Emerging Markets
FOR PROFESSIONAL INVESTORS MARCH 2011
Emerging Markets Edito Emerging Markets Edito Back to 2008? Emerging equity markets underperform developed markets as Emerging Asia drops
Month-end market performance
Emerging markets extended both their record of underperformance against developed markets (for five consecutive months now) and of outflows (since the beginning of the year). Asia’s emerging equity markets experienced a selloff in February as oil prices surged. Portfolios rebalancing out of emerging markets added more pressure on stocks in the world’s fastest growing economies. The specific underperformance of North Asian markets (South Korea, Taiwan) against Japan is a perfect illustration of the massive redemptions faced by emerging market funds over the past five weeks (more than USD 21 bn), and corresponding inflows into developed markets. Even if food inflation now appears to be starting to recede, higher energy prices were challenging for several economies, particularly in Asia.
Source: FactSet, MSCI Source: DataStream
Despite the positive economic momentum, the knock-on implication of higher oil prices is of slower growth in several Asian countries. Cost inflation is likely to prevail in the coming weeks, somewhat
1
Emerging Markets Edito
June2011 2010 March
postponing hopes that inflation has peaked in emerging countries. Other emerging countries such as Turkey suffered from current account concerns, dithering central banks and pressure on credit growth. So despite attractive valuations, they may remain vulnerable. Turkey also suffered from its proximity to the recently volatile Middle East.
Source: Goldman Sachs
Russia shines in a replay of the first half of 2008 The Russian market has been our top country pick for several months. This decision was based on a combination of factors: - Russia lagged other EMs in the recovery (and inflation) cycle - Russian valuations were very appealing - The demand for oil & gas and metals reflects the acceleration in global growth. Based on this analysis, Russia was the sweet spot in the EM universe and has been one of the very few markets to outperform developed markets, indeed beyond our expectations. The Russian equities market has essentially tracked the rise in Brent crude oil over the past few weeks. This is mainly due to the stellar performance of energy stocks, which benefited from additional support related to potential changes in the tax structure for oil companies.
Interestingly, the performance of sectors that are much more focused on domestic activity was rather limited. This is somewhat different to what occurred from 2006 to 2008, when the Russian market rose faster than oil prices. Value should therefore start to emerge in non-oil sectors, mainly financials and consumer stocks, as the positive impact of oil on the Russian economy is not yet fully priced in.
Strong growth conditions for EM should prevail in 2011 We remain confident in our outlook for EM growth over the coming months, despite the prospect of rising inflationary pressure. The stabilisation of the ISM New Orders at elevated levels (85-month high) suggests a higher level of exports from Asia to the US in particular and a more healthy recovery. We do not expect to see a collapse in growth in any way similar to the one seen in the second half of 2008. Although we acknowledge that the global economy faces tough challenges, we think that current policies and support mechanisms are likely to be extended should the risk of a double dip recession re-surface.
2
Emerging Markets Edito
80
June2011 2010 March
ROE gap has narrowed, thus increasing developed markets’ attractiveness.
ISM Index ‐ USA ISM New Orders Index ‐ USA
70
We believe that most of the underperformance may already be behind us; however, some markets are still likely to be quite sensitive to further commodity price increases.
60
50
40
30
Sep‐10
Sep‐09
Mar‐10
Sep‐08
Mar‐09
Sep‐07
Mar‐08
Sep‐06
Mar‐07
Sep‐05
Mar‐06
Sep‐04
Mar‐05
Sep‐03
Mar‐04
Sep‐02
Mar‐03
Sep‐01
Mar‐02
Sep‐00
Mar‐01
Sep‐99
Mar‐00
Mar‐99
20
Source: Factset
One particularly critical factor is for the credit cycle in the US to reach some level of sustainability. The success of the QE II initiative there will be confirmed only if it succeeds in restoring positive economic momentum and boosting investment, hiring and credit growth. This achievement is necessary before the Fed can start any exit strategies. As long as this does not occur, pro-active supportive conditions for economic recovery and asset prices will remain in place as long as necessary.
