Is Latin America on the mend? Earning season can be a tough time trading for anyone looking at short term position but for emerging market investors it can be time to gain insight to emerging market economies.
Just because you choose a position or invest in ETFs does not mean you can tuck them away in the back of your portfolio and forget about them.
South America’s status as a bright spot in the world economy is under threat as commodity prices fall amid declining demand for raw materials from Asia.
Everyone has been talking about how cheap emerging-market equities look after the recent sell-off. This is also true when you compare them to emerging-markets bonds.
For nearly a decade, Argentina has been isolated from international capital markets after declaring the largest sovereign debt default in history. But now the country is re-emerging.
The third-quarter earnings confessions have started up in the emerging world, but for now most of the corporate news is dominated by currencies and political news.
BRAZIL: Vale (VALE, quote) is coming under pressure from the ruling Worker’s Party as members of the current government try to win rich jobs at the giant mining company or even exert outright control. Unlike Petrobras (PBR, quote), the government does not dominate VALE outright, although it has a “golden share” to prevent hostile takeovers. While this may boil over, the hint of corruption could swing some votes as the hotly contested Brazilian presidential election runoff is only two weeks from now.
INDIA: Dr Reddys Laboratories (RDY, quote) could get volatile this week ahead of its earnings release on Saturday. Will this emerging drug stock remain a favorite of global investors after the quarterly numbers come out? Analysts are looking to see operating earnings growth of around 5.6% — fairly muted, all in all — and a net profit drop of 2.2% due to one-time charges. These numbers may shock some traders who expect everything in the emerging world to show blockbuster growth every quarter.
CHINA: China Southern Airlines (ZNH, quote) is the top-performing Asian carrier, with shares up a spectacular 133% so far this year. The question is whether there is any upside left for this stock to unlock. With a current P/E of around 14.7, ZNH actually looks fairly cheap by global standards. But with little sign of any concrete benefit from the company’s recent merger with Shanghai Airlines, future earnings growth may prove difficult, in which case this stock could look expensive next year.
ETFs in the Spotlight
GML (quote) This Latin markets fund is really a Brazil fund (70% weighting) with some Mexican large-cap exposure (17%) and a thin layer of Chilean and Peruvian stocks on top. While it is terrific to see fund managers going slightly off the BRIC track, why not simply buy the individual countries’ ETFs and fine-tune your exposure? Chile’s ECH (quote) is a fine fund in itself, and simply buying AMX (quote) will actually provide a big dose of the Mexican exposure here.
ICN (quote): India is ramping up to become a key player in the currency wars. The rupee has been surging as traders try to buy into the Mumbai stock market. This may be bullish for rupee-backed ETFs like ICN — if, of course, the ETF actually reflects the performance of the rupee and not a basket of Treasury securities designed to emulate it. ICN is up 6.91% year to date while the rupee has climbed “only” 3.89%. That is great outperformance, but unlikely to be repeated.
Police demonstrations have sparked mass unrest in Ecuador and raised the odds of a broader government crackdown, but for now U.S. investors should not worry too much about exposure.
Even though J.P. Morgan officially recognizes Banco de Guayaquil as an ADR under ticker symbol BGYQY, the stock actually does not trade even on an over-the-counter basis. As a result, there really are no Ecuadorian ADRs.
There are also no dedicated or regional ETFs with appreciable exposure to Ecuador. As a blue-chip fund with only 40 holdings, ILF (quote) concentrates on the largest Latin companies — no company traded in Quito made the cut.
And GML (quote) is nominally broader, but still concentrates all of its assets (100%) in four countries: Brazil, Mexico, Chile and Peru.
(Both funds are in positive territory today.)
When you move into Latin mutual funds, the situation gets a little murkier because traditional portfolio managers tend to only publish their holdings every three months. However, among the big players — the Blackrock and Fidelity and DWS funds of the world — there is no Ecuador equity exposure on the table for U.S. investors to worry about.
However, emerging debt funds have dabbled in Ecuadorian bonds, and these portfolios are at risk of compete default if the situation in Quito degenerates beyond the point where the government can meet its credit obligations.
Funds with 2% to 3% exposure to Ecuador include Franklin Templeton’s emerging markets debt opportunities (FEMDX, quote). Other emerging debt funds like Pimco’s PEBLX (quote) are free from direct Ecuadorian exposure:
In terms of follow-on risk, Ecuador is a significant oil exporter to the United States, so any disruption in the country could hurt local producers and push up crude prices.
Recent scares have left the big portfolios a bit reluctant to pump new money into emerging markets. This can be an opportunity for more nimble investors to get into these assets early.
All in all, only $16.4 billion has gone into emerging markets funds so far this year, which puts us at only half of where we should be to match last year’s total flows of $64.3 billion.
Most of this money is going into global funds that mostly concentrate on the BRIC (Brazil, Russia, India and China) group of big emerging markets. Beyond Brazil, Latin America has been a net loser, with overall flows of $2.1 billion leaving the region so far this year.
Sooner or later, we are convinced that the huge cash flows will return to this asset class. It might not happen this year, but it will be a function of market forces and trust factors when it happens.
Perhaps surprisingly, this is less about trust in emerging markets — remember, developed markets are seeing flows taper off also — as it is about a slowdown in cash flowing into retail funds and pension accounts. There is simply less money coming in these days, and what there is will most likely avoid everything but the most low-risk asset classes.
Money market funds have seen their assets grow by a net $10.2 billion in new cash, while Treasury funds are up $4 billion.
Developed markets equity funds have also seen a wave of redemptions as investors dump Europe and even U.S. blue chips for those few assets they consider less risky: Treasury bonds, gold.
When we see the university endowments and other institutional funds come back, it will be a great trigger for upside, especially for the most overlooked corners of the global market. Latin ETFs like ILF and GML, for example, could roar back as the big money comes around: