Capital market report on the Emerging Markets
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19 Iunie 2011 |
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Global overview
EM equity markets dragged down by inflation, interest rate hikes and worries about faltering growth in China and/or the Eurozone
Equities in the Emerging Markets (EM) were generally weaker in May. As in the previous months, prices suffered primarily from worries about inflation and interest rates. This was compounded by mounting concerns about a possible sharp decline in economic growth, due to the sovereign debt crisis in the Eurozone and the restrictive monetary policy being pursued in China. These latter worries triggered some steep declines in commodity prices at the beginning of the month. In the wake of this, the equity markets in Russia and Brazil, which are strongly influenced by commodity producers, slid lower, in particular as the latest economic data released by these two countries was also relatively disappointing.
Early in the year, there were worries about the booming Chinese economy overheating, but now speculations are increasingly shifting towards concerns about a sharp slowdown in economic activity as a result of the restrictive monetary policy and the redefined policy objectives in the country's new five-year plan. So far, however, the economic data are not pointing to any major slump in Chinese economic activity. Regardless of this, it is still amazing to see how market agents on the developed, Western equity markets are pinning their hopes for more robust global economic growth on a planned economy, which is deeply repressive in terms of politics and is planned down to the smallest detail.
No permanent solution to the Eurozone’s sovereign debt crisis is on the horizon
The sovereign debt crisis in Greece, Ireland and Portugal continues to simmer along and there are still no good solutions in sight. A wide range of scenarios is conceivable, but right now no one can be sure which of these will materialise, including the political decision-makers in the Eurozone. It is likely that some of the scenarios for a solution which may make economic sense despite all of the negative side effects and ramifications cannot be implemented due to political resistance. Vice-versa, various approaches which may appear reasonable from a political perspective are not viable on the basis of economic considerations, mainly because they actually only postpone real solutions to the problems. But ultimately the decisions that must be made are of a political nature and thus taking a perspective of a few months at least, it is likely that the situation will be stabilised with further packages of financial aid, even if this only postpones the real problem into the future.
Against this backdrop, the euro has lost some ground against the US dollar. Nonetheless, considering the massive problems confronting the Eurozone, the current exchange rate level of around 1.45 is still amazing, albeit one must note that should be interpreted less as a sign of confidence in the euro and more as an expression of the deep global mistrust of the US dollar.
Growth dynamics in the EM are slowing down – right now, this still looks more like a dip in performance with the long-term upswing remaining intact
Economies in the Emerging Markets in Asia and Latin America are still broadly on track for more growth, but there are clearly visible signs of growth dynamics tapering off in many countries. Right now, the question remains as to whether this merely represents a normal pause during the growth cycle or if it marks the beginning of a longer period of economic deceleration. At the moment, we tend more towards thinking that this is a temporary dip in economic performance within a longer-term, intact growth trend.
Economies in Central and Eastern Europe also continue to recover. Employment is picking up thanks to an upturn in industrial production driven by vigorous external demand. In general, more increases in inflation have been observed in the recent past, driven mainly by higher food and fuel prices. The overall outlook for most CEE currencies is still positive – foreign trade and the prospects of rising interest rates should provide more support as well. The biggest risk factor continues to be the ongoing problems in the Eurozone’s sovereign debt crisis and the related risk of economic slowdown in the CEE countries’ most important trading partner.
Country focus
China
China plans to re-align its economy more strongly towards the domestic market
Just a few months ago, many were nervous about the Chinese economy overheating, but now there are mounting worries that the central bank’s policies will slam the brakes too hard on economic activity. The latest economic data also already indicate how difficult it will be to implement the government’s plans to re-align the Chinese economy: even for much smaller countries it would be a demanding task to shift the economy’s orientation towards a stronger focus on domestic consumption and move away from a model centred on exports and massive investment in capital goods and infrastructure. For China, a vast country with more than a billion inhabitants and numerous conflicts between the individual provinces and regions and the central government, it is a truly Herculean task.
Surveys amongst households are showing that the public’s propensity to save is increasing sharply again. High inflation and worries about job security are just a couple of the reasons that Chinese consumers are inclined to save more and consume less. Moreover, the government-sponsored economic projects initiated during the crisis in 2008-2009 are now winding down, which is also exerting downward pressure on growth.
The measures taken by the central bank on the real estate market and to curb developments in money supply are also now having tangible effects. At the same time, it remains to be seen whether the trend in inflation will start to ease from mid-year, as currently projected. If not, there may be more rate hikes, which would further dampen economic activity. In light of the above factors, the Chinese equity market remains unable to embark on a positive trend. Nor has investors’ mood been helped by the numerous accounting scandals at Chinese companies listed on the US stock markets and in Hong Kong. If the economic worries for China and the Eurozone fade away in the months ahead and inflation does taper off significantly, then the Chinese stock market may be able to post more substantial performance again. For the time being, however, caution is in order, especially for strongly cyclical stocks which are sensitive to economic developments.
India
In India, high inflation continues to be market participants’ main worry. Annual rates of increase in wholesale and food prices are still around 8%-9%. As a result, more rate hikes by the central bank appear to be likely, and we currently anticipate that rates will be lifted by a total of around 75bp by year-end. With this outlook, the Indian equity market remains under pressure. Following the temporary rebound in March-April, the BSE-Sensex stock index slid back near to its lows from February, before recouping some of losses towards the end of the month.
Brazil
Growth dynamics tapering off as inflation remains stubbornly high
In Brazil, the economic data continues to point to a significant slowdown in growth. Compared to the previous year, industrial production is now actually on a declining trend, and the purchasing managers’ index is merely hovering right above the growth threshold. Inflation expectations remain high, but have nonetheless stabilised at level of around 6.5% for 2011. Despite all of the countermeasures deployed by the central bank, lending growth remains far too high. Due to these factors, the equity market continues to be under pressure.
The telecommunications sector has been able to hold up relatively well again. Furthermore, some of the residential construction and real estate stocks appear to be bottoming out now, in the wake of the massive price declines registered for this industry in recent months. The upside potential for the equity market, as measured by the Bovespa Index, appears rather limited at present, but most of the negative scenarios on the downside have probably already been discounted in share prices.
Russia
In Russia, the economic indicators are pointing to a slowdown in the economic recovery process. GDP growth during the first quarter of the year was lower than the government’s forecast and also fell slightly short of what the market was expecting.
Capital has been flowing out of Russia due to uncertainty about the candidacies of Prime Minister Putin and the incumbent President Medvedev in the presidential elections, the decline in oil prices in May and some massive corrections in a variety of commodity prices. At the end of May, the central bank left the key rate unchanged, but moved to raise the overnight deposit rate (which came as a surprise for many market participants). The rouble weakened against the euro-US dollar currency basket in month-on-month terms, in line with falling oil prices. Although yields on Russian bonds rose compared to the previous month, on the whole EUR-based investors still enjoyed positive performance from Russian bonds in May due to the weakening of the euro.
Russia’s equity market came under pressure in May, due on the one hand to the declines in commodity prices and on the other to the rather disappointing outlook for state-regulated gas and electricity prices in the future. By contrast, companies focused on domestic consumption and some Russian banking names held up relatively well.
