Yes, growth is better (often much better) than in the core capitalist territories (US, Europe, Japan), but how much of that is priced in already?
Investors in Developing Markets See Optimism
by Vikas Bajaj and Keith Bradsher
The New York Times
If investors in New York and London are seeing the first delicate signs of a recovery, their counterparts in developing countries say they are witnessing a full-on spring.
After a crushing fall in the last year and a half, stock markets in developing countries are riding a wave of optimism that the recovery of the global economy is at hand and being led by the developing world, especially China. Though emerging markets remain far below the lofty highs they attained more than a year ago, investors are again viewing their chances of growth as better than those of the United States or Europe.
As a result, the Indian Nifty stock index has jumped by 64 percent in the last three months. China’s CSI 300 index of shares in Shanghai and Shenzhen has risen 37 percent and Brazil’s Bovespa increased 41 percent over the same period. By comparison, the Standard & Poor’s 500’s gain of 28 percent looks modest.
“There was a stampede for the exits in the fourth quarter,” said Gonzalo S. Pangaro, portfolio manager of the T. Rowe Price Emerging Markets Stock Fund. “The market is starting to realize that although these markets face issues, they are manageable issues.”
So much so that analysts have attributed some of the recent gains in the S.& P. to investors’ belief that the Chinese economy is improving. It is not just China that is generating optimism. A lot of improving economic data is bolstering developing countries. While industrial production has rebounded in China, so have car sales in India and retail sales in Brazil.
Could all this be irrational exuberance? Current valuations are extremely rich: the price of stocks on the Indian Nifty is more than 20 times earnings. Prices are nearly 21 times earnings on the Bovespa and 29 times earnings on the CSI 300.
The optimistic view is that these price-to-earnings ratios reflect the return of an appetite for risk in the markets, which normally accompanies a more positive outlook, and a belief that these countries are ready to resume strong economic growth.
The skeptical outlook is that the economies would have to leap to double-digit growth rates to justify these valuations and that that could only mean a bubble was forming.
Emerging markets generally swing more wildly, in both directions, than developed countries do. And each of the big developing economies, the so-called BRIC countries, Brazil, Russia, India and China, face weaknesses that could stunt any recovery.
Exports and foreign investment flows, for instance, which are critical for many developing countries, remain anemic. Government spending has taken up some of the slack, but rising fiscal deficits in places like India could limit how much more policy makers can do to stimulate their economies.
For now, there is little talk of caution. In India, the rising stock market surged even more when the government garnered a bigger majority in national elections last month. Many analysts say they expect the government to expedite economic changes and infrastructure overhauls.
Madhabi Puri-Buch, the chief executive of Icici Securities, in Mumbai, said India would weather the crisis better than other countries because domestic consumption, the primary engine for the economy, was still growing. Sales for the biggest Indian automaker, Maruti Suzuki, for instance, climbed more than 10 percent in May.
Investments also are showing signs of revival. Foreign flows into the stock market have turned positive in recent months. Ms. Buch said companies were raising billions of dollars from institutional investors.
“Most companies in their boardrooms would be saying we need to plan for future growth,” she said, “rather than saying we need to batten down the hatches for a long winter.”
Other analysts say the fundamentals of the Indian economy have not improved enough to justify the big rally.
“There is the potential for this new government to make a significant difference in terms of economic reforms,” said Ajay Shah, a senior fellow at the National Institute for Public Finance and Policy. “I would underline the word potential. There are very big gaps between theory and execution, between promise and reality.”
The Reserve Bank of India expects the economy to grow 6 percent this fiscal year, down from an estimated 6.7 percent last year. Optimists like Ms. Buch said economic growth in India could be as high as 7.5 percent, while the World Bank has forecast 4 percent.
In China, industrial production has started to recover, and imports of commodities have risen. But the rebound is heavily concentrated in domestic sectors that benefit from the government’s stimulus program. Exports are still struggling.
An increase in bank lending has prompted a revival of the real estate market and the car market. The government has also offered $1.02 billion worth of subsidies to people in rural areas for car and home appliance purchases, contributing to a 14 percent increase in overall car sales in the first four months of this year, compared with the period last year.
The situation on the ground tells the tale.
For Wu Guo Fei and Wu Guo Cai, brothers who alter clothes at a sidewalk shop in Dongguan, China, near Hong Kong, the shock of the global financial crisis is slowly starting to fade.
From last summer until December, their monthly revenue shrank by 40 percent as some migrant workers at the nearby furniture and handbag companies, a large part of their customer base, lost jobs.
Laboring over foot-powered sewing machines made in the 1960s, the brothers fretted in the winter as workers left for unpaid vacations. But after Chinese New Year in January, the workers started trickling back. “Maybe 80 percent of the workers came back,” said Wu Guo Cai, 46.
Business is still off nearly 20 percent because of workers who did not return, but those who have come back are spending money.
“We expect manufacturing activity will continue to expand in the coming months, supported by the roll-out of the government’s stimulus,” said Jing Ulrich, the managing director and chairman of China equities at JPMorgan Chase.
Outside of China, emerging markets in East Asia are also showing signs of recovering from a steep slowdown in manufactured exports. The Taiwanese economy, for instance, shrank 10.2 percent in the first quarter compared with the period a year ago, but closer relations with mainland China have improved investors’ confidence.
Central banks across the region are maintaining low interest rates, and some, like in the Philippines, are still cutting rates to offset weak exports.
Indonesia has been insulated from the global downturn by its large domestic market and limited reliance on exports, and is benefiting from improving overseas demand for its natural resources.
In Brazil, which has been hurt by the steep drop in commodity prices, industrial production has risen every month since January, though it remains much lower than the corresponding periods last year. The government is predicting that the economy will grow 1 percent this year, down from a previous projection of 3.5 percent. Many independent analysts say Brazil will be lucky to avoid a contraction.
Nonetheless, the Brazilian stock market has risen smartly as investors regain confidence.
“We never thought it would get back to this level so quickly,” said Alessandra Ribeiro, an economist at Tendências, a consulting group. “When there was panic, investors fled to the U.S. to buy Treasury bonds and now they are diversifying again. Brazil is clearly one of those that have been chosen.”
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Emerging markets are doing better, no surprise there, but we have a couple of concerns:
- How much of that is already priced in?
- Although China has a sound fiscal position, so the government stimulus could travel further than elsewhere, but sooner or later overseas demand has to fill in, as China is a very open economy (contrary to India, for instance)
- Is that overseas demand coming? Well, as you probably know by now, we’re not so optimistic on that. The US and Europe, the two biggest markets in the world, are still in quite a funk, and now interest rates are starting to rise as well..
EDC and EDZ are a triple bull and a triple bear emerging markets ETF respectively, so you can take leveraged bets on the direction of emerging markets with these instruments.