transfer to another level. While it remains to be seen whether Geely can make a profitable business out of Volvo where Ford failed, it seems that the technology transfer story favours investments in smaller, domestic Chinese companies rather than in the foreign multinationals for that reason alone.

It is telling that China Rail won a US$4.8-billion high-speed rail project in Indonesia last week, another sign that Chinese companies are starting to compete on the global stage for high value added projects. One advantage that these companies have is that they can bring financing to these deals especially when they are of strategic importance such as the access to coal in the Indonesia rail project. China has built 4000 miles of high speed rail domestically and it only follows that domestic companies are benefitting from the foreign technology transfer. Investors should look to these domestic companies to continue to emerge over the next decade and take on the companies that they were one-time partners with in the domestic Chinese market.

Emerging Markets Weekly

2010-03-19T09:40:00.001-04:00

Despite widespread fears of a property bubble turn bust in China in the coming months, investors need to put rising house prices in perspective. Firstly, the very sharp rise in prices over the past year represents a bounce-back from the fall in property prices in 2008. Prices fell more than 10% in many cities in 2008 when authorities put the brakes on speculation in the housing market. While it is hard to argue against the idea that the real estate market has some characteristics of an asset price bubble, it is also highly plausible that if and when authorities intervene to bring prices down (they have already) that the repercussions for the real economy may be muted. For one thing, housing represents only a small percentage of total wealth in the economy. Mortgage penetration is quite low equal to roughly 3% of total GDP in contrast to in the U.S. where mortgages were ubiquitous prior to the housing crash in 2008.

The other big difference is the high loan to value ratios leading up to and after the collapse of the US housing bubble. In China, homebuyers must put down 30% down payments on first homes and 40% on second home purchases, so leverage is clearly a lot lower in China across the household sector.

It is also worth noting that urban household incomes have outpaced house price increases over the past five years according to data from JP Morgan, so there is an element of affordability in China that was absent in the United States.

After investors experienced the repercussions of collapse in the U.S. Housing market, it is only natural that they are sensitive to housing bubbles in other markets. House prices in China have risen too quickly and the market needs to be cooled off by higher rates, but we are not at the precipice of another crisis.

Emerging Markets Weekly

2010-03-12T15:18:00.002-05:00

There are numerous reasons to expect tighter monetary policy in China this year. Policy was set exceptionally loose in 2009 to affect an economic recovery that is now a reality. For one thing, loan growth was exceptionally strong in 2009 and in the January 2010. Newly increased medium to long term loans directed at infrastructure development more than tripled last year and total net new bank lending equalled about 30% of GDP in 2009. Authorities need to curtail lending and rein in investment spending across the economy.

Reserve accumulation has continued at a very high pace and that has contributed to the very loose monetary policy. US dollar reserve holdings increased by US$450-billion in 2009 taking total reserves held by the central bank to US$2.4-trillion at the end of last year. Therefore, authorities need to allow currency appreciation to resume this year to avoid rising inflation especially since exports have recovered strongly since last year.

Speculation in the property sector also needs to be reined in. Property prices have shot up roughly 30% in urban centers and authorities are concerned about a mounting property bubble. They have undertaken policy steps to curtail property investment such as the enforcement of the 40% down payment ratio on second homes, but higher interest rates need to be a part of this policy. Currently real (inflation-adjusted) interest rates are exceptionally low given the high rate of GDP growth this year.

The World Bank is forecasting 9.5% GDP growth in 2010 and 8.7% growth in 2011. Higher rates and an appreciating currency are necessary to ensure that China meets these targets.

Emerging Markets Weekly

2010-02-19T09:54:00.006-05:00

There has been a lot of water under the bridge since Goldman Sachs released its initial report in 2003 detailing the growth potential of BRIC nations by 2050. Seven years later, the analysis looks prescient albeit too conservative. BRIC nations grew faster than expected and accounted for a greater share of the global growth than anyone might have imagined. Part of the reason for the superior growth performance of the BRIC nations versus the G7 countries is accounted for by the abject weakness of the latter countries since 2007. Yet the fact that the BRIC nations maintained strong annual growth rates despite the crisis is testament to their better economic fundamentals relative to the United States, Japan and Germany for example.

BRIC countries have therefore received a serious upgrade on an absolute and relative basis in the most recent report from Goldman Sachs that updates their economic projections for 2050. China, India, Brazil and Russia are now projected to occupy four out of the top five spots in terms of size measured by GDP in US$ at market exchange rates. The outlook for China is greatly improved in terms of absolute GDP which is perhaps not surprising given that in light of recent strength in China and expectations for China to move ahead of Japan this year to become the second biggest economy in the world.

The end point of convergence is admittedly 40 years off and there will be setbacks along the way to be sure. However, it is hard to argue with the logic that there are far greater opportunities for long term investors in the emerging markets over the long term.

Emerging Markets Weekly

2010-02-12T09:54:00.011-05:00

The global trade rebound over the past year has been largely unreported but represents an important development for export oriented countries such as China. What has been widely reported is the export-led economic slowdown in China in the fourth quarter of 2008 due to the global credit crisis, capital flight from China and the sharp fall in global trade. In response to the abrupt slowdown in China’s economy, policymakers enacted a US$586-billion fiscal stimulus in conjunction with a very aggressive monetary stimulus through the banking system. What is notable about the sharp growth rebound is that it was dominated by fixed asset investment although retail sales did expand strongly over the past year from a low base.

What is encouraging now, is the fact that exports have rebounded strongly since March 2009 which represents the nadir for the global credit crisis. Exports basically fell off the map as the chart below illustrates. After peaking at roughly US$140-billion in October 2008, they were cut by more than half up until they bottomed at close to US$60-billion in March 2009. Notice the impressive rebound in exports over the balance of the year where they finished just shy of the high water mark in 2008.

The rebound in exports is important because China has been heavily reliant on government stimulus over the past year and needs to move to a more balanced form of economic growth. While it will take several years to rebalance the economy toward domestic demand, the rebound in trade is a very important development from a near term perspective.

Emerging Markets Weekly

2010-02-05T09:53:00.008-05:00

Russia appears to be significantly less advanced than the other three BRIC countries in terms of inflationary pressures and therefore in its need for tighter monetary policy. Inflation is actually falling in Russia unlike the experience for Brazil, India and China where inflation has been rising on a monthly and annual basis since the end of 2009. That goes part way to explaining why equity prices in Russia bucked the recent sell off and actually appreciated over the past month in the face of a global equity market correction.

Russia’s economy has been slower to respond to the global economic recovery with manufacturing activity only recently turning positive; the purchasing manager index signaling expansion (50.8) in January after contraction in the final quarter of 2009.

Whereas inflation was high and rising in January 2009, hitting over 13% due to a depreciating ruble, that issue proved fleeting, and inflation has subsided over the past year. Inflation fell to 8.8% in December 2009 taking pressure off the central bank to tighten policy.

In fact rates continue to come down and are currently sitting at 8.75% after a series of interest rates cuts in response to the weaker economic environment.

The other encouraging front in Russia is equity valuations. The market trades at roughly a PE ratio of 8.4 and price to book ratio of 1.1 based on a US$70 oil price according to research by Troika Dialogue suggesting that Russian equities remain cheap even after a doubling in share prices in 2009. Lets not forget that valuations were at bombed out levels back in March of 2009 trading on a historical PE basis of less than 4 according to data from MSCI Barra.

Emerging Markets Weekly

2010-01-29T09:50:00.026-05:00

The message was right but the timing was all wrong when the IMF released an update to its World Economic Outlook last week, announcing that “risk appetite has returned” just as global financial markets were choking on the olive pit of Greek government finances.

Market sentiment shifted over the past week from hope to worry with particular focus on policy tightening in China and the prospects of sovereign default in Greece. The latter issue looks real and intractable with Greece getting knocked out of the European Monetary Union a distinct possibility within the next two years. Policy tightening in China to curb runaway loan growth is a buying opportunity however.

Investors are fretting that as Beijing reins in its bankers from handing out loans as freely as advice that China’s economy will come crashing down. Speaking of advice, Confucius said that, “He who will not economize will have to agonize,” and a little prudence in lending is no bad thing.

Investors are missing the fact that Beijing is simply taking its foot off the accelerator rather than hammering on the brakes. They are still planning to extend nearly twice as many loans in 2010 (in value) as in 2008. And turning back to the IMF update, the global economy is expected to grow 3.9% in 2010 and 4.3% in 2011, a two speed recovery to be sure with emerging economies in the fast lane growing 6% this year and 6.3% in 2011 according to IMF estimates. The advanced economies will see growth of only 2.1% this year and 2.4% in 2011. China is expected to grow 10% in 2010 and 9.7% in 2011.

