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Another Look at Emerging Markets

Fitzroy McLean — Thu, 19 Feb 2009 19:41:54 +0000

After passing much of 2008 standing thankfully on the sidelines, we believe that with current valuations, opportunities have returned for putting capital back into long-term positions in emerging markets.

In fact, we believe that emerging markets will recover faster and outperform developed markets over the long term.

In our December 2007 edition of Without Borders we wrote:

“So much money has been sloshing around the globe in search of an “above average” return that even risky assets have been bid up tremendously. At this stage, however, with new holes in the financial dike showing themselves almost weekly – more holes, we suspect, than officialdom has fingers – the money flows are building toward a reversal. This will hammer the emerging markets the hardest because, historically, in times of crisis, capital packs up its bags and goes home. When that happens, shares of good companies get sold at the falling bid simply because the seller must get liquid, whether to calm his fears or to cover his losses elsewhere. Asset prices become screaming passengers strapped into a luge ride.

“This creates opportunity, of course. Even though the economies of all the most prospective emerging-market countries are strong enough to weather any likely storm, their financial systems aren’t. This is emphatically true in India, China, Brazil, and other fast-track economies. Even so, when foreign financial capital has fled, the physical and human capital will remain, it will still be valuable, and good investments will be cheap in the extreme. But the opportunity won’t be available for everyone – just the investors who’ve been patient.”

Then in April 2008, we gave our presentation on “Bottom Fishing for Stocks in Emerging Markets,” during which we highlighted that the single most important factor in emerging-market stock markets is capital flows. In the emerging markets, the time to invest is when capital has fled the country.

We know we disappointed the crowd when we said that there was not one emerging market we found attractively priced and that shorting in emerging markets is almost impossible, so our strongest recommendation was to do nothing.

It’s quite a skill to do nothing and do nothing well. We sidelined ourselves and watched, staying away from emerging markets for most of 2008.

But now… finally, the catastrophic sell-off in global financial markets had the effect that we expected: there was a huge sucking sound coming from public equity and currency markets in Russia, Brazil, China, Taiwan, Malaysia, India, South Korea, Colombia, Chile, etc. Foreign institutional investors came face-to-face with the reality of lower risk tolerance and deleveraging and were forced to sell. Everything.

The ensuing flight to quality left emerging markets and their currencies decimated… but herein lies the opportunity. We just hope the IMF and World Bank will run out of money or leave them alone, thereby preventing the return to the boom/bust cycle of the 1990s.

Bullish long-term outlook

Remember, the sell-off in emerging-market equities, bonds, and currencies reflects a rush for the exit sparked by global deleveraging and a need to raise cash, rather than any change in the fundamentals. When the current turmoil subsides, we believe that emerging markets will fare better than developed markets and will outperform the latter over the long term. As such, we find that current valuations are solid entry points for putting our hard-earned capital into long-term positions. Consider:

* Emerging-market economies will prove resilient during this economic slowdown and may account for all of world economic growth in 2009 as developed markets slow to zero.

* Emerging economies are not nearly as dependent on consumer spending and almost not at all exposed to consumer credit.

* Emerging markets by and large suffer neither the demographic imbalance nor the entitlement imbalance that plague the developed nations.

* Corporate and personal balance sheets in emerging markets are stronger than those in the developed markets.

* In many emerging markets (Brazil, most of South East Asia, India) as well as several African nations, domestic or regional demand is now more important than exports for GDP growth.

* Among stronger economies, high foreign-exchange reserves and lower foreign debt levels act as insurance against the global slowdown; reserves have grown six-fold to over $4 trillion over the last ten years.

* Over the past ten years, emerging-market companies have produced higher profits with lower (but not necessarily low) leverage, while profits expanded annually by double digits during the past ten years.

Cash Rich, Resource Rich

Compared to the late 1990s Asia crisis, the present situation is much more stable for emerging markets. While we expect current account surpluses to deteriorate given the global slowdown and recessionary pressures, emerging markets will face this challenging period with cash in their bank accounts.

The importance of this change cannot be overstated.

