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Buy or sell? A spotlight on the world's 10 key emerging markets
by Dylan Lobo on Nov 15, 2012 at 09:33
The Macro Research Board (MRB) has forensically examined the world's major emerging markets to determine whether they represent viable investment opportunities.
MRB (Macro Research Board) Partners provides a range of independent research across multiple asset classes.
In a note published on emerging markets recently, strategist Mehran Nakhjavani outlined why investors should maintain a neutral exposure to emerging markets.
In the detailed note titled 'EM growth: nearly there', Nakhjavani said: ‘Investors should maintain neutral exposure to emerging markets (EM) within a global equity portfolio. The lags between policy easing and market outperformance have lengthened. ‘While we are approaching a trigger point where EM growth finally turns around after two years of deceleration, global investors have dug in their heels into “show me” mode. This implies that hard evidence of growth – rather than leading indicators – will need to be apparent before investors discount earnings reacceleration and thereby trigger equity outperformance.’He added: ‘That said, our positioning within the EM equity universe has been shifting towards a more pro-cyclical stance in anticipation of a recovery.’
With this in mind Nakhjavani has taken the microscope to 10 major emerging market countries to determine just how much exposure they should have to these nations.
Chinese growth will pick up moderately in response to supportive policy and the expected pickup in global growth. This will boost relative earnings and drive outperformance of attractively valued equities. An overweight with a 0-6 month horizon is warranted because once the turnaround in relative performance occurs, it is likely to be liquidity-driven, quite steep but relatively short (i.e. authorities are keen to avoid another bubble).Growth
We expect growth to pick up moderately in response to cautious policy easing, which has already triggered an acceleration in money and credit aggregates. What is still missing is for this liquidity to translate into investment growth. Relative GDP momentum will likely be moderate, but should boost relative earnings growth, given that the latter is close to its cyclical lows and will likely accelerate quickly once growth momentum resumes.Policy
Measured policy easing will continue to be supportive as price pressures remain relatively soft. Chinese policy makers still have plenty of ammunition – on both monetary and fiscal fronts – at their disposal should the external environment deteriorate further, or in the face of further delay in domestic investment activity. The downside risk to our view would be if credit quality in the banking system is masked by ‘zombie loans’.Valuation
Valuations are very attractive: China trades at a 12% P/E discount, while ROE is 12% higher than its EM peers.Technicals
Brazil’s growth momentum will likely outpace the emerging market aggregate. Attractive valuations and a relatively oversold market are supportive of equity outperformance. We still prefer domestically-driven sectors, namely consumer discretionary, consumer staples and financials.Growth
The yield curve, economic activity index and leading economic indicator are all suggesting growth acceleration. Easy policy settings to fight ‘currency wars’ are highly supportive of growth and risk assets. Consumption activity remains robust, buoyed by falling unemployment. Growth momentum will likely pick up significantly in 2013, strengthening relative earnings momentum.Policy
The central bank has indicated that risks to inflation are still limited but further easing, if any, will be carried out with ‘maximum parsimony’. Policy will continue to be accommodative and since the disinflation cycle is bottoming, we do not expect further rate cuts. With growth momentum improving, food and energy prices picking up and the favourable base effects fading by year end, there is some modest upside to inflation, albeit within the upper bound of the target range.Valuation
Overall relative valuations are mildly attractive. Equities are trading at a slight discount to the EM aggregate, and relative ROE is low but should rise going forward as we expect earnings to outpace GDP growth.Technicals
Our momentum indicator suggests that the market is mildly oversold.
Russia: maximum underweight
Without a decisively stronger trend in commodity prices, and with unfriendly monetary policy, equity investors should avoid Russia.Growth
Despite the central bank’s view, the deceleration of domestic and external growth drivers continues apace. Earnings growth is following suit, and a higher policy rate will only reinforce pressure on net interest margins. Energy and materials sector earnings are depressed by lower prices, and unlikely to receive very significant support in the near-term.Policy
The central bank’s surprise September decision to raise its policy rate was justified on the grounds that “strong” domestic demand (driven by credit growth) and rising food prices threatened price stability. Neither argument is very strong. In the face of weak external demand and decelerating money supply, industrial production and retail sales, a reversal of this stance in favour of easing is in the cards, but only after more pain is felt via weaker domestic demand.Valuation
Valuations are not as attractive as they appear in aggregate. The energy sector (60% of the market cap) has higher ROE and lower P/E than its EM counterparts, but is missing the catalyst of accelerating oil and gas prices. The latter depend on OECD energy demand growth, which remains subdued. Elsewhere in the market, valuations are less compelling, and the flattening yield curve will put downward pressure on earnings in the financial sector, which accounts for 15% of market cap and is a good proxy for domestic demand.Technicals
Relative momentum is mildly supportive, but not close to significant levels.
