Global Investing

Emerging consumers’ pain to spell gains for stocks in staples

Food and electricity bills are high. The cost of filling up at the petrol station isn’t coming down much either. The U.S. economy is in trouble and suddenly the job isn’t as secure as it seemed. Maybe that designer handbag and new car aren’t such good ideas after all.

That’s the kind of decision millions of middle class consumers in developing countries are facing these days. That’s bad news for purveyors of everything from jeans to iphones  who have enjoyed double-digit profits thanks to booming sales in emerging markets.

Brazil is the best example of how emerging market consumers are tightening their belts. Thanks to their spending splurge earlier this decade, Brazilian consumers on average see a quarter of their income disappear these days on debt repayments. People’s credit card bills can carry interest rates of up to 45 percent. The central bank is so worried about the growth outlook it stunned markets with a cut in interest rates this week even though inflation is running well above target

All that bodes ill for shares in companies selling so-called consumer discretionaries in developing countries  – non-essential items such as autos and high-end cosmetics.

But someone’s loss is someone’s gain. Shares in companies selling consumer staples –food, beverages, prescription meds and tobacco —  are starting to pick up.  In short, everything that outperforms during economic downturns. MSCI’s index of emerging market staples is flat on the year, doing only slighly better than consumer discretionaries. But guess what? In August, when everything was selling  off staples did ok. They fell 2.4 percent, much better than MSCI’s discretionaries index which lost 8 percent.

Bank of America/Merrill Lynch’s monthly survey shows fund managers went overweight consumer staples in August for the first time this year. Back in January when investors were optimistic about the U.S. economic outlook, almost 60 percent of fund managers were underweight staples. They still like discretionaries but cut that position pretty sharply last month.

What of Brazil? Carlos de Leon, a fund manager at RCM still sees opportunities there, especially as minimum wages will rise by an above-inflation 12 percent next year. But unsurprisingly, his picks are consumer staples and defensives including toll road operators, fuel distributors and utilities.

from Jeremy Gaunt:

Getting there from here

Depending on how you look at it, August may not have been as bad a month for stocks as advertised. For the month as a whole, the MSCI all-country world stock index  lost more than 7.5 percent.  This was the worst performance since May last year, and the worst August since 1998.

But if you had bought in at the low on August 9, you would have gained  healthy 8.5 percent or so.

In a similar vein, much is made of the fact that the S&P 500 index  ended 2009 below the level it started 2000, in other words, took a loss in the decade.

That completely ignores, however, a more than doubling of the index between 2002 and 2007.

There is a danger sometimes in allowing the calendar to dictate your interpretation of financial market behaviour.

Clinging to hope in bear-bitten Russia

Poor Russia. After spending six months as the world’s best performing emerging market, the Moscow bourse  has been the big loser of this month’s rout – year-to-date returns of over 10 percent until mid-July have since dissolved in a sea of red, with a plunge of over 20 percent since the start of August. As oil prices fell and the outlook for U.S. and European growth darkened, overweight positions in Russia halved versus July, a survey by Bank of America/Merrill Lynch showed this week.

But get this — Russia remains among investors’ main emerging market punts and only Indonesia is more favoured, according to the BoA/ML poll. The reason is that fund managers are still clinging to hopes that an increasingly wealthy Russian consumer will save the day. Unfortunately those hopes are yet to materialise. Returns on domestic demand-based stocks such as Sberbank, carmaker Avtovaz and supermarket chain Magnit have been even more disappointing this year than the broader Moscow market.

Even the staunchest Russia bull will have been disappointed with data showing Russi a’s economy grew at just 3.4 percent in the second quarter of the year.  That proves the economy was running out of steam even before the August oil price fall and suggests that the Russian consumer is not yet stepping up to the mark. Retail data since then have been more heartening — annual sales rose 5.6 percent in July from 3 percent in June.

So which way could Russia go? Some like Russian investment house Aton say another 20-25 percent stock market drop cannot be ruled out if the global economy goes into a tailspin. That sounds overly pessimistic – - as UBS analysts point out the global macro backdrop and the oil price outlook do not look nearly as bad as 2008. Chinese growth too is holding up well. 