Much like individual households that stash away something for a rainy day, many emerging-market countries now have a greater reserve of wealth with which to buffer financial market headwinds. This gives them the option of taking fiscal stimulus measures to offset the effects of a developed-markets slowdown without having to go into debt. While we decry these neo-Keynesian actions as throwing water on an electrical fire, historically they have boosted share prices.

As part of their fiscal stimulus, we also expect to see higher infrastructure spending by countries with the financial muscle to do so. China, for example, which is projected to have more than 200 cities with populations exceeding one million people by 2025, up from just 23 in 2005, announced in early November 2008 a two-year infrastructure investment and stimulus package of up to 4 trillion yuan ($586 billion). While much of this stimulus will come in the form of strong-arming banks, there will be substantial cash injections in the Chinese economy, and they have the cash to do it: highways, railroads, and airports. The government hopes that this stimulus package will also encourage increased consumer consumption. All this is good news for raw-materials companies, one of which is an undervalued Chinese cement company that is a cornerstone of our portfolio. (Learn more about this company here.)

The turning point

Emerging markets will be the catalyst for global economic recovery, not the West. Like China, many emerging markets that have been saving for a rainy day have the cash and political will to spend on development projects that require raw materials. Others, like Chile and Angola, have the raw materials to sell. Even more so, a few countries like Brazil and Saudi Arabia have both. The economy will get jumpstarted with these countries initiating their own trade without the leadership or consumptive traditions of the Western world.

Perhaps even more pointedly, we foresee a highly inflationary environment over the next several years… all of the dollars with which President Obama will be flooding the world will have to find a home somewhere. This will more than likely spark another commodities boom, which is supported by the world’s ever-growing demographics, resource scarcity, and climate-change legislation.

As such, resource-rich emerging markets are going to find themselves being the future home to foreign investment capital again. Institutional capital will trickle, then gush into these markets as the world wakes up one day and finds oil and copper trading at twice their present levels.

Consequently, today’s emerging markets will be the net recipients of the future inflation that is being created by the West.

Capital Flow Conclusions

We have long said that capital flows are the most important indicator for emerging equity markets. Investor outflows in the second half of 2008 already equal one-third of the total inflows into emerging-market equity funds over the prior five years. This is a positive sign for contrarians looking for a bargain. There has been a bloodbath, and this is a buying signal.

We recognize that the ride will likely be bumpy. Fiscal stimulus, trillion-dollar deficits, and politicoramus bickering may cause a roller-coaster ride to the top… but the evidence strongly suggests that, once institutional funds finally realize that U.S. Treasuries are a fool’s bet, remaining capital will be on the hunt and flowing back into emerging markets. The window is open, and we are dedicating our efforts to finding the most undervalued companies with rock-solid management and balance sheets.

Source: Another Look at Emerging Markets

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2 Currency Plays to Protect Yourself from Bush’s Bailouts

Fitzroy McLean — Thu, 21 Aug 2008 09:53:42 +0000

Most people know the largest economy and most widely held currency in the world are in trouble, says spy-turned-newsletter-editor Fitzroy McLean.

As Byron King said recently in Penny Sleuth, the Bush administration has presided over a massive expansion of government’s role in finance – a new era of bailouts.

These bailouts will have a disastrous long-term effect on the dollar. Fitzroy recommends two currency plays to best protect your portfolio from the buck’s ultimate devaluation…

With declining tax revenues in a down economy, governments around the world have been stepping up to recklessly spend more, usually borrowing from the haves and giving it right back to them in interest payments or proceeds from importing their wares.

There’s one problem though, at least for the U.S.: The Financial Times recently reported that Arab and Asian funds are cutting their exposure to the U.S. dollar.

Can’t really blame them. For years they had been buying U.S. debt and recently switched to ownership: real estate, public equities, etc. But their cash infusions from private capital injections over the last twelve months have withered as the market value of major financial stocks continues to deteriorate. At this point, there is little course of action remaining other than to continue deflating the value of the currency by printing more money.

So, many developing markets are experiencing significant inflation because of a surge in foreign investment (which normally has the effect of driving up wages and asset prices), as well as rising commodity prices.