The MSCI China Index and the Hang Seng Index in Hong Kong have corrected 10% since January 11th setting up a buying opportunity for the next leg of the bull market.

Emerging Markets Weekly

2010-01-22T14:08:00.006-05:00

It may be decades before incomes in emerging markets approach developed market levels, yet it seems clear that the sheer size of these populations means that consumer markets are already very powerful forces in many emerging markets.

It is astounding to learn that there were only 6.5 million mobile phone subscribers in India in 2002. The market simply exploded over the past decade as incomes rose and credit became widely available. Currently India boasts more than 500 million cellular subscribers according to the Telecom Regulatory Authority of India.

In China, retail sales rose nearly 17% in 2009 in real terms, up from roughly 15% in 2008. China now boasts an auto market that surpassed the United States in volume making it the biggest market in the world.

Of course we are at a very early stage of development of these markets given the fact that per capita incomes in the emerging markets are a fraction of incomes in developed markets. That is why, China’s auto market is projected to grow to double the size of the U.S. market in just ten years according to Goldman Sachs and India’s cellular market will likely double in only five years time according to the Telecom Regulatory Authority of India.

Gross national income per capita for Brazil, Russia, India and China was $5910, $7560, $950, $2360, respectively in 2007 according to the World Bank; low by our standards. As incomes grow over the next two decades, these consumer markets will eclipse markets in the developed world.

Companies have recognized this trend and many are thankful for their emerging market exposure over the past year given the weak state of consumer markets in the United States, Europe and Japan. For example, GM saw sales growth of 66% in China in 2009 to 1.8 million units versus roughly 1.9 million units in the U.S. in the first months of 2009. This is a trend that is playing out in Emerging Markets with new first time consumers!

Emerging Markets Weekly

2010-01-08T10:19:00.002-05:00

A quick look at valuation in emerging markets reveals that the BRIC countries are no longer trading at the discounts to long term averages that they were trading at last year at the height of the financial crisis. The chart below shows the trailing P/E ratio for the four BRIC markets revealing that Russia appears to offer the best value and that neither India nor China are anywhere near the high points reached prior to the onset of the global credit crisis.

One way to look at the rising P/E ratios is that the market is discounting a strong rebound in economic growth in 2010. In India for example, analysts are expecting a 24% rise in earnings for the fiscal year ending March 2010. If these earnings materialize as expected over the course of the year, there is every reason to believe the market could move higher because valuations would otherwise recede to their long-term average.

Given the similarities between valuations in emerging markets and developed market on a trailing P/E basis, it would seem obvious that the higher growth prospects in the EM make these markets a better bet.

Emerging Markets Weekly

2009-12-18T12:43:00.003-05:00

The long term potential for real currency appreciation in the emerging markets is often discussed but little understood. It is based on established economic theory (Balassa-Samuelson effect) that suggests currencies will reflect differences in productivity levels in the tradable goods sector between developed and emerging markets and that rising productivity in emerging markets means wages and prices will rise in the emerging markets over the long term.

If you ever noticed that prices are lower for non-tradable goods and services in emerging markets, haircuts for example, but tradable goods necessarily must reflect global market prices. Since productivity is lower in emerging markets, wages are lower too. The difference in prices at the current exchange rate represents the level of undervaluation of a given currency and the potential for real exchange rate convergence between emerging and developed markets over the long term, toward purchasing power parity (PPP). China’s currency is 50% undervalued based on PPP estimates according to a recent study, for example.

As productivity rises in tradable goods sectors in the emerging markets, incomes rise and prices of services such as haircuts are bid up too, even though productivity does not rise for these services (a haircut is a haircut). Eventually the price of these services rise relative to the price of tradable goods implying that real currency undervaluation will disappear over the long term.

Therefore, as incomes rise in the emerging markets over the long term and converge toward developed market levels, exchange rates are expected to converge toward PPP levels.

The Economist newspaper published an annual Big Mac Index that considers currency under/overvaluation based on PPP using the price of a Big Mac as the yardstick of measurement. This rough and ready measure suggests that the Chinese RMB and Russian ruble are roughly 50% undervalued based on PPP.

Emerging Markets Weekly

2009-12-11T15:00:00.002-05:00

Anyone in doubt about the opportunities in banking and other financial services in BRIC markets should consider the opportunity for credit growth to the household sector over the next decade and well beyond. While mortgage lending in the United States, UK and other developed markets hit its pinnacle in 2006 due to very lax lending standards and low interest rates, those markets are in the process of unwinding from an unsustainable credit boom.

Emerging markets also experienced a lending boom over the past decade but crucially from a much lower base. Credit penetration in the BRIC markets remains exceptionally low with mortgage credit currently less than 10% of GDP in contrast to the Unites States where mortgage credit is equal to nearly 75% of GDP. The contrast in numbers is an encouraging indication of one of the many opportunities in banking in the BRIC countries as households gain access to mortgage credit in Brazil, Russia, India and China for the very first time.

It is expected that banks in the developed world will continue to shrink assets and assume less leveraged balance sheets over the next few years as regulators attempt to get a better handle on risks in the financial system. In contrast, it is expected that banks in the emerging markets will undertake significant loan growth due to the lower gearing that they have carried over the past few years.

Not only will mortgage credit rise as a percent of GDP, but output will also rise much faster in the developing world with China now expected to experience output growth as high as 10% in 2010. This one-two combination means that the banking sector could easily see double-digit loan growth over the next few years.

Emerging Markets Weekly

2009-12-04T09:42:00.003-05:00

Infrastructure development will continue to be a challenge for the emerging market economies and an opportunity for investors over the next two decades. Investors have voiced concerns that a lack of infrastructure development in India, particularly in power generation, will create natural speed limits to the economy over the long term—holding back growth and corporate profitability. A recent report by Goldman Sachs estimates that India will require US$1.7 trillion in infrastructure spending over the next decade to overcome these issues—a huge opportunity for investors to be sure but one that will be funded internally.

The good news is that Goldman figures that India can generate sufficient private savings to fund this development. It boils down to a favourable demographic picture whereby the median age of the population is currently 25 years, thereby leading to a rise in the savings rate over the next ten years and beyond as the population ages and as incomes rise, with the savings rate expected to rise to 40% of GDP by 2016. There is more to the story, however.

Corporations in India are operating with low leverage that will enable them to throw off sufficient cash as well to act as an additional source of funds to finance infrastructure development.

All told, infrastructure in India will continue to be a major opportunity for investors over the next decade, and banks will continue to be the intermediary for channelling savings into these projects suggesting that banks will also be an important part of this investment opportunity.

Emerging Markets Weekly

2009-11-27T11:43:00.005-05:00

The last week offered an interesting test of the resilience of the current rebound in capital market prices— especially for emerging markets in light of the default by Dubai on debt issued through its wholly owned corporate entity, Dubai World. The announcement last Wednesday sent shudders through capital markets, leading to one well known portfolio managers to predict a 20% correction in emerging markets. The result, heretofore, has been a muted cementing of the general impression put forward in this column that emerging markets are less risky entities and less exposed to external shocks in global capital markets than before.

It is highly noteworthy that emerging market bonds in the likes of India and China have experienced capital inflows over the past week. These markets are understood to be less risky than many bond markets in the developed world where heavily indebted countries experienced selloffs— most notably Greece and Italy.

The Dubai World incident raises the issue of how tighter liquidity will affect different borrowers with high debt loads. While it is still early to contemplate, the events of the past week provide a nice test for emerging markets in the event of these external shocks and the grade is a resounding pass.

Emerging Markets Weekly

2009-11-20T09:29:00.003-05:00

One after effect of the recent credit crisis is that investors are on alert for market bubbles with heightened sensitivity, with China being the most recent object of attention. The phenomenal credit growth in China this year is reason for speculation that China’s market is in yet another bubble about to burst, but it seems largely unfounded. Sure, property market speculation has been rising, but to call the stock market a bubble is to misunderstand the concept.

A market bubble occurs when prices become divorced from fundamentals. True, they tend to occur in a mania type environment — and the 98% rise in the MSCI China Index over the past year has investors thinking they are seeing a market mania. However, let us not forget that the market fell heavily in 2008 and the rise this year does not even come close to getting us back to past highs. In fact, the MSCI China Index is still 38% below its previous high reached last in 2007, suggesting that the current market rally is anything but a bubble.