Conditions for EM outperformance not yet met As we mentioned last month, we do not expect emerging markets to be in a position to outperform developed markets before the end of Q2 2011.
We still think that EM equities will make up ground on the year-to-date underperformance. In these times of sudden and fierce changes in trends and expectations, the rotation back into EMs could happen as quickly as did the rotation out of them. This is also true for EM Fixed Income, which, after two months of relative mediocre returns, should resume in delivering positive returns in line with the current high carry conditions. We would advise investors who are currently underweighting EM assets to closely follow these indicators with us and get ready for the next phase of the EM secular outperformance trend.
Martial Godet Head of Emerging Markets Equities
Written on 4 March 2011
The indicators we are tracking closely in order to identify a turning point would be: - the relative dynamics of earnings revisions, which is currently favourable for DMs - the inflation momentum in EMs, and the related interest rate tightening cycle, which has not peaked despite some relief on chinese inflation - the relative performance of domestic and cyclical sectors in EMs, which are still favourable for cyclical sectors. This could change should growth falter at some point in developed economies, which will not happen before July - the relative valuation of emerging and developed markets. The valuation gap is widening, but may have further to go as the
3
Emerging Markets Edito
June2011 2010 March
EMERGING MARKETS ALLOCATION GRADINGS 1st March 2011 The charts below summarise the top-down views of BNP Paribas Investment Partners’ Head of Emerging Markets Investments on the level of attractiveness of various emerging markets in relative terms (from -5 worst to +5 best). These views are generated by our core Emerging Markets investment process, using both quantitative and qualitative inputs. They are implemented in all portfolios managed under this investment process. Bottom-up views and portfolio positioning from our global, regional or country-specific investment teams may differ, even if the specialist views of those particular teams are an input into this top-down process.
EM asset class allocation Extern al Debt Equitie s Local Debt
-5 -4 -3 -2 -1 0 1 2 3 4 5
•
• • • •
The current environment is still favourable for EM stocks (large growth differential, robust US consumer demand, strong ISM New Orders, low volatility), although appreciation should slow for some time as Western investors rebalance their portfolios and move out of EM stocks. North Asia, Russia and lowly valued markets with export an component are to be favoured. Positive returns are expected on both local and external debt, thanks to strong fundamentals, but US dollar strength could temporarily trim returns The forward valuations for EM equity markets is still attractive (11x 2011 earnings) The profit boom will support both dividends and investments The earnings growth target for 2011 (+16%) should be exceeded
EM equity country allocation
• Russia Korea China Turkey ASEAN * CE3* Taiwan Mexico Brazil South Africa Chile India
-5 -4 -3 -2 -1 0 1 2 3 4 5
• • • • • • • • • • •
Russia: Compelling valuations. Domestic growth should accelerate. Commodity demand. 2 South Korea: Currency still under-valued, but margin growth relatively low. Benefits from Chinese growth and cheap valuations. 2 China: Under-valued. Macroeconomic data will show mild slowdown, removing some pressure on monetary policy. Taiwan or South Korea better proxy for Chinese growth. 1 Turkey: Strong growth momentum and well-managed companies, but slightly expensive. 1 ASEAN*: Great domestic growth stories. Valuations slightly stretched, but earnings growth should match expectations. Inflation may be an issue in the short term. Position for a rebound of the domestic theme. 1 CE3*: Gradual improvement, but still suffering from low European growth and domestic imbalances. To benefit from investor rotation. 1 Taiwan: Margins could expand again, demand firming, IT sector rebounding. Not cheap, but should deliver growth. 2 Mexico: Limited upside. Correlated to US consumer and CAPEX growth. Under-invested. -1 Brazil: Growth should soften; the currency looks expensive again, while domestic demand-driven sectors are now trading at fair value. -1 South Africa: Limited room for positive surprises despite support from metal prices. -2 Chile: Strong economic environment (strong demand for copper and domestic rebound), but expensive after recent rally. -2 India: Has become expensive in relative terms; hit by various scandals. Inflation is an issue. Will attract investors later this year, once trailing and forward valuations converge further. -2
Source: BNP Paribas Asset Management. *ASEAN: Indonesia, Malaysia, the Philippines, Thailand. CE3: the Czech Republic, Hungary, Poland.
