Excellent fiscal health and strong domestic consumption make Brazil and Russia the stars of the emerging markets, for which the outlook generally is bright. Turkey is another favourite, as it continues to make headway on European Union accession objectives. South Africa and Morocco also offer opportunities. Now may be the perfect time to invest in these markets.

“The outlook has probably never been better,” says Christian Deseglise, product manager for global emerging markets at HSBC Halbis Partners (USA) Inc. in New York. He notes that, on average, emerging markets are expected to grow at a rate of 6% in 2006, double that of the developed world. “Most countries have sound fiscal policies, have been accumulating reserves and have taken advantage of liquidity to reduce debt.”

But the good news is not universal. There’s marked lack of enthusiasm for eastern Europe, where convergence plays have fallen flat and there are economic and political risks. And most managers find Chile and Argentina too expensive.

Brazil continues to be the poster child for fiscal reform. “The country has pursued an orthodox monetary policy, which has brought down inflation,” says Scott Piper, co-head of Latin American funds at Morgan Stanley Investment Management Inc. in New York, and co-manager of TD Latin America Growth Fund. He calls the current inflation rate of 4.5% remarkable in view of the country’s history of hyperinflation and notes the equity market, selling at eight to nine times earnings, remains attractive. Not surprising, Brazil takes up 58.3% of the TD fund — with an overweighting in financials such as Uniao de Bancos Brasileiros SA, and an underweighting in energy stocks.

Deseglise also lauds Brazil. “Brazil is very cheap, and domestic consumption is taking off,” he says.

Both Deseglise and Piper cite Brazil’s 2006 presidential election as a potential, although improbable, risk to the country’s shiny outlook. The Workers’ Party of President Luis Inacio Lula da Silva has been plagued by accusations of corruption for most of 2005. But, Deseglise says, this has had no economic impact. There’s a risk Lula — the driving force behind the country’s economic reform — may not be re-elected this year, but the party most likely to replace the WP is reported to be also market-friendly.

Another risk is that the currency — the real, a favourite among global traders, has appreciated dramatically — is vulnerable to any negative events. But Piper says this is also improbable.

Mexico, which Piper calls a “more mature and expensive” market, remains a less attractive cousin to Brazil. “Retail and the media are Mexico’s bright spots,” he says, noting that consumers now have improved buying power and greater access to credit and mortgages. He favours both Wal-Mart de México and Grupo Televisa SA.

A presidential election will be held in Mexico this year, with left-leaning front-runner Andres Manuel Lopez Obrador posing a threat to the country’s economic outlook. “If Lopez wins, that would be a potential for volatility,” says Piper.

Runaway inflation from high oil prices is another, also unlikely risk. “Oil prices will trend down to the low US$50s or high US$40s a barrel, which won’t dramatically change the outlook,” Piper says.

Unlike Brazil and Mexico, Chile and Argentina are not on the radar for most money managers in 2006. “From a bottom-up standpoint, both are too expensive,” says Piper. Patricia Perez-Coutts, vice president at AGF Fund Management Ltd. in Toronto and portfolio manager of AGF Emerging Markets Fund, agrees Chilean stocks are getting “a little pricey,” adding that, although Colombia and Peru have good prospects, there’s not a lot to buy: “Large global corporations are buying up what they can in these countries, which doesn’t leave us a lot of room.”

South Africa remains an attractive fixture in most emerging markets funds. “We continue to like the consumer-driven sectors,” says Ahmad Zuaiter, portfolio manager at Morgan Stanley in New York. “We’ve maintained a relatively strong neutral weighting in South Africa.”

He suspects the country’s strong commodities cycle — supported by reduced inflation and the emergence of the black middle class — will play out over the next two or three years. Perez-Coutts agrees, saying South Africa continues to be an unrecognized market. “South African companies are efficient and people are buying,” she says. Her fund holds shares in two South African retailers, a bank and a platinum company.

@page_break@Russia also remains a favourite pick of most managers, who like the country’s oil and consumer sectors. “Russia is all about oil,” says Deseglise, whose HSBC Emerging Markets Fund is overweighted in Lukoil Oil Co., the country’s largest oil company. He notes investor sentiment in Russia has improved dramatically in the past year. “A year ago, we were in the Yukos scandal, But today, investors are less worried that something wild will happen there,” he says. He also likes the country’s 8% budget surplus.

But oil isn’t Russia’s only story. “I like the renaissance of the consumer,” Zuaiter says. “We have a large weighting in consumer sectors such as the telecom, food and beverage, and cosmetics industries.”

Only Perez-Coutts is unenthusiastic about Russia. “We had a bad experience with Yukos, and are uncertain about [President Vladimir] Putin’s ability not to squander our money,” she says, noting most of the country’s consumer stories are tiny and illiquid.

The outlook for eastern European equities continues to be poor. Zuaiter likes Poland from a bottom-up perspective, but says political instability may slow momentum.

Convergence plays have also not delivered the expected returns. “We are much less excited than two years ago,” Zuaiter says. “Real interest rates have converged with European rates and most rates have convergence priced in, which doesn’t leave any room for error.” He also notes Hungary is running “pretty irresponsible economic policies,” with a fiscal deficit of 8%-9%, and a current account deficit of 5%-6%. “Hungary has an overvalued currency that is vulnerable to shocks, and there may be some contagion that spills over into the Czech Republic and Poland.”

Deseglise and Perez-Coutts are also unenthusiastic on this matter. The HSBC fund is underweighted in the Czech Republic, Poland and Hungary. AGF is out of Poland entirely, but has holdings in a Hungarian refinery and a utility in the Czech Republic.

Zuaiter prefers Turkey. “It has lowered nominal and real interest rates, continues to offer good earnings and growth potential and is not very overvalued,” he says, noting the government is embarking on infrastructure and housing spending. He has exposure to the investment, construction and retail sectors. “Consumers are getting back the jobs they lost in the 2001-02 recession, and have some disposable income.”

Morocco is another of his Middle East plays. “Like Turkey, Morocco is benefiting from the liquidity resulting from the oil windfall,” he says. “The country stands out in reform.”

He credits the Moroccan market, notably banks, insurance and retail, with offering “tremendous value relative to growth,” trading at 13 times price to earnings. IE