We will move to overweight once we see consistent signs of a revival in growth momentum, i.e. cyclical stocks begin to decisively outperform defensives, and the yield curve becomes more steeply sloped. The latter will occur once the central bank resumes gradual easing.Growth
Economic data are showing signs of bottoming out; industrial production is no longer in freefall, the yield curve is steepening, and cyclical stocks are starting to outperform the broad market, an early sign of reviving industrial production. Moreover, sentiment is improving and earnings momentum has bottomed and is likely to continue rising. That said, we do not expect an imminent or sharp reversal in growth momentum given the weak position of the minority government.Policy
It is unlikely that the Reserve Bank of India (RBI) will resume cutting policy rates in the near term. The reform announcements by the government are positive and remove a major source of policy uncertainty. However, they only signal that the government is willing to trim the budget deficit, and are not substantive enough to allow the RBI to immediately cut rates. In addition, they add a new element of political uncertainty. However, policy will likely become gradually supportive on a 6-12 horizon.Valuation
Valuations are mildly attractive. The 12-month forward P/E ratio is currently below its long-term mean, while Indian companies continue to a have superior ROE relative to their EM peers.Technicals
South Africa: downgrade to maximum underweight
Growth momentum will continue to slow down as the political situation deteriorates and equity valuations are unattractive. In addition, the market is slightly overbought, increasing the likelihood of relative underperformance.Growth
Despite the resilience of retail sales and private consumption, growth will be constrained as labour unrest and work stoppages in the mining sector continue to dampen private sector investment. Commodity exports are contracting, the PMI and the composite leading business cycle indicator suggest further weakness ahead. A full-throated revival in the commodity bull market is the principle upside risk, but does not appear likely in the near future.Policy
The central bank sees risks to inflation being subdued and inflation remaining within the target range, citing food and petrol prices as the main risks to inflation. The monetary policy outlook is modestly supportive. However, fiscal adjustment remains politically unfeasible, implying rising debt ratios and less room for policy manoeuvre going forward. South Africa has benefited from lower bond yields due to foreign investors’ appetite for yield. Negative debt dynamics now threaten the tailwind of a low cost of capital that had been “subsidized” by foreign portfolio investors.Valuation
The market looks mildly expensive relative to the EM world, albeit with superior ROEs. Valuations are mildly unattractive.Technicals
The MRB Relative Price Momentum Indicator suggests the market is slightly overbought.
Financial sector forward earnings will continue to outpace EM earnings for as long as the gradual monetary easing cycle continues. The current account deficit will continue to be sustained by capital inflows for as long as global growth improves and foreigners’ risk appetite remains strong. Sustained fiscal readjustment could eventually allow this tactical overweight to become a longer term play, but in the meantime, Turkish positions should be kept on a short leash.Growth
Turkey’s trade exposure to Europe implies that weak external demand will continue to be a drag on growth even as global activity marginally improves. The weak export numbers are masked by surging gold exports to Iran (exports excluding gold fell on an annual basis), while relatively high oil prices prevent a narrowing current account deficit. Still, with the market dominated by banks, earnings momentum has been very strong given the steep yield curve (reflected in high net interest margins) and still robust credit growth. Strong momentum will continue as long as policy remains easy.Policy
The central bank will continue gradual easing in the short term, given that economic activity is slowing, inflation is likely to decelerate and some fiscal tightening has now been put in place. As global growth mildly improves, the current account deficit will continue to be financed via portfolio capital inflows.Valuation
Financials account for 50% of the Turkish market, which trades at a forward P/E discount and a higher ROE than the EM aggregateTechnicals
Growth momentum will remain robust and policy rate hikes are very unlikely as inflation converges to its target in 2013. However, the market does not warrant a strong overweight in light of unattractive valuations.Growth
Growth momentum will likely remain solid as the US economy continues to recover, while domestic demand stays resilient. Credit growth is robust, car sales are accelerating and retail sales are in an uptrend. In addition, vehicle exports and industrial production are holding up, and the PMI is showing signs of strength. This is all reflected in the uptick in earnings momentum.Policy
The central bank views the recent rise in inflation as temporary. Inflation has been mainly driven by temporary factors, namely rising U.S. corn prices, which have already began to correct, as well as lagged effects of peso weakness earlier this year. We do not expect inflation expectations to rise or the central bank to tighten policy. Overall policy will likely remain neutral.Valuation
The market has become expensive as the sector-adjusted P/E ratio is at a premium to the EM aggregate, while the ROE is relatively lower.Technicals
Equities are no longer relatively overbought, thus removing a short-term headwind.