Valuations are also another indication that the market is not a bubble. Based on price-earnings ratios, the MSCI China Index is trading around its long term average based on 2010 earnings. The market is no longer cheap, but that does mean it is a bubble.

Emerging Markets Weekly

2009-11-13T12:25:00.004-05:00

The past week has seen another surge in China’s economy into overdrive. Industrial production increased 14% in the three months to October suggesting that GDP growth could hit 10% in the final quarter of this year. Authorities are naturally considering monetary tightening and have signaled a desire to move toward currency appreciation over the next year. This policy is highly desirable from several standpoints.

Firstly, the RMB needs to rise so China can pursue monetary policy independent of the U.S. Federal Reserve Bank. By keeping the RMB tied to the U.S. dollar, Beijing is implicitly following U.S. monetary policy which is highly accommodative-- too much so for China’s fast growing economy. The carry trade, whereby investors borrow in a low funding currency such as the U.S. dollar and invest in China’s markets is one aspect of this link in monetary policy. By pegging the RMB to the dollar, China is flooding its own economy with RMB when it takes in U.S. dollar reserves. A better policy is one where the RMB appreciates allowing authorities to better control the domestic money supply.

A higher RMB is also desirable from a global trade perspective. China needs to move away from an export driven economy, and a higher currency would encourage imports and discourage exports. It would also allow China to reduce its intake of dollar reserves which would stem its purchases of U.S. Treasury bonds, currently sitting at close to US$800-billion. This would allow for a long term rise in U.S. bond yields that would reduce household borrowing and eventually rebalance the U.S. economy away from its perpetual deficits on trade.

Investors should therefore expect a tailwind from currency appreciation over the next year.

Emerging Markets Weekly

2009-11-06T11:10:00.003-05:00

The recovery in the global economy does not suggest business as usual for the economic order. Rather, emerging markets are reverting toward trend rates of growth much quicker than the developed world. Moreover the BRIC countries appear to have fast-tracked in importance to the global economy. Between 2002 and 2007, the BRIC countries accounted for roughly 38% percent of global economic growth on average. Since then, they have risen in prominence. This year, in what will prove to be the worst year for the global economy in decades, the BRIC countries are expected to add 1 percentage points of growth to a contracting global economy, a feat never before achieved. In other words, without BRIC, global GDP would have contracted a further percent this year.

Next year, the BRIC countries will have recovered much of their past swagger but not so the global economy due to weakness in the advanced economies, according to IMF estimates. The BRIC countries will account for more than half of global growth in 2010 adding 1.6 percentage points to growth. It remains to be seen whether the advanced economies will regain their dominant place in the global economic order, but high levels of indebtedness for the advanced economies suggest that the change may indeed be permanent.

Emerging Markets Weekly

2009-10-30T12:22:00.001-04:00

More than a year after the credit crisis and the BRIC nations, Brazil, Russia, India, and China have the wrested the growth momentum from the developed world in convincing fashion. The BRIC countries have rebounded from the crisis well ahead of the developed world with the exception of Russia’s economy that was hit hardest of the four this year. China’s economy grew strongly in the third quarter of 2009 posting GDP growth at an 8.9% rate representing a remarkable return to form for the world’s most populous nation.

The economies of India and Brazil have bounced back smartly too and Russia’s though slower to recover is benefitting greatly from higher oil prices recently. These economies were able to rebound quickly because of superior economic policies pursued over the past decade vis-à-vis the developed world. The most important policy initiatives are as follows:

Well capitalized banking systems: It is worth reiterating that the banking systems in China, Brazil and India were not greatly affected by the credit crisis for several reasons. Firstly, the banking authorities were far more conservative in regulating the banking sector. In Brazil, India and China, a mix of policies ensured that banks were better able to withstand economic recession. Brazil also required banks to hold bigger capital buffers and had more conservative measures of what constituted capital as well as high reserve requirements on bank deposits.

In China, government policy to recapitalize the banking system in the late ‘90s and early ‘00s ensured that China’s banks had very big capital buffers leading into the crisis. In India, convertibility restrictions prevented banks from getting overseas exposure, and banks were also well-capitalized heading into the crisis.
High Foreign Exchange Reserves: Currencies were protected by large caches of foreign exchange reserves dominated by U.S. Dollar holdings. Each of the BRIC nations had hundreds of billions of dollars of forex reserves at their disposal to manage the capital flight that took place when the credit crisis hit. China, most notably, has roughly US$2.3 trillion of foreign exchange reserves, but Russia was able to use roughly one-third of its US$600-billion in foreign exchange reserves to manage the depreciation of the ruble.
Low levels of foreign indebtedness. High commodity prices leading into the crisis allowed Russia and Brazil to benefit from strong government revenues derived from national commodity production. Moreover, Brazil’s government pursued conservative fiscal policies that led to a dramatic fall in net foreign debt and falling inflation this past decade. Only India was hampered by a high and nagging budget deficit. As a a result, these countries have been able to purse Keynesian style stimulus programs to offset the fall in output caused by weak global exports without raising questions about long term growth prospects.

Emerging Markets Weekly

2009-10-23T11:19:00.001-04:00

Last week in Brazil, authorities announced a 2% tax on foreign purchases of stocks and bonds to stem the tide of currency appreciation. The tax sent a brief shockwave across capital markets, but they have since recovered suggesting that investors are not overly bothered by the tax. At 2%, the tax represents just a fraction of the rise in the stock market and the currency this year.

The real has appreciated 35% against the dollar this year on higher commodity prices and a credit rating upgrade by Moody’s, and the central bank action led to only a 2% fall in the value of the real on the day. Policymakers may be concerned about the strength of the currency and its threat to the competitiveness of the country’s manufacturing sector, but the currency is rebounding from a sharp decline last year. Moreover, Brazil’s is a relatively closed economy with exports accounting for only 15% of GDP.

The move led to a roughly 2.9% fall on the day by the main Bovespa Index and a subsequent 1% recovery the subsequent day confirming the fact that a 2% tax will have little lasting impact on the currency and the stock market.

China may have one of the most undervalued currencies in the emerging markets suggesting that trade could soon start contributing to GDP growth (last week also brought third quarter GDP results for China that showed GDP growth expanding 8.9% on the quarter), but investors need not be overly concerned by the strength of the real. Versus China’s yuan (China is Brazil’s number one export destination), Brazil’s currency is roughly flat since the beginning of 2008. The currency is merely recovering lost ground given up during the global credit crisis.

Emerging Markets Weekly

2009-10-16T15:12:00.003-04:00

Despite significant gains in its stock market over the past year, Russia is rebounding from a brutal fall and still looks cheap for investors with suitably long time horizons. The country is home to undervalued oil assets and a banking sector that could expand at very high rates over the next two decades.

Russia now boasts the status as the world’s biggest monthly oil producer since Saudi Arabia has borne the brunt of OPEC production cuts over the past year. The collapse in oil prices last year devastated Russia's economy and stock market. GDP contracted more than 10% in the first half of the year, and the stock market fell 75% from peak to trough.

The country is only now turning the corner from economic recession to recovery and looks set to expand between 3% to 4% in 2010. Moreover, economic output will remain below trend for the next several years, and the government is attempting to make up for the shortfall through fiscal stimulus.

Cost cutting combined with a return to top line growth at the corporate level will result in earnings growth of 60% on an annualized basis between 2009 and 2011 according to Goldman Sachs, who sees a potential for 40% further upside to the market through 2011 assuming oil prices rebounding to US$110 per barrel.

"Oil is very interesting because energy companies in Russia are the cheapest globally, and demand from emerging economies is going to be higher," says Ghadir Abu Leil-Cooper, head of Europe Middle East and Africa equities at Barings, and manager of Excel Emerging Europe Fund reached in London. Moreover Russia’s banking industry is also highly attractive over the long term given the low credit penetration with mortgages accounting for only 2.5% of GDP currently.

Emerging Markets Weekly

2009-10-02T14:08:00.003-04:00

The resilience of the emerging markets in the current financial crisis is best captured in recent IMF forecasts for global GDP growth this year and next. Advanced economies are not only subtracting from global output in 2009, they are the cause of the contraction. In contrast, emerging and developing economies are tapped to grow 1.9% in 2009. The same picture largely emerges in 2010. World output is pegged to rebound fairly strongly to 3.1% growth with the developed world delivering tepid growth of 1.3% and the emerging world turning in growth of 5.1%. In other words, the developed world is no longer the growth engine of the global economy.

