Strong domestic consumption in Brazil, Mexico and Russia continues to fuel a bright outlook for emerging markets, which the International Monetary Fund expects will grow 5.2% in 2007, while the industrialized world chugs along at 2.7%.
Among smaller players, Egypt is gaining favour for its growth opportunities and reasonable valuations.
Turkey continues to attract attention for cheap price/earnings ratios and growth in net income.
However, there is a marked lack of enthusiasm for several Eastern European countries; poor growth profiles and large current account deficits continue to plague them.
Prospects for South Africa have fallen flat.
So, compared with last year’s unbridled enthusiasm for emerging markets, managers are more muted in their 2007 forecasts. “Emerging markets have gained critical mass and are responsible for 30%-35% of world growth,” notes Christian Deseglise, product manager for global emerging markets at HSBC Halbis Partners (USA) Inc. in New York. “In general, we expect 2007 earnings growth to be robust, but perhaps not as strong as in 2006.”
A global recession triggered by a significant downturn in the U.S. housing market could upset the outlook, but there is confidence that many economies could weather any potential crisis.
Latin America is one such favoured region. “The markets in Latin America are on their own course,” says Patricia Perez-Coutts, manager of AGF Emerging Markets Fund and vice president of Toronto-based AGF Funds Inc. “The sets of earnings we have seen in many of these countries — as well as in other parts of the emerging markets — have proven that earnings stability is there, even in the face of a global slowdown.”
Brazil remains the region’s crown jewel. With the re-election of President Luis Inacio Lula da Silva — whom Perez-Coutts calls “the best friend an investor could possibly have” — political risk is viewed as non-existent. Oil producer Petroleo Brasileiro SA (a.k.a. Petrobras) remains the largest name in AGF Emerging Markets Fund with a weighting of 3%, while more than half of the fund’s remaining exposure to Brazil is devoted to domestic consumption and bank plays. The fund is also invested in Companhia Vale do Rio Doce, the iron ore mining interest that recently purchased Inco Ltd.
Deseglise praises Brazil for remaining one of the cheapest emerging markets countries. “Brazil trades at about eight times forward earnings, interest rates are coming down quickly and inflation is around 3%,” he says, noting that HSBC Emerging Markets Fund is overweighted in Brazil.
Mexico’s domestic consumption story is making that country increasingly popular. “We’ve been investing in domestic consumption in Mexico for some time,” says Perez-Coutts. “But now other investors are seeing domestic consumption as a strong component of economic growth for the country,” Her fund has holdings in broadcasting company Grupo Televisa SA, cellular company América Móvil and other domestic stocks, including beverage companies.
Perez-Coutts likes Mexico’s mature political establishment, declining interest rates and stable currency. She notes that as a result of significant growth in the domestic economy, Mexico is better positioned to weather a severe U.S. slowdown than it was 10 years ago. “With oil prices and transport costs high, Mexico also has a geographical advantage,” she adds.
Scott Piper, co-head of Latin American funds at Morgan Stanley Investment Management in New York and co-manager of TD Latin American Growth Fund, also likes Mexico’s domestic plays, especially airlines. “In Mexico, Brazil and Chile, 95% of domestic travel is still by bus,” he notes. “As air travel becomes more affordable, the story will become very interesting.”
However, he is less enthusiastic about other Chilean prospects: “Chile’s success has come and gone, and there’s nothing exciting to buy from a bottom-up perspective.”
His fund has stakes in Ar-gentinean, Peruvian and Colombian banks, and in an airline in Colombia. “We like Peru and Colombia,” he says. With elections completed, he sees little political risk in Latin America in 2007.
Apart from Russia, there is significantly less to get excited about across the pond. “There is really not much to say about Eastern Europe, other than I don’t see much growth from the larger three economies — Hungary, the Czech Republic and Poland,” says Perez-Coutts. “Poland looks the most interesting. But I can find better companies with better growth profiles and cheaper valuations elsewhere.” The AGF fund has no holdings in Poland but is invested in a Czech Republic utility and a Hungarian oil and gas company.
@page_break@Deseglise points to Hungary’s policy slippage and “worrisome” current account and fiscal deficits — perpetual obstacles in the country’s plans for European Union accession. He notes that valuations in Eastern Europe have increased quickly.
He is much more positive about Russia and has overweighted the country. “Growth has been strong, liquidity has been flowing into the country and money supplies are growing quickly,” he says.
Deseglise also finds Russian domestic consumption a compelling story. “In the past few years, Russia was only about oil and energy. But it’s now spreading into other sectors,” he says. “We have holdings in the banking and retail sectors.”
A collapse in the price of oil — to US$40 or US$45 a barrel — could have a negative impact on the Russian economy. But Deseglise doesn’t think this will happen: “We think oil prices will remain high. Perhaps not as high as US$78 or US$80 a barrel, but as long as they remain around the US$60 mark, that will be very favourable for Russia.”
Perez-Coutts, a risk-averse, bottom-up investor, prefers Brazil’s Petrobras to Russian oil plays. “We are still wary of the lack of transparency in Russian companies,” she says. AGF has only one Russian investment: Polyus Gold.
HSBC has significantly underweighted South Africa, which Deseglise describes as “one of the few emerging markets countries —along with Hungary and Turkey — in which fiscal, trade and current account balances are not very good.”
Perez-Coutts is also cautious about South Africa. “High oil prices are not good news for South Africa, which is a net importer of oil,” she says. “In addition, the strong rand has come off somewhat, and it is not as supportive of the export business as it once was.” She continues to play South Africa’s strong domestic consumption story and points to the 2010 FIFA World Cup, which South Africa will host, as a catalyst for an infrastructure boom.
Perez-Coutts is even less enthusiastic about Middle East plays: “We are not participating in the Middle East because it is not yet investible.” Her fund has made one banking play in Turkey — Akbank, which sold 20% of its shares to Citigroup Inc. this past October — but is leery of the country’s precarious economy. She does expect improvement and says eventual EU accession should make Turkey’s capital markets more appealing.
The HSBC fund also holds financial stocks in Turkey. “Turkey is a cheap market and could be one of the best performers in 2007,” says Deseglise. He is also optimistic about Egypt, his fund’s only significant Middle East play, which is overweighted in the telecom and construction sectors. IE
Domestic consumption drives 5.2% growth forecast
Brazil, Mexico and Russia are expected to lead emerging markets in 2007, while Egypt and Turkey also find favour
- By: Maureen Halushak
- January 22, 2007 January 22, 2007
- 12:27