Even though commodities are generally priced in USD, many developing markets historically peg their currencies to some multiple of the dollar, so they feel the inflationary effects of rising corn, wheat, and oil as well. De-pegging would usually cause their currencies to strengthen against the dollar, mitigating the inflationary effects of rising commodities prices. Sounds great in theory, but many developing markets have been focusing on pro-growth policies, allowing inflation as a necessary evil. In our view, this trend is changing rapidly.

As we have discussed earlier, it doesn’t take too many riots for governments to give in and ‘do something.’

Unfortunately, this has historically been a far cry from actually ‘accomplishing something’ because, after all, you can always blame the other political parties.

Our assessment, however, is that the great constituency is growing impatient, and as family budgets around the world are stretched thin in the face of a myriad of other challenges (real and perceived) like climate change, energy scarcity, and population growth – governments will eventually adopt freer market policies with long-term benefits.

Argentina’s recent decision to eliminate export taxes for agricultural products is an indication of this trend, even in a highly leftist regime. China’s reduction of fuel subsidies is another.

The great shift in defending against inflation will likely culminate in many developing markets abandoning their dollar pegs and floating freely.

Last year, Kuwait and China broke away from their strictly USD pegs in favor of a basket of currencies which includes the euro, yen, pound, ruble, South Korean won, Thai baht, Aussie dollar, Canadian dollar, and Singapore dollar. Kuwait has been the most hawkish of the GCC about the dollar, at least publicly.

The country, which has the world’s most highly valued currency (its currency unit buys the most of any other currency unit), made the change in preparation to switch to the proposed GCC single currency, the Khaleeji, when it debuts in 2010 across Saudi Arabia, the UAE, Qatar, and Kuwait.

As long as the world’s energy trade balance favors the Gulf, our expectation is that the new currency will perform well against the dollar and euro, and it is likely that other members of the currency bloc will flirt with de-pegging prior to 2010.

The same analysis applies to China’s renminbi (which literally means “the people’s currency”). Prices may rise and growth may fall, but China will likely maintain its status as a worldwide manufacturing source and export-intensive economy; and turning a cold shoulder to U.S. dollar-denominated investments will put significant upward pressure on its currency.

One way to profit from this trend is by buying into the currencies themselves. EverBank (www.everbank.com) has a host of international currency deposit accounts, including a Chinese renminbi money market fund.

Alternatively, some investors are putting money in the Chinese renminbi exchange-traded note (NYSE:CNY). Beware before buying the renminbi ETN: You are accepting counterparty risk from Morgan Stanley so do not buy CNY if you think Morgan Stanley won’t be able to pay the note.

Personally, we are much more comfortable with Barclay’s Asian and Gulf Revaluation Fund (NYSE:PGD). This fund covers five currencies that are currently pegged to the U.S. dollar, and the fund stands to gain substantially if the pegs are revalued. The currencies include Hong Kong, Singapore, China, the UAE, and Saudi Arabia, and we are comfortable betting on the trend that at least the latter three will rise substantially against the dollar.

PGD charges a 0.89% management fee and was just recently introduced in mid-June. Its volatility will likely be mild, until, that is, one of the five countries revalues its currency.

P.S Fitzroy McLean is a co-editor of Without Borders, the spirited and highly profitable new monthly advisory service from Casey Research. A former military man turned spy, Fitz eventually came to his senses, trading in his cloak and dagger for a briefcase and a degree from Oxford, then set out to use his unique skills as a successful fund manager and full-time international entrepreneur.

Fitz and co-editor Simon Black, another former intelligence operative, are on a nearly non-stop quest around the world looking for the best places to easily diversify internationally (and, in the process, enjoy the best life has to offer.

There’s no other newsletter quite like it. But don’t take our word for it: a 3-month trial subscription with 100% money-back guarantee allows you to experience Without Borders for yourself at no risk. Learn more by clicking here now.

Source: “I’m from the Government and I’m Here to Help.”

How to Safely Play China’s Growth

Fitzroy McLean — Wed, 14 May 2008 15:57:28 +0000

In our constant travels for Without Borders, we look for progressive, undervalued international investment opportunities in booming economies with governments that treat capital well. To even begin to make the cut, the countries also have to possess multiple economic growth engines, open trade and business freedom.