This goes back to the greater resiliency of the emerging economies in the current crisis relative to past downturns. The result is all the more impressive given the severity of the current crisis. It seems clear that emerging equity markets overreacted to the downturn given their swift recovery and given the resilience of government bond markets. In previous cycles, U.S. High yield debt and emerging market sovereign debt performed similarly. In 2002, yield spreads on the Emerging Market Bond Index (dark blue, right graph) indicated that investors judged the risk of default by emerging countries higher than the risk of default by U.S. sub investment-grade borrowers (yellow line, right graph).

In contrast, the current crisis raised the perceived and actual default risk of U.S. high-yield borrowers relative to emerging market sovereign borrowers. In other words, emerging markets were in far better shape this time around. The reasons are manifold including high foreign exchange reserves, low levels of debt and fiscal deficits, and reduced foreign currency exposure in many key emerging markets. These factors have allowed the emerging markets to achieve stronger and faster economic recoveries relative to the advanced economies and suggests that their leadership role could continue for the next several years.

Emerging Markets Weekly

2009-09-25T11:03:00.013-04:00

At the start of the year, in the midst of the financial crisis, we were quick to point out the extremely low valuations in emerging markets and the once in a lifetime opportunity for investors to buy in to multi-year growth stories on the cheap.

After a dramatic recovery and phenomenal gains over the past year, the world’s stock markets no longer appear cheap—with the exception of Russia for one. Back in February, Russia’s stock market was phenomenally cheap. Yet even after 70% plus gains this year to date, Russia’s stock market remains a buying opportunity for investors with suitably long time horizons.

The MSCI Russia Index is still undervalued based on historical valuation measures and Russia’s economy is recovering after a very difficult year. The index trades at a price earnings ratio of roughly 7, roughly half its average valuation based on data on record dating back to 1996.

Russia’s economy will grow roughly 3% next year after contracting more than an estimated 8% in 2009. Retail sales and investment are weak, but a rebound in in oil prices, economic recovery in the developed world, and softer inflation will allow Russia’s economy to pull out of economic decline and recover. The country boasts low levels of public debt and high foreign exchange reserves that have allowed the central bank to stabilize the currency.

Emerging Markets Weekly

2009-09-18T10:29:00.001-04:00

The long term growth potential of India’s market is at times questioned by the high level of government indebtedness in contrast to, say, China’s low level of government debt. At 80% of GDP, India’s high level of indebtedness is a potential drag on growth in the near term and calls for fiscal consolidation now the economy has recovered. The general government budget deficit including off balance sheet items such as subsidies on fertilizer and oil consumption exceeds 10% of GDP. Fortunately, India is in the envious position of having a very high potential rate of GDP growth that will allow it to stabilize its debt more easily than developed nations.

For example, as long as the economy can grow 8% a year over the long term, the debt to GDP is manageable because the rate of growth of the GDP will exceed the growth rate of debt caused by interest payments. Assuming real interest payments on debt of 3% per annum, the government could run a fiscal deficit in excess of interest rates (primary deficit) of 5% to stabilize the debt to GDP ratio. Moreover, the government has long term plans to reduce the national debt by selling off state assets worth an estimated 30% of GDP. If that transpires, which will undoubtedly happen slowly, interest payments on debt will fall.

As India’s economy recovers this year, its economy is expected to grow between 6% to 7%, weaker than recently expected due to a poor monsoon. Investors need to keep a watchful eye on India’s ability to return to its long term potential rate of growth of 8% of GDP. The sooner that the economy recovers and output rises, government finances will recover more quickly and government debt will be stabilized.

Emerging Markets Weekly

2009-09-11T09:47:00.005-04:00

Despite concerns in the media that China is about to kill off its economic recovery with tighter monetary policy, the opposite appears to be true. Policymakers appear determined to ensure that China achieves 8% economic growth that is believed to be their unofficial growth target. The economy rebounded in the second quarter to year on year growth of 7.9% and appears likely to exceed that number in the third quarter of this year.

Bank credit is expanding at a 30% year-on-year pace since March 2009, fuelling a tremendous expansion in investment associated with the US$586-billion stimulus plan that was unveiled at the start of the year. The focus of the plan is on infrastructure spending, and it is proceeding according to plan judging by the rollout of projects including rail expansion, airport development, etc. It is evident in the data on fixed asset investment-- up 33% over the year to August.

The government budget deficit of 4.5% for 2009 and net debt of 20% of GDP suggests that the government is well within its limits to boost output this year and next. Investors should bear in mind that the stimulus spending will roll out over the current year and next, so there is plenty more ammunition to carry China’s economy forward to 2011 in expectation of a global economic rebound.

Inflation continues to print negative in China, down 1.2% on an annual rate in August. Expect inflation to begin rising by the start of 2010 as higher oil and food prices start to hit headline numbers. Given the massive loan and money growth in China, we will look to China as one of the first place to see interest rate hikes in the first half of 2010. Nevertheless, risks of a double-dip recession are not a concern for China.

China data for August (year-on-year %):

CPI: -1.2%
PPI: -7.9%
Fixed Asset Investment: 33.0%
Retail Sales: 15.4%
M2: 28.5%

Emerging Markets Weekly

2009-09-04T10:07:00.006-04:00

Even with a headwind of a high savings rate, the brute force of 1.3-billion people spending even a little more money thanks to rising incomes is propelling China’s consumer market forward. Savings may be falling as a percentage of total output, but incomes are rising making the consumer market in China an unstoppable force that will see urban consumer spending grow five-fold between 2006 and 2025 to US$2.3-trillion according to a report by McKinsey Global Institute (MGI), catapulting China’s consumer market to the third spot globally.

A middle class is taking shape in China-- accounting for roughly one-third of the population today from virtually nothing in 1990 and set to rise to 70% of the population by 2020 according to MGI. At US$3000 in annual income, the threshold for entering the middle class may sound despairingly low by our standards, but it is the point in the developing world where households start buying non-discretionary items beyond food and housing, bearing in mind that the cost of goods is far lower in emerging markets such as China.

Look no further than the mobile phone industry to capture the imagination of the potential for China’s domestic demand. Each month, the mobile phone industry lifts its net and snags an additional 10-million subscribers or so to add to the 650-million people already with mobile phones in China.

At the high end of middle class incomes, car purchases will surely be a major focus of status-hungry consumers. China now has the second largest highway network in the world and leapfrogged the United States to the position of number one car market in the world this year. Given that the auto market is in its infancy, the prospects for car companies over the next decade have auto executives in rapture.

Domestic companies have two natural advantages over foreign competitors: cultural knowledge and established distribution networks; many also benefit from government regulation. Foreign multinationals may have initial success in the four tier one cities (Shenzen, Shanghai, Beijing, and Guangzhou) in China where they are “out-marketing” the competition says Jonathan Chajet, Managing Director for Interbrand China, but they are finding that a great deal of spending comes from the 37 tier two cities and the 136 tier 3 cities with populations greater than 1-million inhabitants. These tier 3 cities represent more than half of all disposable income in China, according to MGI.

It is astounding to think that China has the largest auto market in the world when only 0.5% of the population owns a car in contrast to the United States where 80% of the population owns a vehicle. It is the same story for so many goods and services in China. The growth potential is astounding.

To read the full story at National Post click here:
http://www.nationalpost.com/story.html?id=1963896

Emerging Markets Weekly

2009-08-28T11:37:00.002-04:00

In recent weeks, I have been reading a great deal about the China stimulus package and the potential for overcapacity due to the overwhelming focus on investment and infrastructure spending. The sentiment is clearly turning, call it phase three in the global slowdown and China recovery story.

The first phase was dominated by selling and fears that China was headed for a massive recession. The second phase was the turnaround story for both the economy and the stock market as the doubters eventually came onside to the recovery view. And finally, phase three is a transition to renewed fears, this time about the sustainability and quality of the growth.

These are good questions to ask, and there is undoubtedly validity to the concerns that China is spending its way out recession through brute force. There will be overcapacity and low returns to many projects.

On the other hand, retail sales figures are encouraging. The data shows that retail sales volumes have jumped considerably over the past year thanks to the stimulus package. It is difficult to tell how reliable the data because it is purported to include some government and corporate spending.

Nevertheless domestic consumption growth is a response to government stimulus measures. Auto sales for example are very strong—with China recently leapfrogging to the number one spot in global auto sales.

Investors need not fear a collapse in spending in the near term because the stimulus extends to 2010. Bank lending is being reined in and that is evidenced by a slowdown in lending and the money supply between June and July but the authorities are not about to slam on the breaks too hard.