4
Emerging Markets Edito
June2011 2010 March
DISCLAIMER This material is issued and has been prepared by BNP Paribas Asset Management S.A.S. (“BNPP AM”)* a member of BNP Paribas Investment Partners (BNPP IP)**. This material is produced for information purposes only and does not constitute: 1.
an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or
commitment whatsoever or 2.
any investment advice.
Opinions included in this material constitute the judgment of BNPP AM at the time specified and may be subject to change without notice. BNPP AM is not obliged to update or alter the information or opinions contained within this material. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the Financial Instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for a client or prospective client’s investment portfolio. Given the economic and market risks, there can be no assurance that any investment strategy or strategies mentioned herein will achieve its/their investment objectives. Returns may be affected by, amongst other things, investment strategies or objectives of the Financial Instrument(s) and material market and economic conditions, including interest rates, market terms and general market conditions. The different strategies applied to the Financial Instruments may have a significant effect on the results portrayed in this material. The value of an investment account may decline as well as rise. Investors may not get back the amount they originally invested. The performance data, as applicable, reflected in this material, do not take into account the commissions, costs incurred on the issue and redemption and taxes. *BNPP AM is an investment manager registered with the “Autorité des marchés financiers” in France under number 96-02, a simplified joint stock company with a capital of 64,931,168 euros with its registered office at 1, boulevard Haussmann 75009 Paris, France, RCS Paris 319 378 832. www.bnpparibas-am.com.] ** “BNP Paribas Investment Partners” is the global brand name of the BNP Paribas group’s asset management services. The individual asset management entities within BNP Paribas Investment Partners if specified herein, are specified for information only and do not necessarily carry on business in your jurisdiction. For further information, please contact your locally licensed Investment Partner.
5
Emerging Markets Edito Emerging Markets Edito Back to 2008? Emerging equity markets underperform developed markets as Emerging Asia drops
Month-end market performance
Emerging markets extended both their record of underperformance against developed markets (for five consecutive months now) and of outflows (since the beginning of the year). Asia’s emerging equity markets experienced a selloff in February as oil prices surged. Portfolios rebalancing out of emerging markets added more pressure on stocks in the world’s fastest growing economies. The specific underperformance of North Asian markets (South Korea, Taiwan) against Japan is a perfect illustration of the massive redemptions faced by emerging market funds over the past five weeks (more than USD 21 bn), and corresponding inflows into developed markets. Even if food inflation now appears to be starting to recede, higher energy prices were challenging for several economies, particularly in Asia.
Source: FactSet, MSCI Source: DataStream
Despite the positive economic momentum, the knock-on implication of higher oil prices is of slower growth in several Asian countries. Cost inflation is likely to prevail in the coming weeks, somewhat
1
Emerging Markets Edito
June2011 2010 March
postponing hopes that inflation has peaked in emerging countries. Other emerging countries such as Turkey suffered from current account concerns, dithering central banks and pressure on credit growth. So despite attractive valuations, they may remain vulnerable. Turkey also suffered from its proximity to the recently volatile Middle East.
Source: Goldman Sachs
Russia shines in a replay of the first half of 2008 The Russian market has been our top country pick for several months. This decision was based on a combination of factors: - Russia lagged other EMs in the recovery (and inflation) cycle - Russian valuations were very appealing - The demand for oil & gas and metals reflects the acceleration in global growth. Based on this analysis, Russia was the sweet spot in the EM universe and has been one of the very few markets to outperform developed markets, indeed beyond our expectations. The Russian equities market has essentially tracked the rise in Brent crude oil over the past few weeks. This is mainly due to the stellar performance of energy stocks, which benefited from additional support related to potential changes in the tax structure for oil companies.
