Emerging Markets Radar (September 16, 2013)

Emerging Markets Radar (September 16, 2013)

Strengths

• Brazil posted a $299 million trade balance surplus in the first week of September. Deutsche Bank’s Chief Economist J.C. Faria reports that average daily exports fell 2.1 percent, led by a 19 percent drop in shipments of mining products. Daily imports declined by 2.7 percent, led by a 22 percent fall in imports of cars and car parts, along with a 10 percent drop in oil imports. The moderation in imports is encouraging considering gasoline and other refined oil imports have been the main headwind driving the nation’s trade balance to a deficit of $3.47 billion year-to-date.

• Turkey posted a 4.4 percent year-on-year GDP growth in the second quarter, considerably stronger than the consensus estimate of 3.5 percent. The reading may have surprised to the upside due to a noticeable increase in inventory building, whose contribution to GDP growth in the second quarter was about 2.3 percent, and due to an unusually high public spending contribution to economic growth. We feel that the reading is encouraging considering the cyclically-extended current account deficit shaved 3 percent off GDP in the second quarter, and due to private consumption growing at 4.2 percent during the first six months of the year.
• China’s August industrial output went up 10.4 percent versus the estimate of 9.9 percent, while retail sales were up 13.4 percent versus the 13.3 percent estimate. Fixed asset investments were up 20.3 percent versus the estimate of 20.2 percent, and money supply (M2) was up 14.7 percent versus the 14.6 percent estimate. Total social financing was Rmb 1.57 trillion in August versus Rmb 809 billion in July. Power output for August was up 13.4 percent versus 13.3 percent. These better-than-expected macro numbers boosted market bullishness and confidence on government policy.

• China’s exports rose 7.2 percent in August, higher than the consensus of 5.5 percent growth. China’s August CPI was 2.6 percent and in line with the market expectation, while PPI deflation eased further to -1.6 percent from -2.3 percent in July.
• China’s passenger vehicle sales were up 13.2 percent in August, while heavy duty truck sales increased 35 percent, showing strong recovery in construction.

• China State Council announced The Airborne Pollution Prevention and Control Action Plan this week, in which all cities will aim to reduce the intensity of PM10 by at least 10 percent by 2017. This also includes coal in the energy mix to decline from 70 percent in 2012 to 65 percent in 2017. Environmental protection related sectors should see investment increase.
• It was reported that all banks in China can now apply for preferred stock issuance which can save banks from earning dilution and will raise the tier-one capital ratio. This action can certainly improve banks’ liquidity.

• The Philippines kept its rate unchanged at 3.5 percent, as was expected.
• Malaysia’s July industrial production rose 7.6 percent above the consensus of 4.9 percent, which points to a bullish third quarter GDP growth.
• Bank of Korea kept its policy rate on hold at 2.5 percent after seeing improving exports and an improving housing market. The jobless rate edged down to 3.1 percent in August after staying at 3.2 percent for three consecutive months.
• The Philippines fiscal deficit grew 35.6 percent in July to underscore a faster pace of expenditures, which bodes well for third quarter GDP growth.
• Taiwan’s August exports grew 3.6 percent year-over-year, up from 1.6 percent growth in July, but did miss the Bloomberg consensus of 4 percent.

Weaknesses

• The preview of Brazil’s September IGP-M inflation index came in at 1.02 percent, well above 0.13 percent which was reported in the first August preview. Deutsche Bank economists are of the opinion that recent Brazilian real appreciation could eventually bring some relief, however the short-term outlook for wholesale prices and therefore the IGP indices, remains negative. Of further concern is the fact that the foreign exchange market posted a $2.1 billion deficit in the first week of September, pointing to a deterioration of the terms of trade.