It will take policy makers years to rebalance China’s economy from saving toward consumption, and the path forward will not be straight. But over the next fifteen years, hundred of millions of people will urbanize, their incomes will rise and so too will consumption as the middle class grows.

If we have to choose between the U.S. economy that can barely eke out growth with trillions of dollars of stimulus or China’s that is responding to its stimulus package and over the long term has so much greater potential for growth, I take China, hands down.

Emerging Markets Weekly

2009-08-21T20:00:00.000-04:00

Up until last fall, most currencies of emerging market countries appreciated strongly versus the US dollar and to a lesser extent against the Canadian currency. This extra kicker to equity returns, reversed at the time that equity markets fell in the emerging countries last year with the notable exception of China, where the RMB largely stopped appreciating.

The slowing of foreign direct investment and reversal of portfolio flows led to this currency weakness despite large U.S. dollar foreign exchange reserves in the BRIC countries, China once again being the exception to this rule. The large foreign currency buffers did allow central banks the ability to manage foreign currency depreciation when the crisis was at its peak.

In China's case, authorities have resisted the natural currency appreciation that would have occurred due to the country's very sizeable trade surplus that exceeded 10% of GDP for several years. Moreover, capital flows did not turn sufficiently negative to significantly reduce the $2-trillion plus worth of dollar reserves at the central bank's disposal. Authorities also made it clear that they would not seek a policy of competitive devaluation with the RMB to boost trade but opted instead for fiscal and monetary stimulus measures.

The strengthening positions for the emerging markets this year means that currency appreciation is back on the table-- and has been happening. Over the long term, we should expect to see a rise in exchange rates for the BRIC countries due to higher rates of productivity in their tradable goods sectors. Therefore, India and China would benefit most from this phenomenon. The Balassa-Samuelson effect is the formal name for this theory that seeks to explain why price levels tend to be higher in higher income countries. The answer alluded to here is that higher productivity in tradable goods is the reason and explains why countries such as China and India with higher rates of productivity in the tradable goods sectors should experience appreciating exchange rates over the long term.

It is this phenomenon why investors will get a foreign currency headwind from investing in emerging markets.

Emerging Markets Weekly

2009-07-31T09:53:00.000-04:00

The end of the easing cycle of monetary policy appears to be upon us in China and India, months or perhaps more than a year before the developed market tightening cycle begins. India and China enacted very aggressive monetary policies beginning late 2008 to combat the global economic recession. Those policies have achieved a high degree of success achieving measurable growth rebounds. Policies will now start to transition from growth stimulus to inflation control.

Inflation in the emerging markets peaked in the summer of 2008 with the collapse of the global economy and the plummet in oil prices. The fall in inflation allowed central bankers to focus exclusively on growth. Policy rates were lowered aggressively across the emerging markets with the exception of some countries that had significant capital flight.

Investors should expect that interest rate cuts in India and China have run their course and that a focus on inflation will rise to the fore in 2010. In China, very loose monetary policy has led to exceptionally strong credit and money supply growth. While this outcome is not a visible concern for authorities, lending rates clearly needs to be reined in over the next year.

Inflation is now rising on a monthly basis even if it is still falling on year over year comparisons in China. What this means is that inflation pressures are only just starting to rise, and it will be several months before inflation rises on a yearly basis. Nevertheless, the fact that inflation has bottomed suggests that interest rate cuts have now reached their conclusion. Recent reports that China's two largest state owned banks announced limits on new loans for 2009 supports this claim.

In India, the Reserve Bank of India stated in its July 28th monetary policy statement that industrial production activity is picking up and that inflation concerns were starting to surface. Similar to China, annual inflation is negative, but monthly inflation is beginning to rise.

We view these developments positively because they confirm that the global economic recovery is happening in the emerging world. We also believe that the pick up in pricing power will lead to an earnings recovery in the near term. It is too early to begin fretting about tightening policy because inflation is only just bottoming, but we are following these developments over the next six months with a watchful eye.

Emerging Markets Weekly

2009-07-24T11:52:00.000-04:00

The Russian economy has endured a deep recession in 2009 as a result of the global credit crisis. The stock market has sold off heavily as a result and since recovered with very strong gains. Yet it is still highly undervalued and an opportunity for investors with patient money who can wait two years at a minimum for a return to healthy growth.

What started as a lack of liquidity in the banking sector in 2008 has led to a widespread and deep recession in Russia. A sharp contraction in household consumption—the main source of growth in Russia in recent years—has been caused by rising unemployment and weak consumer confidence.

There are signs that the Russian economy bottomed in June after a devastating fall in output of roughly 10% in the first half of the year. The sharp fall in private consumption expenditure has been exceeded by a drop in investment and a rundown in inventories.

The fact that inventories have contracted suggests that as in the developed world, the fall in output exceeded even the fall in demand and bodes well for a period of growth due to restocking. Household consumption contracted 2.2% in the first quarter of 2009 well beyond the 15.2% fall in fixed capital investment in the first quarter.

The Central Bank of Russia (CBR) has steadied the ruble exchange rate since March when we first pointed out that Russian energy producers were dirt cheap (they have since rallied 70% or more). The CBR raised interest rates (since lowered on weak inflation reports) and ended the capital flight that occurred in the first two months of the year

The rise in oil prices is a very positive development for the country’s finances and bodes well for long term value of the ruble and for government finances. Investors should now expect slow and steady ruble depreciation over the next year.

Russia is expected to transfer US$43.7-billion out of its Reserve Fund, a sovereign wealth fund funded by petrodollar revenues, to funds its first budget deficit in a decade, that is expected to clock in at 8% of GDP in 2009.

Russia remains a viable long term investment opportunity due to its large energy reserves, sizeable foreign exchange reserves and long term potential rate of output. Its economy will return to modest growth in 2010 and is likely to recover more strongly by 2011. Its stock market is highly undervalued-- trading at around half the valuation of the other BRIC markets.

Emerging Markets Weekly

2009-07-10T10:02:00.000-04:00

Investors fretting about rising valuations in China need to recognize that valuations typically rise at the beginning of economic recovery. Typically earnings eventually catch up to rising prices as the economic recovery takes shape. The 80% rise in the MSCI China index since October is in fact underpinned by rising earnings that are likely to catch up to the rise in prices over the next couple years.

Government stimulus measures are clearly working and leading to a major ramp up in analysts' twelve-month forward earnings estimates in China. Earnings in utilities, technology and industrial sectors are expected to rise 125%, 78% and 41.7% respectively over the next year.

The rise in share prices is clearly outpacing earnings, however, and valuations suggest the market is no longer cheap. This analysis is deceiving because prices tend to predict earnings recoveries leading to rising valuations at the start of an economic recovery.

The MSCI China index appreciated strongly in 2003 when the global economy recovered from recession, taking its P/E ratio to around current levels. A subsequent earnings rally allowed equity prices to continue rise, more than doubling between 2004 and 2007, yet valuations were no higher at the end of that period.

The P/E ration on the MSCI China index at 16.74 is below the level it reached in February 2004 after the market had also risen on the back of economic recovery. Investors who sold out of the market at that point would have missed a doubling in the index over the next three years. The interesting point to note is the P/E ratio was no higher three years later than it was in February 2004.

The MSCI China Index peaked in October 2007 at a P/E ratio of over 30. Clearly we are nowhere near overvalued territory today.

Emerging Markets Weekly

2009-07-03T10:40:00.000-04:00

Investors interested in the contrasts between India and China on the one hand and the US on the other might consider the vastly different economic consequences of the current credit crisis.

Growth prospects are the first place to start with the contrast overwhelmingly wide. The World Bank forecasts GDP growth for India and China this year at 5% and 6.5% respectively and rising to 8% and 7.5% respectively in 2010. In a study of contrasts, the U.S. economy will contract at a 3% rate in 2009 and rise 1.8% in 2010. Similarly, industrial production will rise 7.4% in 2009 yet contract at a 12.5% rate this year in the U.S.

Retail sales have risen strongly in China in 2009 at a 17% annual rate of change. In contrast, retail sales in the U.S. have fallen sharply for the first time in decades. American consumers have hit a debt wall with little prospect for recovery in the near term.

One of the more interesting developments is the rise in emerging market bond yields versus the rise in high yield bonds in the United States. In the last U.S. economic recession, bond yields spiked up across all risk assets high yield bonds and emerging market bonds alike. This time around, emerging market bond yields (EMBI) have not risen in lockstep with high yield bonds indicating that sovereign borrowers in the likes of India and China are far less risky this time.