Three things are in Russia’s favour. One is that prices for oil, the mainstay of the Russian economy, remain over $100 a barrel –  that should allow the government to keep spending ahead of elections.  Second, most other emerging markets look uglier. Stocks in fellow-BRIC India may have fared better during the August selloff but the picture is far from rosy. Growth is slowing, as testified by factory expansion that fell for the third straight month in July and car sales that are down for the first time in over two years.  The central bank remains uber-hawkish.  Little surprise then that the BoA survey showed India to be investors’ least favoured market.

The clincher could be valuations. Russian stocks, always cheap, are even cheaper after the selloff, trading at just 5  times forward earnings — almost half the emerging markets average. For that reason, John Lomax, HSBC‘s chief emerging equity strategist reckons the current market dip is a buying opportunity. The market will recover if fears of a U.S. double-dip recession prove unfounded, he says.

from MacroScope:

The thin line between love and hate

The opinion on Turkey’s unorthodox monetary policy mix is turning as rapidly as global growth forecasts are being revised down.

Earlier this month, its central bank was the object of much finger-wagging after it defied market fears over an overheating economy by cutting its policy rate. It defended the move, arguing that weaker global demand posed a greater risk than inflationary pressures.

Investors were not persuaded. When I told one analyst about the Turkish rate move, he practically sputtered down the phone: "You're not kidding?!"

The lira sold off, dropping to 2-1/2 year lows against the dollar.

But the central bank could yet be vindicated. With fears intensifying over weakening global demand, its decision to cut rates looks increasingly prescient. As my colleague Sujata Rao has pointed out, other emerging-market central banks have followed the Turks.

Witness Societe Generale’s head of emerging markets strategy Benoit Anne's mea cupla in a note issued just two weeks after Turkey's controversial rate decision:

"I guess I need to apologize to the Central Bank of Turkey which on many occasions had been the object of my sarcasm over the past few months: the Central Bank of the Republic of Turkey is actually at the forefront of policy-making in the emerging-markets universe. And I bet some other central banks will follow suit with rate cuts in the pipeline."

from MacroScope:

Emerging markets: Soft patch or recession?

Could the dreaded R word come back to haunt the developing world? A study by Goldman Sachs shows how differently financial markets and surveys are assessing the possibility of a recession in emerging markets. One part of the Goldman study comprising survey-based leading indicators saw the probability of recession as very low across central and eastern Europe, Middle East and Africa. These give a picture of where each economy currently stands in the cycle. This model found risks to be highest in Turkey and South Africa, with a 38-40 percent possibility of recession in these countries. On the other hand, financial markets, which have sold off sharply over the past month, signalled a more pessimistic outcome. Goldman says these indicators forecast a 67 percent probability of recession in the Czech Republic and 58 percent in Israel, followed by Poland and Turkey. Unlike the survey, financial data were more positive on South Africa than the others, seeing a relatively low 32 percent recession risk. Goldman analysts say the recession probabilities signalled by the survey-based indicator jell with its own forecasts of a soft patch followed by a broad sustained recovery for CEEMEA economies. "The slowdown signalled by the financial indicators appears to go beyond the ‘soft patch’ that we are currently forecasting," Goldman says, adding: "The key question now is whether or not the market has gone too far in pricing in a more serious economic downturn."

Counting the costs of Hungary’s Swiss franc debt

The debt crises in the euro zone and United States are claiming some innocent bystanders. Investors fleeing for the safety of the Swiss franc have ratcheted up pressure on Hungary, where thousands of households have watched with horror as the  franc surges to successive record highs against their own forint currency. In the boom years before 2008,  mortgages and car loans in Swiss francs seemed like a good idea –after all the forint was strong and Swiss interest rates, unlike those in Hungary, were low.  But the forint then was worth 155-160 per franc. Now it is at a record low 260 — and falling – making it increasingly painful to keep up repayments. Swiss franc debt exposure amounts to almost a fifth of Hungary’s GDP. And that is before counting loans taken out by companies and municipalities.