Interestingly, the performance of sectors that are much more focused on domestic activity was rather limited. This is somewhat different to what occurred from 2006 to 2008, when the Russian market rose faster than oil prices. Value should therefore start to emerge in non-oil sectors, mainly financials and consumer stocks, as the positive impact of oil on the Russian economy is not yet fully priced in.
Strong growth conditions for EM should prevail in 2011 We remain confident in our outlook for EM growth over the coming months, despite the prospect of rising inflationary pressure. The stabilisation of the ISM New Orders at elevated levels (85-month high) suggests a higher level of exports from Asia to the US in particular and a more healthy recovery. We do not expect to see a collapse in growth in any way similar to the one seen in the second half of 2008. Although we acknowledge that the global economy faces tough challenges, we think that current policies and support mechanisms are likely to be extended should the risk of a double dip recession re-surface.
2
Emerging Markets Edito
80
June2011 2010 March
ROE gap has narrowed, thus increasing developed markets’ attractiveness.
ISM Index ‐ USA ISM New Orders Index ‐ USA
70
We believe that most of the underperformance may already be behind us; however, some markets are still likely to be quite sensitive to further commodity price increases.
60
50
40
30
Sep‐10
Sep‐09
Mar‐10
Sep‐08
Mar‐09
Sep‐07
Mar‐08
Sep‐06
Mar‐07
Sep‐05
Mar‐06
Sep‐04
Mar‐05
Sep‐03
Mar‐04
Sep‐02
Mar‐03
Sep‐01
Mar‐02
Sep‐00
Mar‐01
Sep‐99
Mar‐00
Mar‐99
20
Source: Factset
One particularly critical factor is for the credit cycle in the US to reach some level of sustainability. The success of the QE II initiative there will be confirmed only if it succeeds in restoring positive economic momentum and boosting investment, hiring and credit growth. This achievement is necessary before the Fed can start any exit strategies. As long as this does not occur, pro-active supportive conditions for economic recovery and asset prices will remain in place as long as necessary.
Conditions for EM outperformance not yet met As we mentioned last month, we do not expect emerging markets to be in a position to outperform developed markets before the end of Q2 2011.
We still think that EM equities will make up ground on the year-to-date underperformance. In these times of sudden and fierce changes in trends and expectations, the rotation back into EMs could happen as quickly as did the rotation out of them. This is also true for EM Fixed Income, which, after two months of relative mediocre returns, should resume in delivering positive returns in line with the current high carry conditions. We would advise investors who are currently underweighting EM assets to closely follow these indicators with us and get ready for the next phase of the EM secular outperformance trend.
Martial Godet Head of Emerging Markets Equities
Written on 4 March 2011
The indicators we are tracking closely in order to identify a turning point would be: - the relative dynamics of earnings revisions, which is currently favourable for DMs - the inflation momentum in EMs, and the related interest rate tightening cycle, which has not peaked despite some relief on chinese inflation - the relative performance of domestic and cyclical sectors in EMs, which are still favourable for cyclical sectors. This could change should growth falter at some point in developed economies, which will not happen before July - the relative valuation of emerging and developed markets. The valuation gap is widening, but may have further to go as the
3
Emerging Markets Edito
June2011 2010 March
EMERGING MARKETS ALLOCATION GRADINGS 1st March 2011 The charts below summarise the top-down views of BNP Paribas Investment Partners’ Head of Emerging Markets Investments on the level of attractiveness of various emerging markets in relative terms (from -5 worst to +5 best). These views are generated by our core Emerging Markets investment process, using both quantitative and qualitative inputs. They are implemented in all portfolios managed under this investment process. Bottom-up views and portfolio positioning from our global, regional or country-specific investment teams may differ, even if the specialist views of those particular teams are an input into this top-down process.