The near term credit crunch is a study of contrasts and looks likely to expedite the long term convergence of emerging markets to developed market standards. Mortgage penetration for example is very low in India and China, 8% of GDP and 13% of GDP respectively. Mortgage penetration in the U.S. at 82% of GDP has obviously gone beyond all measures of sound economic policy.

As credit rises in the India and China, for example, the financial sector will be a prime beneficiary. Credit on the other hand continues to contract in the U.S. economy and will likely do so for the next year or two.

Emerging Markets Weekly

2009-06-26T09:19:00.000-04:00

Investors concerned about how U.S. government and central bank policies will affect emerging markets over the next few years are focusing on the potential side-effects of these policies on the U.S. dollar.

Trillions of dollars in additional government expenditure will likely lead to higher bond yields and a weaker dollar necessary to finance the U.S. budget deficit. This will lead to higher commodity prices. Moreover, expansionary monetary policy by the U.S. Federal Reserve Bank will also have repercussions for the dollar in that dollars will leak out the trade account and cause the currency to depreciate over the long term.

1) Commodity price effects:

2) Export effects:

Emerging Markets Weekly

2009-06-19T08:35:00.000-04:00

The meeting of the leaders of Brazil, Russia, India and China in Yekaterinburg Russia last week for their first ever BRIC summit happens at a time of relative strength for this group amidst the global economic downturn. China leads the pack with continued signs that its economy is responding well to government stimulus efforts.

This week the IMF upgraded its outlook for growth in China this year and next on signs that its economy is growing, 7.2 percent in 2009 and 7.7 percent in 2010. Infrastructure and other government-influenced investment increased an estimated 39 percent in the first four months of 2009. Consumption is also reported to be strong with car sales rising 14 percent on a year ago in January to May. Yet exports were down 20% on a year ago between January and May demonstrating that China’s economy can grow without contribution from the trade sector.

China’s strength is also being felt globally in commodity markets for example where China is the only country driving demand and prices for oil and industrial commodities higher. Also in trade, China is making an impact, and is now the biggest destination for Brazilian exports. The aforementioned rise in auto sales will place China first in auto sales in 2009 ahead of the U.S., more than five years ahead of forecasts from as recently as last year.

The BRIC summit is important because it is the start of a coordinated effort by the BRIC nations to effect change on the global economic order. The four nations control more than US$3-trillion in foreign exchange reserves the bulk of which are denominated in US dollars, and they are letting it be known that they wish to reduce their reliance on the US dollar.

Most recently China has arranged currency swaps with many nations to allow foreign trade to be conducted in RMB rather than dollars. It has also allowed foreign banks to launch international bonds denominated in RMB and now allows cross-border trade in five Chinese cities to be conducted in RMB. Finally, China also announced recently that is has increased its gold holdings by 76% since 2003 to become the fifth largest holder of gold.

The rise to prominence of BRIC nations was brought forward due to the global credit crisis and their sphere of influence in the global economy will only rise in prominence over the next several decades.

Emerging Markets Weekly

2009-06-12T10:00:00.000-04:00

The steady stream of data coming out of China continues to point to economic expansion. Industrial production in May increased 8.9% from 2008 and retail sale rose 15.2% from the previous year.

The economic expansion is being funded by very strong loan growth since the start of the year to coincide with the government stimulus package. Total lending for the first five months of 2009 totaled Rmb5.8-trillion (US$850-billion) in excess of the Rmb 5-trillion government targets for the entire year.

Investors and analysts concerns that China cannot grow without the contribution of net exports are misplaced. China indeed developed an enormous trade and current account deficit in recent years worth roughly 11% of GDP in 2007; nevertheless, domestic factors accounted for the majority of economic growth between 2000 and 2007 for example.

China’s economy expanded at close to 10% per year on average between 2000 and 2007, and net exports contributed only 1.2% of that growth. Investment accounted for 4.5% of growth and private consumption contributed 2.9% in annual growth.

Trade data—both imports and exports—continue to be weak, falling again in May, but this is a reflection of the decline in global trade rather than weakness in China’s domestic economy. A fall in exports is likely to coincide with a fall in imports since the latter are an important component of the former in China.

The end result is that China’s economy can grow with or without the rest of the world. It will likely grow at a rate below the 10% average over the past two decades, but weak trade is not devastating to China’s economy.

Emerging Markets Weekly

2009-06-05T09:58:00.000-04:00

Recent data from India and China signify that fiscal and monetary stimulus in China and India is working and that economies are expanding. The Purchasing Managers Index in China rose for a third straight month in May indicating that the manufacturing sector is expanding. Most notably, the new export order index signaled expansion.

In India, GDP data for the fourth quarter 2008 indicated that India’s economy grew more quickly than originally anticipated at the height of the global economic crisis. Economic output in the fourth quarter was reported at 5.8% with a healthy shot in the arm from government spending. That factor and the recent favourable election results for India’s Congress Party has induced capital back to the region—US$5-billion in a single month—and sent the stock market soaring.

Positive data and rising stock markets tend to beget more capital inflows and higher economic growth as a result—especially since capital outflows were the primary cause of the economic downturn especially in India. Investors should expect positive revisions to India’s GDP numbers this year and next over the coming weeks and months.

The positive economic data has reignited discussions of economic decoupling in India and China . Without wading into the debate, suffice it to say, that the economic growth and return to profitability has more justification in these two countries than anywhere else in the world.

The developed economies are likely to recover later this year or early next year. As the dust settles it will become apparent that the recovery will be weak and that will have repercussion for emerging markets. That said, investors are realizing that the selloff in emerging markets was far too rapid and that fundamentals in these countries are more favourable than in the developed world. Therefore, stock markets at current levels—well beyond the rebounds in the developed world—are justified.

Emerging Markets Weekly

2009-05-29T09:41:00.000-04:00

China's economy is starting to run hot again thanks to a significant fiscal and monetary boost over the past six months. Lending jumped by roughly 30% in March and April, a total of US$758-billion in new bank lending in the first four months of the year.

The positive implication of the loan expansion is economic recovery. Steel production ramped up in earnest at the end of the 2008, rising by 24% since late December. The retail autos sector has also rebounded -- nearly doubling in monthly sales volume since last summer.In fact, China is experiencing a broad-based economic recovery with the exception of the export sector. The manufacturing purchasing manager's index fell off a cliff late last year with the collapse in exports but now points to economic expansion.

Investors concerned that the major rise in lending could lead to a banking crisis are misplaced however. The banking sector was very well capitalized heading into the current downturn according to Peter Bottelier, Senior Adjunct Professor of China Studies at John Hopkins Univeristy in a recent conversation; non-performing loans will obviously rise says Bottelier but will not lead to a US style banking problem. For one thing, the consequences of this rampant loan growth are potentially more benign for China than for the developed world because private sector credit penetration is obviously far lower in China.

Moreover, China has already undergone effective bank recapitalization this past decade in China as a result of bad loans to unproductive state owned enterprises in the 1990s. These non-performing loans across China's banks were estimated to be as high as 40% of total loans outstanding. To fix the problem, authorities disposed of the non-performing loans by transferring them to four government funded asset management corporations (AMCs), a version of the much vaunted Swedish model that was used to fix that country's banking system in the early 1990s.

China's banks were again cleared of bad loans and recapitalized prior to public stock flotations in 2005 and 2006. Since that time, banks balance sheets have looked better than ever and non-performing loans (NPL) plummeted. The ratio of NPL to total assets for China's largest banks was down to 2% in April from over 12% in March, 2005.
We continue to believe China will lead the world out of the current economic crisis and current data confirms our view the current excessive rise in bank lending notwithstanding.

Emerging Markets Weekly

2009-05-22T11:00:00.000-04:00

Last week we saw further signs of the emerging market trading blocs that are forming and that will eventually displace the old economic order. The US dollar is the world's reserve currency—the currency of choice for trade settlement. However, severe recession in the United States combined with a banking crisis is opening the door for China to increase its influence in the global economic theatre.

The recent visit of Brazilian President Lula Da Silva to China was significant in this regard. Calls this week by Da Silva to establish trade settlement in local currencies rather than dollars is an early sign of the rising influence of the RMB vis-à-vis the US dollar.

Recently, policymakers in Beijing called for a new international reserve currency to displace US dollar hegemony as the world’s reserve currency making it clear that China wants a place in the new economic order. China has signed 3-yr RMB/local currency swaps with Argentina and other emerging market countries-- a sign of China’s growing sphere of influence.

China is now Brazil's biggest trading partner displacing the U.S. from the number one position, and recently, China signed a US$10-billion deal with Brazil to secure 200,000 barrels of oil a day (bpd) from Brazil's largest oil company, Petorbras, for the next decade. The deal is based on a $10 billion loan for Petrobras from China at below market rates.