Hungarian families could get some relief in coming months via a government plan that caps the exchange rate for mortgage repayments at 180 forints until the end of 2014.  But the difference will have to be paid – with interest — from 2015.  Meanwhile, the issue threatens to bring down Hungary’s banks which must pick up the cost in the meantime and will almost certaintly see a rise in bad loans –  no wonder shares in Hungary’s biggest bank OTP are down 25 percent this month.  “(The franc rise) suggests a massive jump on banks’ refinancing requirements going forward, ” says Citi analyst  Luis Costa.

These overburdened banks will end up cutting lending to businesses, meaning a further hit to Hungary’s already anaemic economic growth. ING analysts earlier this month advised clients to steer clear of Hungarian shares, “given the burden from (forint/franc) depreciation not only on loan-takers but also the implications this has for the domestic growth story.”

Thanks to some deficit cutting measures and low inflation, Hungarian bonds have been among fund managers’  favourites this year. Unlike countries such as Brazil or Poland, Hungary was not raising interest rates. Citi’s Costa says longer bonds are still being too slow to price the risks – he predicts  the 70 basis point spread between two-year and 10-year Hungarian swap rates will widen much further. And late on Wednesday, JP Morgan said it was going underweight Hungarian bonds. Analysts there suggest that at a time when other emerging markets are preparing to slash interest rates, the falling forint might force Hungary’s central bank to do the opposite.

from MacroScope:

Turkey sets dovish tone for emerging central banks

Amid widespread shock over Turkey's interest rate cut  last week, there were a few who felt the move might just make sense. With economic growth collapsing in the West, the developing world will take a hit sooner or later --- in such an environment lower interest rates are usually a good idea. So with a  global financial market rout under way, many more emerging policymakers could be contemplating following Turkey's example.

One central bank has already done so -- Pakistan on Saturday slashed  interest rates by half a percent. That surprised analysts there, all of whom had predicted unchanged rates, given inflation is running above 12 percent. Now there is speculation Israel,with its close economic ties to the United States, could also be forced into a rate cut later this month.  Policymakers in other emerging economies that are midway through the rate tightening cycle are backpedalling on prospective  increases -- South Korea's central bank, which some had predicted would tighten policy later this week, said on Tuesday it was putting rate hikes on ice. Markets have "changed dramatically," its governor told parliament.

Manik Narain, emerging markets strategist at UBS says that while inflation is still an issue for many developing countries, safeguarding growth -- and exports via a cheap currency --  is becoming a bigger priority.

"After Turkey, any stigma associated with cutting rates has been removed," Narain says.  "Across the board we are seeing rate rise expectations getting pared back."

That is reflected in interest rates swaps, used by investors to bet which way rates will go. In many countries the front end of the swaps curve is steadily moving lower. That  implies lower interest rates, including in countries that until last week were expected to tighten policy. Markets have this week started to signal rate cuts in Korea and Thailand for instance while in India, South Africa or the Czech Republic they have scaled back the extent to which rates could rise. Czech swaps are now pricing in 60 basis points in rate increases over the next year, compared to expectations of 100 bps just last week, Narain noted. South African front-end swaps too have collapsed, indicating a mere 25 bps in rate rises over the coming year. Last week they had forecast 85 bps.

In Latin America, the picture is similar. Chilean swap rates are now pricing in a 50 percent chance of a 25 bps cut until year end, JPMorgan analysts say, pointing out that until recently they had predicted one more hike by end-2011. Brazilian swaps too are now pricing in rate cuts over the 1-year horizon while in Colombia swaps have reduced the amount of hiking that's priced in,  JPM noted

What that spells is weaker emerging currencies as the world tips back into currency war.  But  investors' love affair with local emerging bonds should continue. And provided the developed world doesnt slip back into recession, emerging equities should also get some support.  But the strategy will not work for everyone -- Turkey's rate cut flies in the face of its own overheating economy and that has triggered a meltdown on stock, bond and currency markets.

from MacroScope:

Turkey stuns with rate cut but is it on to something?

