With everything that’s going on in Europe and the continuing political charade in America, you might easily be distracted. But there’s another far more important story developing in other regions of the world. And in my opinion, it’s as important and perhaps more important than these other headline grabbers out of Europe and America.
In the last few months we have seen a persistent weakness in trends out of the BRIC nations. This is important because the countries have been the one truly strong leg in the global recovery. This has been nowhere more apparent than in corporate earnings. While domestic revenues have remained flat to down, international companies continue to experience strong growth on the back of this growth. But the trend appears to be changing.
If we look at the most recent PMI data from all four nations we can see how different this slow-down is from the scare in 2010. It’s deeper in all regions (except China). Brazil, Russia and China are already in contraction mode and in the case of Brazil it’s quite deep at 46. India’s PMI readings are still on the expansion side, but at levels seen just 2 times in the last 6 years.
This has hit markets hard in recent weeks and commodity markets in particular as they tend to be BRIC sensitive. I believe investors would be wise to heed the risks in the commodity sector, but also keep an eye on commodity prices as they’ve proven to be a fairly good real-time indicators of future expected economic worries in these parts of the world.
This is the primary exogenous risk to the US markets at this juncture. If the BRIC countries were to experience a substantive and sustained recession, Europe and the USA would suffer mightily as they continue to struggle with their balance sheet recessions. This is a story that needs greater attention as Europe and the USA steal the spotlight. This is just one more piece in an already worrisome global economic puzzle.
TPC Friends- I mentioned we bought EM 9/6 with the idea of it outperforming the SPX – It seems the markets have discounted alot here but it may not be enough to entice other buyers. It also may(is) still be more expensive than other market participants beleive…..this postion is down as of yesterday -9.19% our small cap EM is down -11.96%.
Finding that fulcrum is what we all strive at. The point in which a particular market has declined, the present pessimism is lagging and showing up today, the future looks terrible but the markets have discounted something far worse and the market turns. [fear] We did this trade short term 2-3 months. Love me or hate me I’ll share my actions as a learning or teaching tool. The good, the bad and what ever this one turns out to be(right now it’s ugly) Here’s why we did the trade:
We said EM would underperform 2011. Inflation, relative outperformace and destabilizing torrent of liquidity. On 9/6 EM had underperformed the SPX by 700bps in line with this view. We avoided them all of 2011. We think the SPX completed it’s first bear market down leg and a multi month rally would correct the 5 month(now 6 months 20%) 18% decline back up to 1250-1300 before heading much lower..950-975 Q1 2012. EM- SHCOMP Daily(China) Nifty Daily(India) (IBOV Daily) Brazil, (Micex Daily) Russia all showed improving relative strength vs. the SPX. (you take the composite divided by the Spx)Also the dividend yields exceeded those of Devolping markets by 75bps at the time. WHEN THIS MXEF/SPX DIVIDEND YIELD WAS GREATER THAN .75 which has rarely occured 15.6% of the time the forward annualized returns were 27.5%. This combined with the rate cuts of brazil. When braxil central bank since 1999 has targeted rates 1 month later the market went up on average 5.01%…3 months…13.60%…..and 6 months…20.27%. So this is what we saw. There was risk(see cullens comments above)but I felt this was the best place given valuations had come down to more attractive levels. I did not have this data then…but GMO has EM equities at 7.2% 7 year forecast. I think it gets better above 10% in 2012 but we are short term over sold. So far I have been WRONG. But all we’ve done is get better valuations, higher yield and scare investors further. This is what I saw. This is why I made the buy. and I will have to learn from this. The Macro picture detoriated further and risk taking/redemptions have been poor. But that was my process. It doesn’t always work how I want it to. Kind of like life.
Would urge you to take note that Shanghai broke a 20 year trend line that has held multiple times over that period, including the 08/09 panic lows, about a month or two ago. No support on the chart for another ~8-10% down.
Would also note the Bovespa broke a similar trend line dating back to 2002; it too held at the panic lows.
Big dollar break out as well.
Maybe your s-t trade will work but I’d rather play Europe for a bounce than EM given how bad EM is looking technically with multi-decade chart breakdowns…
VII,
I just updated my numbers for EM. Essentially it is what GMO does but I update it since they release their numbers so late. Since my methodology is the same it usually comes in within a few bps. Anyway, after the declines this month I put the projection at around 9.2%.
That is a pretty strong potential return. However, if this slowdown is as pervasive as it appears it will be we may have an oooprtunity to buy EM with long term high teen return potential, which I haven’t seen for quite a few years. Juicy!
Lance-Well Done.
The lesson I think here…and maybe others will have advice is that…when the macro picture detoriates some of the stats arn’t worth much. When we look at the last 10 years of movement policy has distorted markets. If those policies are being less supportive or being removed it can trump proabilities. So we break through 10-20 year trends and go to longer term trendlines.
When the bear awakes standing still(holding cash) may be the best way to stay alive. Many of you on this site are doing just that. Right now I’m the guy who got attacked on teh 5 o clock news because he sat in the woods cooking fish outside the bear cave.
“Juicy”..sounds like a man is getting ready to eat the bears leftovers. Well done Mr. Paddock.