Growing trade relations across emerging markets will serve to increase the prospects of the RMB gaining prominence as a reserve currency. One prerequisite for this to happen is the removal of controls on China’s capital account so there are no restrictions on the flow of its currency. Nevertheless these are the first signs that China is slowly increasing its sphere of influence in the global financial order.

Emerging Markets Weekly

2009-05-08T10:14:00.000-04:00

The strong reboundin BRIC stock markets since November confirms our research last fall that suggested these markets were highly undervalued and that rebounds would come quick-- and that they would be big. Indeed, the rise in these stock markets have been very impressive. The gains since November for Brazil, China, India and Russia are 57%, 64%, 29% and 51% respectively in Canadian dollars as of May 7th according to data from MSCI Barra.

One of the interesting characteristics of these rebounds is that they came well in advance of the bottom of advanced economy stock markets. However, one would think that expectations for an early recovery of the U.S. economy from recession are driving gains higher in the near term. The extension of this rally may ultimately depend on economic recovery in the developed world. In that event, there is good reason to believe more gains will come.

It is worth pausing at this point in the rally to take a look at valuations to make sure that prices are not too far ahead of fundamentals. It is clear that stock markets discount economic recoveries roughly six months in advance of the fact. So valuations undoubtedly rise in these circumstances.

A look at P/E ratios for Brazil, Russia, India and China shows that valuations have indeed bounced off the absolute lows seen last November. Valuations in China appear to have run ahead fastest. Thecurrent P/E ratio for the MSCI Brazil Index at 12 is close to its long term average of 13; China is trading at a P/E of 12, just above its long term average of 11; India is trading at a P/E of 14 below its long term average of 17; and Russia is undoubtedly the cheapest market with a P/E of 4 below its long term average of 15

Valuations are clearly not excessive at this juncture and past experience suggests that an economic recovery will coincide with a continued rise in valuations above long term averages. We will continue to monitor valuations for this risk, but currently we are nowhere near this point.

Percentage Gain Since Market Bottom:

Emerging Markets Weekly

2009-05-01T10:13:00.000-04:00

The current global economic crisis is an opportunity for Brazil to see convergence in real interest rates several years after the country successfully put the inflation genie back in the bottle. This change will result in a permanently higher potential rate of growth for the economy says Guilherme da Nobrega, chief economist of Itau Securities in Brazil.

Brazil suffered from hyperinflation that relegated the economy to weak growth before the government introduced the Real Plan in 1994. Consumer price inflation has finally come under control since 2005 around the central bank's central target of 4.5%, but real (inflation-adjusted) interest rates have remained stubbornly high -- close to 10% since 2000.

Brazil should arguably have a much lower real interest than it has experienced over the past few years but rising inflation due to cyclical pressures in 2008 raised questions about the ability of the central bank to control inflation. This factor delayed a fall in real interest rates associated with the falling debt to GDP ratio this decade.

Now that commodity prices and inflation are declining in Brazil due to the global economic recession, Brazil will see real gains in terms of lower real interest rates over the medium to long term. The fall in real interest rates will result in lower debt service costs on the government debt valued at roughly 60% of GDP, and will allow the economy to achieve a higher trend rate of growth.

Emerging Markets Weekly

2009-04-24T10:18:00.000-04:00

Central banks in BRIC economies pursued mercantilist policies in recent years aimed at export promotion through currency manipulation. Large trade balances were achieved through foreign exchange accumulation specifically US dollar accumulation. China is the most extreme example where rapid foreign exchange accumulation resulted in nearly US$2-trillion forex reserves. These reserves were an inefficient use of domestic savings given the cost of accumulating these reserves equals the difference between domestic interest rates and the yield on US Treasury bonds.

Nevertheless, these reserves have proved an important source of stability for BRIC countries in the current economic downturn in contrast to previous episodes of currency weakness. The reason is simple, dollar reserves are hugely important to protect both private sector borrowers with dollar denominated debt. Russia used roughly one-third of its forex reserves to provide dollar funding to the domestic economy over the past six months. This process allowed for a more steady unwinding of dollar loans during capital flight in recent months.

In contrast, the Asian currency crisis and Russia's debt default in 1997-98 were all about US dollar loans that could not be financed. As currencies fell abruptly, the domestic cost of funding these dollar loans went through the roof and caused widespread insolvency. It is also noteworthy that despite better polices in the BRIC countries, not all emerging nations have managed foreign exchange risk properly. Hungary is drowning in a sea of foreign currency debt where roughly 80% of new home loans and 50% of business credit and personal loans between 2006 and 2008 were denominated in Swiss francs. As the forint has fallen, the cost of servicing debt has ballooned.

Russia, India and Brazil experienced currency depreciation in recent months due to capital flight. As a result, export competitiveness has risen substantially because inflation has also fallen. There are still ample reserves to maintain currency stability and there are strong signs that currencies have stabilized since the start of this year. The widespread economic slowdown in these countries have not resulted in a fundamental deterioration in the growth outlook over the medium term in contrast to the currency crisis last decade. In other words, government policy has resulted in a much better growth picture for BRIC nations this time around.

(Click for larger view)

Emerging Markets Weekly

2009-04-17T10:38:00.000-04:00

Data released this week confirms a near-term bottoming phase in China's economy. The GDP data marks the point that US$586-billion stimulus package and aggressive lending policies are achieving their desired results.

Fixed asset investment growth increased at a 28.6% pace in the latest quarter representing a substantial pickup in activity from last year. The bulk of this activity is direct consequence of official policy that is geared toward infrastructure investments.

Lending activity has increased at a torrential pace in the first quarter of 2009 a clear sign that the change in policy direction is being felt in the real economy unlike in the developed world where flooding of bank reserves by central banks is not leading to increased lending. More than 90% of intended lending for 2009 was reached in the first quarter alone suggesting that things are progressing in the loan department too quickly and may have to be reigned in later this year.

The data confirm that China's economy has clearly bottomed and is the first to emerge from the global economic recession. The government will continue to pump life into the domestic economy until a broad based global economic recovery takes hold. There is no telling when this might happen, and it is quite possible that more stimulus measures could be announced late in 2009 or early 2010.

We have been highlighting China's better prospects for growth over any other country in the developing world for several months now and continue to believe that the authorities have the wherewithal to maintain economic growth despite severe headwinds in the global economy.

Emerging Markets Weekly

2009-04-03T15:36:00.000-04:00

As central banks in developed nations around the world are running out of means to stimulate their economies, emerging markets still have plenty lot of room to ease monetary policy further to stimulate their countries' economies in 2009.

Around the globe, developed nations, with the exception of continental Europe, have cut key lending rates to close to nothing to ease lending rates in the midst of a severe credit crunch that has unfolded since the fourth quarter of 2008. Central bankers in the advanced world have now moved toward quantitative easing - a form of money printing in simplest terms.

In contrast, emerging markets have been slower to ease monetary policy for several reasons. For one thing, inflation fell more slowly in emerging markets and given that the economic slowdown hit the developed world with a lag. For another thing, some countries, most notably Russia, were forced to raise rates to shore up their currencies due to capital flight and inflation pressures.

Now that the global economic recession has firmly taken hold and inflation concerns have receded, there appears to be ample room for BRIC countries to ease monetary policy over the balance of the year and in 2010. These countries continue to grow on average in 2009 whereas the advanced economies are contracting deeply. Room for policy easing in the emerging markets will support stock market recoveries that have taken hold in earnest.

Emerging Markets Weekly

2009-03-27T15:38:00.000-04:00

The global credit crisis has taken its toll on economies of both developed and emerging markets, but the cost to fixing the financial systems of the developed world are destined to result in a major increase in gross debt to GDP for the advanced world economies. In contrast emerging markets are facing a lower expansion in budget deficits, higher growth trajectories, and falling ratios of debt to GDP.

China for example will incur a budget deficit of only 2.2 percent in 2009 despite a massive spending program aimed at boosting growth next year, and China is expected to see its economy grow over 6.5% in 2009 according to the IMF. The US in contrast is expected to produce a yawning fiscal deficit of 12% of GDP in 2009. Despite the massive spending increase, the US economy will contract in 2009.

More generally, the developed world economies will see large fiscal deficits in 2009 and 2010. The G-20 advanced economies are expected to see fiscal deficits of 7.9% and 6.8% this year and next. These Keynesian style spending initiatives will debt to GDP ratios in excess of 100% over the long term.