EM asset class allocation Extern al Debt Equitie s Local Debt
-5 -4 -3 -2 -1 0 1 2 3 4 5
•
• • • •
The current environment is still favourable for EM stocks (large growth differential, robust US consumer demand, strong ISM New Orders, low volatility), although appreciation should slow for some time as Western investors rebalance their portfolios and move out of EM stocks. North Asia, Russia and lowly valued markets with export an component are to be favoured. Positive returns are expected on both local and external debt, thanks to strong fundamentals, but US dollar strength could temporarily trim returns The forward valuations for EM equity markets is still attractive (11x 2011 earnings) The profit boom will support both dividends and investments The earnings growth target for 2011 (+16%) should be exceeded
EM equity country allocation
• Russia Korea China Turkey ASEAN * CE3* Taiwan Mexico Brazil South Africa Chile India
-5 -4 -3 -2 -1 0 1 2 3 4 5
• • • • • • • • • • •
Russia: Compelling valuations. Domestic growth should accelerate. Commodity demand. 2 South Korea: Currency still under-valued, but margin growth relatively low. Benefits from Chinese growth and cheap valuations. 2 China: Under-valued. Macroeconomic data will show mild slowdown, removing some pressure on monetary policy. Taiwan or South Korea better proxy for Chinese growth. 1 Turkey: Strong growth momentum and well-managed companies, but slightly expensive. 1 ASEAN*: Great domestic growth stories. Valuations slightly stretched, but earnings growth should match expectations. Inflation may be an issue in the short term. Position for a rebound of the domestic theme. 1 CE3*: Gradual improvement, but still suffering from low European growth and domestic imbalances. To benefit from investor rotation. 1 Taiwan: Margins could expand again, demand firming, IT sector rebounding. Not cheap, but should deliver growth. 2 Mexico: Limited upside. Correlated to US consumer and CAPEX growth. Under-invested. -1 Brazil: Growth should soften; the currency looks expensive again, while domestic demand-driven sectors are now trading at fair value. -1 South Africa: Limited room for positive surprises despite support from metal prices. -2 Chile: Strong economic environment (strong demand for copper and domestic rebound), but expensive after recent rally. -2 India: Has become expensive in relative terms; hit by various scandals. Inflation is an issue. Will attract investors later this year, once trailing and forward valuations converge further. -2
Source: BNP Paribas Asset Management. *ASEAN: Indonesia, Malaysia, the Philippines, Thailand. CE3: the Czech Republic, Hungary, Poland.
4
Emerging Markets Edito
June2011 2010 March
DISCLAIMER This material is issued and has been prepared by BNP Paribas Asset Management S.A.S. (“BNPP AM”)* a member of BNP Paribas Investment Partners (BNPP IP)**. This material is produced for information purposes only and does not constitute: 1.
an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or
commitment whatsoever or 2.
any investment advice.
Opinions included in this material constitute the judgment of BNPP AM at the time specified and may be subject to change without notice. BNPP AM is not obliged to update or alter the information or opinions contained within this material. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the Financial Instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for a client or prospective client’s investment portfolio. Given the economic and market risks, there can be no assurance that any investment strategy or strategies mentioned herein will achieve its/their investment objectives. Returns may be affected by, amongst other things, investment strategies or objectives of the Financial Instrument(s) and material market and economic conditions, including interest rates, market terms and general market conditions. The different strategies applied to the Financial Instruments may have a significant effect on the results portrayed in this material. The value of an investment account may decline as well as rise. Investors may not get back the amount they originally invested. The performance data, as applicable, reflected in this material, do not take into account the commissions, costs incurred on the issue and redemption and taxes. *BNPP AM is an investment manager registered with the “Autorité des marchés financiers” in France under number 96-02, a simplified joint stock company with a capital of 64,931,168 euros with its registered office at 1, boulevard Haussmann 75009 Paris, France, RCS Paris 319 378 832. www.bnpparibas-am.com.] ** “BNP Paribas Investment Partners” is the global brand name of the BNP Paribas group’s asset management services. The individual asset management entities within BNP Paribas Investment Partners if specified herein, are specified for information only and do not necessarily carry on business in your jurisdiction. For further information, please contact your locally licensed Investment Partner.
5
