Investing In Emerging Markets: October 2006

Friday, October 13, 2006

After a long climb, emerging-market stocks have taken a startling tumble. On May 22, the Morgan Stanley Capital International Emerging Markets index fell for a 10th straight day, its longest skid since August, 1998. In India, the Bombay Stock Exchange Sensitive Index finished down 4.2%, recovering from an early 10% plunge that shut down trading for an hour.

The preceding run-up in prices helped set the stage for emerging markets' sudden slump, says Alka Banerjee, who focuses on international markets as vice-president of global index management at Standard & Poor's. "There had to be a pullback," she says. "It doesn't mean in the long run these [equities] are bad bets."

Only recently emerging-market stocks were at all-time highs. The S&P/IFCI Composite index, which tracks emerging markets, surged 20.6% in the first four months of the year. This month, the index has shed 6.3% through May 19. The S&P/IFCI Turkey index alone tumbled 18.9%.

Banerjee recently spoke with BusinessWeek Online reporter Marc Hogan about the factors weighing on emerging-market stocks and what they mean for the rest of the world. Edited excerpts from their conversation follow:

What's behind the volatility we're seeing in emerging markets?

The genesis is in most of the activity that the markets around the world have seen in the last few weeks. You have rising interest rates, expectations of inflation, and high commodity prices. Commodity prices have taken a beating in the last few weeks, but it's also the momentum that has been building up.

Emerging markets have had a good three-year run. They've been up and up and up. This year, all of a sudden, in the last four months they're up 20.6% [through Apr. 30], though individually the rates of increase have been different. That's a very high rate of increase, and at some point profit-taking had to occur. People have pumped huge amounts of funds into emerging markets in the last year [or more]. At some point investors were bound to get edgy because a lot of this money is coming from hedge funds. That kind of money does seem to move out very quickly, and it seems that that ride is over.

But emerging markets are not yet negative even for the year. They've lost some of their value, but they're still up a lot. There's more volatility because people don't know where things are. They don't know if they're overvalued. They don't know whether they should pull out, or if there's still some [upside] left. And it's not just specifically emerging markets. All these fears are pretty universal. This has been in the U.S. markets, too. Emerging markets, because they've had such a run-up, have obviously fallen a lot more than the others.

Along those lines, what implications do the emerging markets' recent declines hold for larger markets globally?

There are two schools of thought. One school says we should just go overseas and let U.S. [asset] allocations remain where they were. Another school of thought says there's value in the U.S., and you should be here. I don't think there's a clear consensus on where market value lies at this point. There's too much volatility.

It's amazing the amount that commodity prices have gone up. Interest rates have gone up, and bond prices have crashed because of that. Some people are just saying put [your assets] in cash and Treasury bills, because that's the safest place to be. My personal view is that these markets have gone up so much they had to pull back. It's natural.

How do higher U.S. interest rates affect emerging markets?

If you have higher interest rates in the U.S., people can invest in U.S. government securities and get reasonable enough returns without having to take on the additional risk and volatility associated with an emerging market. You lend here and you're fine, you get good enough returns, especially because these emerging markets have gone up so much that maybe it's time to pull out.

It's the same thing in Japan, where interest rates have gone up. You even saw a currency crash a few months ago in Iceland. People pulled their money out of Iceland because interest rates came down there, and these developed-market interest rates went up. The differential was much less.

What should investors be looking for in these markets? Are there any areas of opportunities after the recent weakness?

In earlier times, when emerging markets used to have these booms and crashes, a lot of the crashes came because there were inherent inefficiencies in these markets. This time I don't see that so much. There is a lot of run-up because of commodities. Emerging markets are being propped up because of commodity prices going up. It's not just because of pure speculative buying.

Meanwhile, countries like China have gone up because their fundamentals are very strong. There are different reasons, all of which are valid reasons for countries to go up. Even if the markets have pulled back, those fundamentals still remain. They haven't changed.These markets still are a good bet. How much allocation do you give to it? That's an individual manager's choice. I don't think you'll see a crash like in the 1997 Russian crisis, where there were inherent inefficiencies that were revealed.