Finding these opportunities is just half the mission. The more important, and often more difficult task, is finding safe ways to play them.

Consider China. Unless you’ve been cooped up in Guantanamo for the last few years, you’re already familiar with the miracle of China, Inc.; 11.4% GDP growth, the world’s “go to” manufacturing center, a 1 billion strong local consumer market, and some of the greatest business opportunities in the history of the world.

So far, so good. But when you drill down another level, the level where you hope to find undervalued investment opportunities, things quickly get more complicated. Thanks to that country’s emerging middle class, flush with exponential growth in purchasing power and investable funds, , the Shanghai stock exchange has become one of the hottest capital markets in the world. And one of the most dangerous.

Over the last 7-years, the Shanghai Composite Index has returned approximately 80% to investors with some serious roller coaster rides along the way, including days of such catastrophic meltdown that even the most seasoned investors make a bee-line for the nearest emergency exit.

The Price/Value Disconnect

The most disturbing thing about the Shanghai market is the often complete disconnect between the price of a given stock and the value of the underlying company. In China, soothsayers in the local newspapers predict what numbers will endow great luck… just like a fortune cookie at your favorite Chinese buffet; and as you are undoubtedly aware, stock symbols in Shanghai are numbers, not letters. So when the great sage says 0, 4, 7, and 9 are today’s lucky numbers, that spells good news for Shanghai Zenhua Port Machinery Co., symbol: 900947, and poof, the stock jumps—irrational exuberance at its most irrational. This and similar actions of an inexperienced, first generation investor class, coupled with a general overconfidence among the Chinese on the outlook for their stock market, periodically drive the Shanghai exchange to bubble territory, that is subsequently corrected in stomach churning down moves.

So, the sort of booming economy and big upside we like, but with an unpredictable and wildly irrational stock market.

What’s an investor to do?

Because we’re looking to buy into the growth, and to do it safely, stepping up to the craps table in Shanghai along with all the other speculators and soothsayers isn’t going to cut it.

Instead, we invest in undervalued Chinese companies listed on more established exchanges. Simple, but effective.

Some examples…

We are currently following a Jersey-domiciled, London-traded cement company based in the western China province of Shaanxi (not to be confused with the neighboring Shanxi province…). Shaanxi is one of the fastest growing provinces in China, and this cement company is ideally positioned to capitalize on this growth. Currently trading on London’s Alternative Investment Market (AIM) at only 6.4 times earnings and 4.6 times current assets, this stock is as undervalued as it gets, especially considering the growth prospects.

While it has already provided us with solid profits, we see it as a relatively near-term double from today’s levels. But we digress from the central point here… which is, because it trades on the London AIM, and not Shanghai, your shares have nowhere near the volatility.

Confirming that point, we looked at twelve worst performing days of the Shanghai Composite Index since January 1 2007, with single day losses ranging from 5% to over 10%. On average, during those steep drops, our Chinese cement play outperformed the index by an average of 6.85%. Viewed from another angle, on the 12 worst performing days of the Shanghai Composite Index since January 2007, our AIM-listed Chinese cement company actually posted a daily gain on eight of those twelve days, and posted a far better return than the index on all twelve.

For us as investor this means we are able to capitalize on one of the fastest growing industries in one of the world’s fastest growing economies with one of the industry’s most seasoned management teams, and doing it all safely, with far less volatility than in Shanghai.

We believe in the Asia growth story, and we believe in companies like our China cement story (the name of which we can’t share here because it wouldn’t be fair to our subscribers). But we are only willing to risk our hard earned capital in a way that makes sense to us. So in China, we look for solid, undervalued companies on established exchanges – and there are a number of these gems if you dig for them – and save the gambling for the casinos in Macau.

Fitzroy McLean is the co-editor of Without Borders from Casey Research, a monthly service dedicated to searching the world for undervalued, lower risk investments. A three month, no-risk subscription offer is available that will bring you current with all of the Without Borders recommendations… learn more now.

Source: How to Safely Play China’s Growth