Well, I have some exposure, but it is pretty hedged. What I do in a situation like this is have a plan of action. Since the BRICS are undervalued I will bring it up to my preferred exposure based on some strength, basic trend following, but shorter term. I only add on longer term signals if overvalued. If it keeps going down I keep increasing how much I will add when it turns and add that at the shorter term signal. Then if I cross a longer term signal I add as much as I am willing to hold based on the valuation at that point. If I can add a bunch of exposure on a longer term trend and it is projected to return in the mid teens I am pretty damn happy.
What’s the rationale for investing in EMs ? Are the debts in those countries (much) lower ?
In general yes, but that isn’t my rationale. It is that they are cheap. Growth plus high yields leads to high returns. Personally, I hope they get a lot cheaper.
My rationale has changed….
EM are a fantastic tax mitigator. For me..they will offset many of the gains I’ve had this year.
I bought them for the Capital Loss..(i’m never wrong)
Debt to GDP in EM by 2014 will be much lower at around 30-35% according to some projections, whereas in developed countries, it will be closer to 100%.
Demographics and these lower levels mean that from a longer investment perspective, growth dynamics are really good.
In relation to exposure to EM, I would rather favor EM bonds to Equities, but not right now, more widening to come:
http://www.economist.com/node/21530992
You also have to look at countries and regions. Overall, EM bonds funds both in external debt as well as local currency ones have had some really good returns last couple of years, as well YTD.
http://www.economist.com/node/21529080
Also, from a credit perspective, the picture is much better given we have moved from HY ratings to more investment grade like profile in the last couple of years. You have had more upgrades in EM and more downgrades in developed countries so far this year.
So overall, short term, be cautious, longer term, debt picture is much better.
Best,
Martin
Good point. BRIC story is really more important in the sense of “normal” economic activity, not “black swan” one. And, as for now, people still significantly overplay Greece and underplay China and Brazil. Awakening might come soon.
Right. And the theme was for a long while that the BRIC countries wouldn’t be affected at all. I read similar stories on several other websites.
And take a look at the BRL/USD, KRW/USD and SGD/USD. They all took a severe beating. Money is fleeing those currencies/countries. More proof, IMO, that the EURO was not the only currency that took a beating (against the USD). More proof of more deleveraging up ahead. This is a nightmare scenario for the folks in D.C. It’s all so like 2008.
Guy’s what is your favored em investments, MSCI index’s?
If I want broad exposure in index form, yes, EEM works. However, buying active managers or individual countries might make sense as well depending on what you are trying to accomplish.
A key is to realize how cheap these guys can get. There were times last decade when you could buy whole countries trading with a mid to low single digit P/E. If you are patient it is hard to lose money on markets trading at a trailing P/E of 4 or 5. When that happens more narrow managers or indexes make a lot of sense. Mutual funds instead of ETF’s may make sense then too because it pays to ignore trading out of it when things are that low and just ride the tiger.
By the way, I think the emerging value opportunity is starting to show up in Europe as well. I’ll be updating my projections at my site by Monday at the latest, but I wanted to know if anybody has access to good valuation numbers for the various markets in Europe?
So falling BRICs could be good for the US by easing commodity pressures (i.e., gas prices) and allowing the consumer to deleverage faster, like the tax cuts and/or spending increases we should be getting but aren’t.
This is an admittedly myopic view: falling BRICs are not whole-Earth Pareto optimal.
EM – This is important to say- I WAS WRONG ON MY CALL HERE. We’ll see if it was just early. I just visited with my team about this one. And it was a great discussion. Two CFAs,1 PhD(from a well known school).and some other folks much smarter than I am.
The range is wide here SPX- 1080-1250. It would be out of our range for any quick move below 1080..here. I’m getting off topic of EM but please forgive me(i read a commentors comments about staying on topic…and I’m going to try and do a better job at this for the benefit of others..with occasional banter with Trixie)
We kind of see a broad paint brush..from 800-1380 since 2000. So the lows should be made soon around 950(first recognition) then bounce then 850 where we’ll put on longs…BUT- and I think B ferro really nails this…and as much as it pains me to say this…Bond Vigilante/Willy2 will get his bond caos inflation around 2015. We should see two real terrible bond moments which will coincide with the final low in the Secular Bear around 2014-2016..which is our generations 1982 moment. I don’t believe…Q1 2013 will be the final low. I think the bond market will have 2 moments out in 2014-2016 that will make Willy2 very happy.
EM- the divergence continues..bottoms are being close to put in..we’ve completed the 5th wave but the SPX is not close yet. It’s going to be bumpy..were moving out tomorrow and I think the first two weeks of October could send us down to 1080 where we will go long into December. If it goes below 1080 it is out of anything we are anticipating short term. This could be the extreme pessimism we need to go long again.
BUT I WAS WRONG ON MY EM CALL 9/6.
I’m staring at the EEM weekly price chart (36.95) and it looks like it wants to retest the summer of 2009 congestion area and right below that is a big price gap at the 28-ish area and below that is the horror show of the fall of 2008 and the spring of 2009 …$20-ish.
Read Full Article »