In contrast, the emerging markets will see falling debt to GDP ratios over the long term despite the global recession. The encouraging result here is attributed to the higher rates of economic growth across the emerging markets which will allow the emerging markets to grow their way out of rising fiscal deficits.

Emerging Markets Weekly

2009-03-20T15:39:00.000-04:00

Excel Income & Growth Fund* is one of the only balanced funds in Canada with a focus on emerging market equities and debt. One of the more interesting aspects of the portfolio is the sizable holdings of Reserve Bank of India Treasury Bills valued at roughly 20% of fund assets.

These short term debt instruments offer investors a sizeable yield pick-up over comparable T-bills in Canada and the U.S. For example, the current rate of interest on the T-bill portfolio is roughly 9.14%. This represents a significant yield pickup for investors, considering the current 0.64% rate of interest on 1-year T-bills in Canada.

Investors unsure of where to invest in the near term can take advantage of the yield pickup on the t-bill portion of the portfolio which provides an important component for managing overall portfolio risk.

Over the long term, Excel Funds has positioned the Excel Income & Growth Fund to take advantage of the higher growth opportunities in the emerging markets.

For investors looking for a less risky approach to emerging markets, this first quartile ranked Fund is ideal and presents an excellent alternative to traditional balanced funds that are invested in low-yielding government bonds in Canada and the U.S.

Emerging Markets Weekly

2009-03-13T15:39:00.000-04:00

To offset the global economic recession, governments around the world are partaking in Keynesian style deficit spending programs. The US and China are most noteworthy for the size of their plans, the US approving US$787-billion in spending over two years and China planning to spend US$586-billion over the same timeframe. While the US stimulus package is highest in absolute dollars, the market is reacting favorably to China's plan, pushing stock prices up in China and dumping US equities in response to the efforts of the US administration.

China's Stimulus Package will cover approximately 0.4% GDP in 2008, 2% GDP in 2009, 2% GDP in 2010, totalling 4.4% of GDP (at purchasing power parity) putting it on par with the U.S. stimulus in terms of size relative to economic output. Stimulus expenditures include infrastructure investment, safety nets, housing/construction support, strategic industries support, and other expenses.

Yet despite the similarities, the market has reacted favourably to China's stimulus package in contrast to the experience in the US for very good reasons. China's economy continues to grow and its banking sector remains well capitalized. Therefore, the opportunity for stimulus to lead at a quicker economic recovery is more pronounced, not to mention the fact that China could quite possibly achieve 8% GDP growth for 2009 while a contraction in US GDP is a foregone conclusion.

China also has more room to increase fiscal stimulus over the next two or three years. China's level of public debt will rise to only 22.2% of GDP according to IMF estimates leaving China the least indebted nation partaking in deficit spending.

Investors should expect China to lead the global economy out of economic recession as a result. The outlook for the US economy remains subpar for as long as the next decade as the economy is forced to undergo a stifling debt workout. In contrast, China's economy could see strong recovery in 2010 and the stock market could react accordingly.

Emerging Markets Weekly

2009-03-06T15:40:00.000-05:00

Stocks in Russia are now dirt cheap and oil and gas producers are priced more cheaply than anywhere else in the world.

Share prices of three of the biggest energy producers in Russia -- Gazprom, Rosneft and Lukoil -- are down by roughly three-quarters or more from their 52-week highs. These three companies figure most prominently in Excel Emerging Europe fund accounting for roughly 30% of fund assets.

Capital flight has put a serious damper on capital spending plans and reduces the outlook for production over the next few years. However, these companies look very cheap on a historical earnings basis.

State-controlled Gazprom is trading at two times 2008 earnings according to Thomson Reuters. Rosneft is trading at three times earnings and Lukoil is trading at just over two times earnings from last year. The market is dirt cheap and offers investors access to the world's largest gas reserves in the world not to mention a very large stream of global oil production.

Investors have sold out of Russia due to a one-way bet on ruble devaluation after the bank took the currency down stepwise in 20 mini-devaluations since last August. The currency is off by roughly 30% versus the U. S. dollar over the past six months but is stabilizing and may be forming a bottom here.

The decision by authorities to defend a slow depreciation of the ruble in the face of capital flight caused investors, even domestic ones, to sell out of Russia to avoid currency losses thus exacerbating the capital flight. This process also caused a slow bloodletting of the country's foreign exchange reserves, which fell by roughly 35% or US $200-billion.

The currency has stabilized in recent weeks and the central bank has successfully defended the lower value it has set for the ruble, although futures markets are still predicting an 18% decline this year.

At this point, investors may want to look to Russia and its highly cheap energy assets and buy in very cheaply for long run expected appreciation.

Emerging Markets Weekly

2009-02-27T15:41:00.000-05:00

The notion of economic decoupling of emerging market economies from developed markets was widely dismissed in recent months given the significant economic downturn in the emerging markets and outright recession in some countries.

It is clear that the global economies are very closely connected through trade and capital flows even more so in recent years; however, the divergence in prosperity and economic growth in the emerging markets vis-à-vis the developed world is quite striking this year.

Two thousand and nine will see a sharp contraction in economic growth in OECD nations. The U.S., Europe and Japan are all experiencing recessions of significant magnitude. Japan is currently having its worst post-war economic recession.

In contrast, emerging markets are still growing on average. The IMF is forecasting roughly 3 percent expansion in emerging market economies with China and India leading the way. China may even see its economy grow 8% in a very challenging year.

China's stock market has risen roughly 30% since November in anticipation of this economic growth. Brazil's stock market has also appreciated for similar reasons, Chile's too. These results contrast greatly to the almost daily deterioration in Canadian, U.S., European and Japanese equities.

It seems clear that the emerging markets will actually lead the way out of this economic mess. The banking systems of China, India, and Brazil are in very strong relative positions and lending has exploded in China in January.

In what looks to be the toughest year for the global economy, emerging markets are offering a strong ray of hope for recovery.

Emerging Markets Weekly

2009-02-20T16:01:00.000-05:00

After a tough year, emerging market investments have been relegated to also-ran status in the popular press, but this sentiment is at odds with the facts. Every broad developed market index (not individual country) is under water over the past decade according to MSCI Barra but not so for developed markets. The MSCI BRIC Index is actually up 9.01% on an annualized basis over the past decade and this includes the latest setback including a 45% fall over the past year. Investors who did not invest in the BRIC countries are getting a second opportunity to do so this time around. Unfortunately, many investors have been selling BRIC in favour of bonds and GICs.

The sharp rise in bond holdings over the past year is motivated by the strong performance of bonds as an asset class and flight to safety issues. More bond buying pushes yields lower and prices higher and creates its own momentum. With government bond yields exceptionally low, investors will make the same mistake by missing EM, but this time by investing in bonds rather than by owning developed market foreign equities.

History should not be followed blindly and just because MSCI BRIC bettered the MSCI World Index by roughly 11.5% per year on an annualized basis over the past decade does not mean that will happen again. Developed markets are now undervalued as are emerging markets. What are less compelling now are government bonds. The fall in bond yields over the past year suggests that bond could very well be the losing investment over the next decade. Now is the time to rebalance portfolios out of bonds and into emerging markets.

Emerging Markets Weekly

2009-02-13T16:03:00.000-05:00

Anyone who doubts that the BRIC emerging markets are cheap needs only consult the standard yardstick for measuring equity market valuations, the P/E ratio. It is patently obvious that valuations in emerging markets reached very high levels at the peak of the past bull market in 2007. India and China were particularly overvalued as investors all wanted too much of a good thing. The notion that growth could sustain the very high P/E multiples was in hindsight overly optimistic, However, market are inefficient on both the upside and downside and these markets have clearly overshot to the downside.

Valuations are such that the BRIC nations individually and collectively are very cheap. Brazil, China and India are all trading near historical lows reached at the bottom of the Asian Currency/Russian Debt Crises in 1998 and Russia is the cheapest on record. The current economic slowdowns in these countries are an order of magnitude less severe this time around because the economic fundamentals in these markets are far better.

The long term fundamentals for investing in these countries, we believe, have not changed. Urbanization and industrialization are leading to higher rates of productivity growth, faster GDP growth and higher profitability at the corporate level.

The fact that these markets are as cheap or cheaper than the developed markets in the US and Canada is strong justification for investing in these countries, China, India and Brazil in particular are likely to lead the global economy out of recession because they are not hampered by weak banking sectors or high levels of indebtedness. Since valuations have declined to level not seen since 2002, investors are being given a second chance to buy into the emerging market growth story.

Emerging Markets Weekly

2009-02-06T16:04:00.000-05:00