Emerging Markets Radar (June 17, 2013)
Strengths
- The rise in U.S. government bond yields that has threatened to reverse fund inflows into emerging markets is likely to prove as a red herring, according to BCA Research. With emerging market economies now surpassing 50 percent of world GDP, their higher savings rate will eventually cap any further increase in safe-haven bond yields. Although the higher savings rate does not fully eliminate the risk of weakening global growth, it does provide a floor for emerging market fund outflows.
- Both the Chilean and Peruvian central banks left their benchmark rates unchanged this week. As commodity, export-driven economies both nations continue to face challenging external conditions amid weaker global demand. However, their domestic consumption growth continues to be resilient, and continues to support their expected economic growth levels for this year; 4.5 percent for Chile and 6.3 percent for Peru.
- Malaysia’s industrial production rose 4.7 percent year-over-year in April, more than three percentage points higher than expected and the first month-over-month increase since November, as demand from domestic infrastructure projects helped offset sluggish export growth.
- China’s inflation-adjusted retail sales growth accelerated to 12.1 percent in May, the fastest pace year-to-date, as the impact from the leadership’s anticorruption efforts was limited beyond catering, tobacco and liquor. Sales of gold, silver and other jewelry gained 38.4 percent in May from a year ago.
- Despite the past two weeks’ sell-off related to Federal Reserve tapering fears and a rebound in Japanese yen, the Philippines experienced the mildest foreign outflows within Southeast Asia and maintained a strong year-to-date inflow of $1.5 billion.
Weaknesses
- Russia and Brazil have seen the share of labor compensation as a percentage of GDP increase over the last decade, thus negatively impacting corporate earnings. It is worthwhile mentioning that most emerging markets have actually seen the share of labor income in GDP fall over the same period, giving way to higher corporate profits.
- China’s new bank loans, aggregate financing, year-over-year growth rate of exports, imports, and industrial production in May, all came in lower than expected. Producer prices continue to deflate further, a clear reflection of anemic demand and an absence of government stimulus.
- The unemployment rate in the Philippines during April rose to a three-year high of 7.5 percent from 7.1 percent in March, while exports declined by a larger-than-expected 12.8 percent year-over-year in April, versus a 0.1 percent gain in March. Its central bank refrained from cutting interest rates given the recent sell-off in both Philippine equities and the Philippine peso
- Thailand, Indonesia and the Philippines recorded an aggregate $1.4 billion foreign outflow from equity funds last week. This is the highest weekly exodus since September 2011, or the height of the eurozone sovereign debt crisis.
- Homebuilders in Mexico continued to struggle this week. After multiple recent defaults on their debt, hopes were placed on favorable debt refinancing agreements with the syndicate banks. This week, Urbi, a real estate developer of low-income subsidized housing, failed to reach an agreement on its debt refinancing plans, casting doubt on the expected sector recovery.
Opportunities
- Worse-than-expected macroeconomic data, amid an apparently disrupted pro-growth government policy leaning in China, has again depressed Chinese equity valuations. Among the most reliable measures, price-to-book ratio has round-tripped back, approaching the lowest reading since the height of the eurozone debt crisis in October 2011. Historically, such cathartic cleansing was typically followed by a mean-reverting rally, and an overall 3.4 percent dividend yield, offering additional downside protection.
- Continuing with the dividend yield theme, the recent commodity weakness and sell-off in emerging markets that depressed valuations now presents an opportunity for new entrants to invest in the upside optionality, earning a high dividend yield while waiting for stock market appreciation. Poland, Malaysia, Taiwan and Colombia, among others, all have dividend yields above 3 percent at the moment; significantly higher yields than U.S. government bonds. As a matter of fact, our Chief Investment Officer Frank Holmes recently wrote a piece on Why It Pays to Invest in Emerging Market Dividend-Payers.
- The leaders of Mexico’s main political parties announced that Parliament will hold two extraordinary sessions over the summer term to discuss pending projects. Among the projects to be discussed are the initial debates on President Pena Nieto’s long-awaited energy and fiscal reforms. Some doubts over Pena Nieto’s capacity to have the proposed reform bills passed by Parliament have been hovering over the Mexican market in recent weeks. The announcement on the reforms, which aim to boost investment and economic growth, should provide support to Mexican equities in the short and medium term, as well as increase the long-term upside.
Threats
- Despite Brazil’s effort to dismantle taxes previously imposed on foreign capital, which aimed to prevent an over-appreciation of the Brazilian real, the move could prove counterproductive in the short term. The loosening of capital controls is most likely to weaken the real, as both debt and equity investors sell emerging markets in favor of safer-haven investments. A short-term depreciation of the real could have upsetting consequences should inflation spike on higher import prices before imports can be substituted domestically.
- The Czech Prime Minister’s office is involved in a spying and bribery investigation, as one of his top aides and the head of military intelligence were arrested and charged on illegal spying and bribery accusations. Overnight on Thursday, police officers carried over 31 raids related to the investigation, seizing as much as $7.8 million in cash and gold. Prime Minister Necas has so far refused to resign despite opposition pressure. There is still little insight into the investigation; however, we view this as a serious threat to political stability in the country rather than a short-lived political dispute.
- Weak seasonality in Chinese manufacturing activity in the summer months, coupled with a dearth of material government policy action, may continue to weigh on investor sentiment in an otherwise frail market trading pattern for this time of year.
