Wednesday, August 4, 2010

Emerging market update



In the past 8 years, the Brazilian stock market, when measured in dollars, has risen almost 20-fold. This is simply breathtaking. Of course, a lot of that rise was a recovery from the collapse in the early 2000s (which in turn was precipitated by a super-strong dollar, collapsing commodity prices, and Argentina abandoning its dollar peg), but still, you'd have to say that Brazil is on fire. Its currency has been steadily appreciating vs. the dollar since late 2002, which has to be an all-time record for any Latin currency to my knowledge.

And since I'm in S. Africa at the moment, I'll mention that the rand has been strong against the dollar since late 2001, rising from 12 to 7.25 today. The press here says the rand is "overvalued," but I would note that wine and food are a terrific bargain. We had lunch at a scenic winery restaurant in the Stellenbosch region (S. Africa's Napa/Sonoma), and most of the wine on the list costs a mere $3 per glass, and it can hold its own against most of its California counterparts. S. African restaurants offer tremendous wine bargains for American tourists, since it appears to me that they mark up the wine no more than 50% above what you would pay at the winery (which is about as cheap as it comes).

Emerging market economies have been the direct beneficiaries in recent years of the Fed's decision to move from very tight to very easy monetary policy, which in turn has helped bring down the value of the dollar and has helped boost commodity prices across the board. Emerging economies have also benefited from very positive structural reforms of their own as well as generally tight monetary policy (with the notable exception being Argentina). I've seen tremendous progress here in S. Africa, and Brazil's accomplishments in recent years would have been almost unthinkable a decade ago (I used to be very bearish on Brazil).

The progress in emerging economies has been reflected in stronger currencies, lower inflation, stronger equity markets, and lower interest rates. From a supply-side perspective, this is fabulous news, since all of these improvements reflect and encourage rising investor confidence and thus more investment and more growth. I don't see an immediate threat to a continuation of strong returns for emerging market investments. Let the good times roll, these countries need it.

17 comments:

John said...

We discussed emerging markets some months back. I believe it was just prior to the 'euro is doomed' scare in May. I seem to remember suggesting a dollar cost averaging strategy into a good managed emerging markets fund keeping a multi year time horizon. I still think it is a good idea and will reap large rewards. It will IMO vastly outperform bonds.

Benjamin said...

Every once in a while I am tempted by South American stocks. Then, sooner or later, the South Americans do what South Americans do best--wreck everything. Do I mention Argentina? Venezuela? Mexico (technically Norte, but...).

I can remember a money firm in Los Angeles--TCW--touting Mexico maybe 20 years ago. Mexico tanked.

Is Brazil different? I sure hope so, and you gotta admire their oil/ethanol efforts. I just sense that corruption and lack of transparency and dancing the samba all night long will collapse the Brazilians, as much as I am rooting for them.

Benjamin said...

BTW, another AEI guy talks deflation.

John Makin of Caxton Associates and the American Enterprise Institute spoke with CNBC this morning about the threat of deflation now hanging over the U.S. economy.
Makin explains that deflation is already here. He talks about how CPI is only at 0.9% right now, and heading lower. That prices and wages in the U.S. are falling, and that we are now exporting deflation to Europe and Japan via a weakening dollar.
Housing is where this starts, and Makin thinks that the American public believes that house and car prices will be cheaper in the future. He also argues that, if we included housing prices in the CPI, we would already be in a deflationary period.
Bond yields are a key source of knowledge about where the economy is, and Makin points out that yes, bond yields falling on both short term and long term government debt makes clear that markets believe in the deflationary storyline.
He calls for more Fed action, and further experimental measures including the purchase of more treasuries.
Makin calls monetarists "wackos" for fearing inflation due to the increase of money supply.
It's compelling viewing for anyone concerned about our coming Japan scenario.

Public Library said...

Benj,

I like more and more of what you are saying except the 'Fed do more' stuff. I think the Fed should do less and normalize rates. This would send a clear signal the market needs to operate on its own accord.

Cutting off the lifelines of beleaguered individuals and corporations is just what this economy needs to rebuild. Providing more lifelines will send us into a Japanese deflation trap more quickly.

I also agree about EM. Everyone jumps on this trade every decade or so as if these countries are magically not corrupt, communist, or not prone to cut-off their nose to spite their face. However, it usually ends the same way...

Public Library said...

Btw, Russia banning wheat exports is a great reminder of what type of countries you are really investing in with EM...

John said...

I'm not crazy about the Russians either. Most diversified EMF I know of have a light weighting there. It is a highly specialized area of investing and should not be attempted by individuals without competent guidance. Countries like Brazil, Turkey, Poland, among many others will grow much faster than developed countries over the next several years...but there are risks. One needs patience and a stomach for volatility to reap the high potential rewards.

Public Library said...

Too much ivory tower economics in the EM space. I was in Hungary just before the currency blew up again in 2005/06.