What factors could exacerbate the recent weakness? Are there any other potential trouble spots?

[The key factors remain] commodity prices, interest rates, and fears of inflation. But the fundamentals that drove these markets up still look good -- unless oil crashes, which I don't really see happening. Or if India, China, and Taiwan suddenly lose all their growth patterns, which again is hard to imagine in the next few months. I don't imagine anything going drastically wrong unless what we've been seeing suddenly reverses.

In general, again, emerging markets have not given back all their gains for the year. It's not a complete meltdown. It's just a natural stop to the heady gains that we've seen.

Wednesday, October 11, 2006

Citigroup, on the hunt for takeover candidates again, is most likely to make big acquisitions in emerging markets, which offer faster growth and the chance to be more than a marginal player, analysts said on Tuesday.

Citigroup Chief Executive Charles Prince said in an interview with the Financial Times on Monday that the financial services group is looking at acquisitions outside the United States as it tries to boost earnings from foreign countries to 60 percent from 45 percent in the next few years.

The stakes are high for Citi, whose shareholders are clamouring for lower costs and higher returns three years into Prince's reign as chief executive.

The financial group has looked at acquisitions in Western Europe, according to the Financial Times, and speculation and other media reports have suggested Citi is looking at various banks across the United Kingdom, France, and Spain, among other countries.

But most major Western European banks are slow-growing, and would boost the proportion of Citi's overseas earnings to well over 60 percent.

"It's about growth and for people in America that probably means Latin America, Asia and Eastern Europe," said Simon Maughan, analyst at independent research firm Blue Oak Capital.

Determining which banks are likely targets is tricky, analysts said, but there are deals that have already been made public. A Citi unit is part of a consortium bidding for an 80 percent stake in China's Guangdong Development Bank for about $3 billion. There are two other rival bids, and the results of that deal should be disclosed soon.

Citi plans to increase its stake in China's Shanghai Pudong Development Bank <600000.SS> to 19.9 percent from less than 5 percent soon.

Taiwan's Bank of Overseas Chinese <5818.TWO> is in advanced talks to be bought by Citigroup, a source at the Taiwan bank said last week, and a deal could be announced this month. The Taiwan bank had assets of about 270 billion Taiwan dollars ($8.2 billion) at the end of 2005.

In Turkey, local bankers have said Citi is looking at state-owned Halkbank, the sixth-largest bank there with assets of about 32.6 billion lira ($21.7 billion) at the end of the first half. Stakes of Akbank and Oyakbank are also up for sale in Turkey.

In Central and Eastern Europe, one analyst said Citi may be interested in Austria's Erste Bank der oesterreichischen Sparkassen, in part because of its portfolio of assets across the region.

But buying the entire bank, whose market capitalization is about 15.5 billion euros ($19.5 billion), would be difficult because its largest shareholder is a foundation owned by Austrian savings banks that is unlikely to sell.

Rob McIvor, a Citigroup spokesman in London, said he couldn't comment on possible takeover candidates, but that Citigroup does see acquisitions and organic growth as key to its strategy.

NIX ON WESTERN EUROPE

Rumors that Citi might be in the market for Barclays and Lloyds TSB have helped lift the UK banks' shares this month.

Various media reports have also said Citi may be looking at BNP Paribas and Societe Generale in France and BBVA in Spain.

But these acquisitions are unlikely, in part because of their size--BNP Paribas, for example, has a market capitalization of about 80 billion euros ($102.2 billion).

Citigroup's Prince has said he is not interested in "transformative" acquisitions, which some analysts have interpreted to mean very large deals.

To account for an extra 15 percent of Citi's 2005 earnings, a bank would have to earn about $3.7 billion a year. Most major Western European banks earned far more than that last year.

Wherever Citigroup buys, it had better boost earnings and keep expenses under control, investors said. Citigroup's second-quarter revenue grew 10 percent to $22.18 billion, but expenses rose 16 percent to $12.77 billion. The bank's $5.27 billion profit trailed the $5.48 billion reported by Bank of America Corp., the second-largest U.S. bank.