Turkey's central bank, never known for its orthodox approach to monetary policy, managed to stun markets yet again today. Faced with a currency that has fallen over 5 percent against the dollar in the past five weeks, the bank decided to cut interest rates by half a percent, helping the lira plumb fresh 28-month lows. Analysts had expected it to raise the overnight borrowing rate by 350 basis points, which it duly did as well. In addition, it said it would start auctioning dollars if needed. A real policy mix, as one bond trader in London remarked.

On the face of it, a rate cut is the last thing Turkey needs -- the economy is clearly overheating, with first quarter growth over 11 percent. Inflation is above target and there is a huge current account deficit that  needs financing. According to RBS analyst Tim Ash, "the danger with this totally out-of-the-box move is that investors will seriously begin to question the credibility of the central bank as an institution".

But some observers, puzzling over the move, are wondering if the central bank could really be ahead of the curve this time. The bank said the rate cut was needed given potential risks to the Turkish economy from the deepening global weakness. After all, its decision comes  on the heels of an unexpected Swiss rate cut and Japan's yen market  intervention -- both moves dictated by the need to curb surging currencies. There is talk of more bond buying from the ECB and the U.S. Fed.  And another emerging central bank, Russia, on Thursday held interest rates steady, stressing the need to guard against a slowdown during an uncertain time.

What Turkey is essentially doing is betting on a global recession, say BNP Paribas analysts. They say the central bank's strategy could pay off  "if the global recession is deep enough and it doesn't lead to a global selloff of risky assets."  It remains to be seen if other emerging central banks follow its example.

Chavez health scare keeps the bid on Venezuelan bonds

Venezuelan President Hugo Chavez last week declared himself reborn, phoenix-like, for his 57th birthday, singing and jigging on the balcony of his palace, belying his cancer diagnosis.  That may have disappointed some investors who hoped  the left-wing leader’s health issues would  prevent him from contesting or winning yet another presidential term. Venezuela’s dollar bonds, considered among the riskiest debt securities in the world, have risen sharply since Chavez announced his illness — the most-traded 2027 bond is quoted around 77 cents on the dollar, more than 10 cents off  troughs hit before his operation in June.

Market players are sensitive enough not to mention Chavez’s health problems.  JP Morgan analysts for instance this week recommended an overweight on Venezuelan bonds, citing  “idiosyncratic domestic political events where positive outcomes could offer important market upside, the odds of which may still be underpriced.”

Stuart Culverhouse, head of research at frontier markets brokerage Exotix, is more succinct.  “I think anything that points towards a possible change in government, that would bring with it a more orthodox policy direction, would be welcomed by the market,” he says.

It is political risk that has kept Venezuelan bond yields in the mid- to high-teens. Fear the mercurial president will suddenly declare a default has so far outweighed the fact that his  country could earn well over $90 billion from oil exports this year.

So how big could the upside be for bond markets?

“I see Venezuelan yields going to 8 percent if we get a smooth transition and a pro-market government. I can see a 500 basis-points rally,” Sam Finkelstein, a fund manager at Goldman Sachs Asset Management, said recently.  He too is overweight Venezuela, though  unlike many, he has held that position since last September when parliamentary elections dented Chavez’s majority and raised hopes of an opposition win in 2012.

It’s possible the market is assuming too much. Chavez himself has made clear he does not intend to withdraw from politics. Culverhouse points to Argentina where a bond rally unfolded following the death of former leader Nestor Kirchner last year.  There,  investors’ hopes that Kirchner’s exit would push the country onto a more sensible policy path were soon dashed — his widow Cristina, Argentina’s current president, has shown no sign of deviating from her husband’s legacy and is likely to win the upcoming election.

from Jeremy Gaunt:

Debt crisis on the beach

This is supposed to be the time the Greeks call “ta bania tou laou” – the people’s bathing.  Markets are supposed to be quiet. Analysts have done their two-month outlooks for July/August and traders are working on their tans.

Not this year, at least in Europe.  The Greek bailout fight and the previously unthinkable march of Washington towards default have nailed a lot of people to their desks.

European equities  volume in July, with one session left, is 47 billion shares. That compares with 35 billion a year ago and 29 billion in 2009.

The beaches must be empty.