If you were actually on the ground floor, you easily noticed there was no local economy and the banking system was fragmented. They were not a financial capital nor a manufacturing mecca.

However, they became the 10th most expensive city in the world. It was a bloody joke but many portfolio managers were fooled by the distance between reality and their expensive relax-the-back chair.

John said...

Public,

For sure risk averse investors should avoid the space. No problem.

Incidently, Chevron (CHV-NYSE) closed up today for the eleventh consecutive day. Of course, many factors are involved in short term equity moves. But for such a large company to have such a sustained move is unusual. I do not think it is based on the prospects for domestic demand. The growth is overseas in emerging markets.

A conservative investor might look here for a way to participate. Wait for a pullback and slowly build a long term position (AFTER doing your OWN homework, of course). Same idea might work with Exxon. Either should handily beat a bond fund or CD over time.

JMCO

mdelp said...

Scott,

I have been following your posted since early 2009. fantastic reading.

I manage reserve accounts for corporations and am considering taking my approach and creating an open end mutual fund focused on short term high yield bonds. I would appreciated any feedback on this since you have been involved in that industry.
thanks

Benjamin said...

Public Library-
9 times out of 10, yes the Fed should shut up and expand the money supply by 4 percent a year like robots.
This is that 10th time.
The worst recession in the postwar era, and falling real estate prices. Basically, with falling r/e you will not get a recovery. More and more banks will tank, more and more small businesses will have access to capital cut off. A deflationary spiral, ala Japan.
Yes, there are risk to a Superman Fed. Like inflation.
Right now, I would rather take an inflationary boom, than a deflationary recession.
But hey, I like your posts, and I like hearing another point of view.

John said...

Benj,

There is $1 Trillion plus sitting in member banks accounts at the Fed earning .25%. There is plenty of money. The problem seems to me to be a reluctance of businesses and individuals to borrow. Some of it is probably uncertainty and unease with this government. Every businessman I know dislikes it and feels it is hostile to his/her interests (anecdotal for sure). The result is a hunker down attitude, ask your workers to work overtime if needed and maybe pick up a temp if absolutely necessary. Permanent employees are the last option selected. They are added only if business is so good it pays well to do it. It's happening but not nearly enough to offset new workers entering the workforce.

I think the other reason is one Public Library and others have touched on is the desire by consumers and small businesses to pay down debt (delever). I do think this will prove not to be an extremely long process and has a lot to do with confidence in the future. Pent up demand will build and in time (how much is the question) will be released in the form of increased spending. In the longer run its a good thing but in the near term its contributing to a slower economy than usual at this point in the recovery. I'm not certain of the number but it seems like I read the savings rate is up to 6% and will likely climb higher.

I am hopeful a change in government direction will improve confidence (particularly among business leaders) and lead to more spending and investment. Also many large corporations have huge amounts of cash on their balance sheets and will come under increasing pressure to employ it more efficiently (acquisition, stock buybacks, dividends, technology upgrades, etc.) We should see more action on this front soon.

Some say the fed has no more bullets. I disagree. Additional QE could be employed but as Public Library and Mark Gerber have effectively argued there are unintended consequences to this action (increased instability, etc.)and we have already used this option extensively. For better or worse, I don't think the fed will go there again unless there are compelling reasons to do so, and particularly not right in front of an election.

The US economy is still growing as is the global economy. Commodity prices overall firm and there is ample liquidity in the financial markets. I continue to believe this slow patch will be resolved on the upside later in the year and as we move into 2011. Many disagree and I have been wrong enough in the past to respect their opinions. At this time I think the weight of the evidence points my way...but if the facts change I like to think I can change with them.

Family Man said...

Scott,

Is a current spike in food prices anything to worry about (i.e. some kind of shock which can force Central Banks to tighten rapidly)

Thanks,

Benjamin said...

As always John, I enjoy your commentary--even when I disagree!

John said...

Benj,

The Fed meets next week. Today's unemployment data may spur some movement. I am still doubting it but they may signal something new. We will see.

Scott Grannis said...

Family Man: The Fed doesn't try to use food prices as an input to their policy decisions. Food prices, like energy prices, are volatile. That's the main reason the Fed has decided to use the core (ex food and energy) version of the PCE deflator as it's policy target.

I don't completely agree with this approach, since I think the Fed should also focus on the value of the dollar, commodity prices, and other market-based signals of the effective stance of monetary policy. But it does have its merits.

Scott Grannis said...

mdelp: Re using short term high yield bonds as an alternative for corporate reserve accounts. That might be attractive to some, given the current environment of easy money and the benefit that confers to those who are leveraged. But short-term HY bonds are not necessary riskless investments, whereas "reserve" accounts tend to be risk-averse. So you are mixing apples and oranges to some extent.

Family Man said...

But for EM CB food inflation probably is of more weight.