Korean equities are our preferred high beta play on a global economic recovery, but given recent outperformance, future relative gains will likely await concrete evidence of a Chinese soft landing. With the generally high quality of its corporate sector, Korean equities offer better longer-term exposure to Chinese growth than do Chinese equities. An overweight is justified even though investors are still unconvinced by the timing of the Chinese soft landing.Growth
Korea’s growth is closely linked to the global economic cycle. Growth momentum will be primarily driven by improvements in the U.S. and China. Domestic demand has recently slackened but should pick up on a 6-12 month horizon as employment conditions improve, and the effects of modest prior monetary and fiscal policy easing feed through to the real economy. Earnings momentum has already picked up and our expectation of improving growth implies more upside to earnings from current levels.Policy
The central bank held policy rates on hold during its last meeting citing international oil and grain prices, along with recent typhoon damage as risks to inflation. We view the outlook for policy as mildly supportive, with inflation to remain muted. Moreover, there is room to ease both monetary and fiscal policy further to support economic growth should the exterior environment deteriorate.Valuation
Valuations are not compelling; the relative 12-month forward P/E ratio is trading at the normal discount to the EM aggregate. Korea’s ROE is traditionally lower than its EM peers, and remains so.Technicals
Indonesia: Upgrade to overweight
Upgrade Indonesian equities to overweight: although a commodity-oriented economy, some 90% of the market’s market cap is geared to local, rather than foreign demand. Robust domestic demand, coupled with our China view, suggests that stronger growth momentum should resume, while policy will likely remain accommodative.Growth
Overall GDP momentum will likely continue to decelerate in a mushy global environment, but domestic demand has plenty of room to accelerate due to robust consumption, credit growth and investment. It is domestic demand that is overwhelmingly represented in listed stocks and their earnings profile. Our China view implies that Indonesia’s external demand (and the income effect from improving terms of trade) should gain positive momentum in the coming months.Policy
Policy will continue to be accommodative as inflation is likely to remain comfortably within the central bank’s target range. In addition, gradual improvements in the current account deficit and the trade surplus recorded in August remove some worries of overheating. That said, the central bank will only cut rates in the event of further deterioration in external demand, which is not our base-case scenario.Valuation
Valuations are mildly unattractive. The relative 12-month forward P/E ratio is trading at a premium, but ROE is, as usual, superior to Indonesia’s EM peers.Technicals
Taiwan: neutral (technology overweight)
A neutral overall position is warranted. Relative performance is not supported by growth, policy or valuation. In terms of sector positioning, maintain a significant overweight in technology and a corresponding underweight in all other sectors.Growth
Domestic and external demand is weak, with both consumer and business confidence falling. Exports are still declining and Taiwan’s export orders are showing no signs of improvement. Our expectations for a Chinese soft landing suggests that exports ought to turn positive in the near term and our favourable view on the technology sector is reinforced by Taiwanese export orders for electronic products, which are holding up relative to the total. In addition, the technology sector’s earnings momentum is outpacing that of the broad market, in line with the global semiconductor sales cycle.Policy
The recent bout of rising inflation is temporary and driven by food prices. Once supply side price pressures ease, the central bank will likely stay cautious, and will only act to ease policy in the event of further deterioration in external demand.Valuation
Overall valuation is unattractive: the market trades at a 20% premium to the EM aggregate on a forward P/E basis, while the ROE is substantially lower than its EM peers. Relative to the broad market, Taiwan’s technology sector has a slightly lower P/E and higher ROE.Technicals