The company's shares are showing weak growth, too. Since Prince took over on Oct. 1, 2003 through Monday, Citi's shares have risen 8.7 percent, compared with a 26.7 percent increase for the broader U.S. bank sector.

"They keep saying that revenues will grow faster than expenses, but they never seem to get there. I would give Prince another 12 to 18 months to fix things," said Lee Delaporte, research analyst at Dreman Value Investors, which owns Citigroup shares.

Sunday, October 01, 2006

Emerging stock markets rebounded in the third quarter from their steepest drop since 2002 as investors anticipated that domestic economic growth would fuel demand for consumer goods.

Standouts in the quarter, including China Mobile and Wal-Mart de México, may extend their gains because incomes are rising at a faster pace in developing countries than in the United States.

"We're in a sweet spot, as far as I'm concerned," said Mark Mobius, who manages emerging market equities at Templeton Asset Management in Singapore. "Economic growth in these countries is very good."

The Morgan Stanley Capital International Emerging Market index, a dollar-denominated measure of 25 countries in Asia, Latin America, Eastern Europe, the Middle East and Africa, added 3.8 percent this quarter. It was the index's eighth advance in nine quarters.

During the second quarter, the emerging-market index fell 5.1 percent. The decline resulted from a 25 percent plunge from May 9 through June 13, the biggest for any time period since October 2002.

Funds investing in emerging- market stocks had net outflows of $1.6 billion this quarter, according to Brad Durham, a managing director at Emerging Portfolio Fund Research, which tracks 15,000 funds with a combined $7 trillion in assets. U.S. equity funds suffered outflows of $6.8 billion, Durham said.

The U.S. expansion will slow as a cooling housing market curbs consumer spending in the world's largest economy, the International Monetary Fund said this month. Prices of existing homes in the United States fell last month for the first time in 11 years and sales slipped to their lowest level since early 2004, according to the National Association of Realtors.

On Sept. 14, the IMF cut its 2007 growth forecast for the U.S. economy to 2.9 percent from 3.3 percent, the weakest since 2003.

The Chinese economy will expand 10 percent in 2006, its fourth straight year of double-digit growth, according to the IMF. The Fund raised its forecast for India to 8.3 percent this year, from a 7.3 percent estimate in April. The Indian economy grew 8.5 percent in 2005.

"The view that we will see a slowdown in the U.S. economy seems to be increasing," said Parameswara Krishnan, a fund manager at DNB Nor Asset Management in Chennai, India. "If we see that happening, countries that have a buoyant, domestic-driven economy may actually be safer bets."

China Mobile gained 24 percent this quarter, while Wal-Mart de México rose 20 percent.

Asia outside of Japan, MSCI's largest emerging-market region, climbed 4.8 percent this quarter. Demand from China and India, and the resurgence of growth in Japan helped support profits and share prices in Asia.

An MSCI index that tracks Eastern Europe, the Middle East and Africa climbed 0.7 percent, while a Latin American index added 3.2 percent. Egypt's CASE 30 index surged 35 percent, the world's best performer this quarter. Shares of United Housing & Development, an Egyptian construction company, more than doubled.

Middle Eastern stocks slumped along with other emerging markets in the second quarter as the prospect of higher interest rates around the world prompted investors to shun riskier assets.

Gulf markets added to the slump in the quarter as oil prices fell. Saudi Arabia's Tadawul stock index tumbled 15 percent, the worst performer among 80 indexes ranked by Bloomberg. It plunged 23 percent in the second quarter. Saudi Basic Industries, the largest publicly traded company in the Middle East, led the declines, slumping 26 percent in the latest quarter.

In Russia, stocks advanced for a seventh straight quarter. RBC Information Systems, a Russian media company, was among the top performers, jumping 43 percent in the quarter. A drop in oil prices limited gains. Shares of Gazprom, Russia's natural gas monopoly, added 1.9 percent this quarter after a 24 percent rally in the first half. Lukoil, Russia's largest oil producer, slid 8.7 percent this quarter.

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