• Turkey’s current account deficit widened to a larger-than-expected $5.8 billion in July, weakening the Turkish lira, according to an official release by the Central Bank. The total deficit rose to $42.1 billion in the first seven months of this year, $8 billion higher than last year. A major increase in gold imports was the driver behind the deterioration in year-to-date trade numbers. Local analysts however, were quick to add that a fall in tourism income, resulting from the Taksim Square protests, also played a significant role in widening the current account deficit.
• Bank of Indonesia, the central bank, raised its benchmark rate by 25 basis points to 7.25 percent. It also cut its GDP growth forecast, reducing the numbers to be 5.5 to 5.9 percent, from 5.8 to 6.2 percent for 2013.
• The Philippines’ jobless rate for July edged up to 7.3 percent from 7 percent a year ago. This is in spite of a strong GDP growth rate of 7.5 percent in the second quarter.
• China’s August imports pulled back up 7.2 percent versus the market expectation of 11.3 percent.
• Taiwan’s August imports contracted by 1.2 percent, up from -7.6 percent in July and below the consensus expectation of rising 2.6 percent.

Opportunities

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• As shown in the chart above to the left, Asian cyclical stocks are trading close to the cheapest price-to-book valuation versus defensive stocks in the last ten years. In the chart to the right above, it shows that China is by far the cheapest country to own in Asia right now, based on profitability-adjusted price-to-book valuation.

• The front page of the Financial Times this week highlights that U.S. investors are piling into European equities at the fastest pace since 1977. U.S. investors deployed $65 billion into European stocks in the first six months of 2013, the highest rate in at least 36 years according to Goldman Sachs. A 15 percent undervaluation across large cap equities in the continent, as estimated by HSBC, is set to drive performance in the near term. Europe, as China’s main trading partner, is also set to benefit directly from China’s recovery.

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• As shown in the chart above, a combination of macroeconomic factors has led to currency depreciation for most Latin American currencies against the U.S. dollar over the past three months. These short-term movements could raise concerns regarding the inflationary pressures in some parts of the continent. However, HSCB reports that there may also be benefits to this weakening of currencies. Given that most countries of the region have floating foreign exchange regimes, the depreciation drive could help to rebalance the external accounts, limiting and eventually reverting, the recent trend of current account deterioration.

Threats

• Mexican President Enrique Peña Nieto unveiled a long-awaited tax reform promising to create a universal social security system and unemployment insurance in exchange for a series of tax increases. The proposal introduces a capital gains tax and aims to raise rates on top earners. There is widespread agreement that a fiscal overhaul was urgently needed in order to address the abysmally-low tax base and root out widespread corruption. There remains huge controversy over the recipe however, considering Peña Nieto’s party lacks a congressional majority and will be relying on the left wing to pass the reform. The main end of the reform is to increase state spending by around $35 billion per year, or 3 percent of GDP. However, we feel that the reform contradicts the president's campaign promises to introduce a set of strategic reforms to boost competition.

• Vodafone and Verizon officially announced the terms of a transaction in which Verizon will pay Vodafone around $130 billion for its stake in the joint venture. Upon closing the transaction, Vodafone would have more cash to back up its expansionary strategy. Bank of America Merrill Lynch is of the opinion that Vodafone, as a global group and with fingers in EEMEA (the Europe, Middle East and Africa region), may have negative implications for the competitive environment in key markets as it deploys the recently acquired liquidity. In addition, Vodafone’s operations in existing markets will now become more significant contributors to the bottom line and will increase the company’s focus on these remaining markets. With a large capital expenditure budget available, Vodafone will invest in strengthening its competitive position, effectively disrupting previously stable pricing markets, and resulting in increased competition for existing players.
• The anti-corruption campaign in China has widened to probe business practice and individual professional conduct among state-owned enterprises (SOEs). Although it is extremely positive for the economy to clean up corruptions, it may increase short-term risk premium for some H-share stocks. For example, the wide-spread physician bribery in the healthcare sector in China is not a secret and needs to be stopped, but the lack of public supervision on government officials along with the compensation structure for physicians are ultimately to blame.