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Value ideas in emerging market shares.

Summary: Financial panics can create bargains in the stock markets. It is now time to seek value in emerging markets equities

Emerging markets witnessed an international financial meltdown in 2015 matched in scale and scope only by the Asian flu of 1998. While Russia was in financial distress since the Ukraine crises erupted in late 2013 as a popular revolt against President Yanukovych erupted in the Kiev Maidan. Brazil's Petrobrass corruption scandal and Malaysia's 1MDB sovereign wealth fund failure led to loss of investor confidence in emerging markets, as did the protests against President Erdogan's government in Gezi Park in Istanbul and border violence due to the Syrian civil war. The collapse of crude oil and metals markets was devastating for the world's commodity exporters, from Colombia to Nigeria, Indonesia to South Africa. Abenomics and ECB money printing led to a 20 per cent rise in the US Dollar Index, a deflation shock for GCC economies whose currencies are pegged to the greenback.

It is no coincidence that the bear market in GCC equities coincided with the spike in the US dollar index since April 2014.

The emerging markets "Lehman moment" came on August 11, 2015, when the People's Bank of China (PBOC) devalued the yuan and triggered a catastrophic contagion across Asian, African and Latin American currencies and stock markets, exactly as in 1998.

Even though India has among Asia's lowest trade (five per cent of exports), exposures to China, the Indian rupee plunged five per cent despite no real current account deficit, a $50 billion crude oil import windfall and Modinomics. The Sensex fell 12 per cent as global capital fled Dalal Street. The exodus of capital was even more traumatic in Southeast Asia, thanks to a bombing in central Bangkok, street protests and political instability in Kuala Lumpur and falling industrial production/exports in Seoul and Taipei. Emerging market currencies like the Turkish Lira, Brazil Real, Malaysian Ringgit, South African Rand and Colombian Peso have all lost 30-40 per cent against the US dollar even before the first Federal Reserve decline to hike interest rates in the September FOMC.

Financial panics can create bargains in the stock markets. It is now time to seek value in emerging markets equities. Despite Russia's financial meltdown since the Kremlin annexed Crimea and intervened in Ukraine in 2014 or the 20 per cent fall in the German stock market on China angst in 2014, Europe's emerging markets in the former Warsaw Pact have shown remarkable resilience. Poland, Hungary and the Czech Republic actually benefit from the fall in oil prices and the exodus of global capital from China/Asian emerging markets, Russia and Brazil. The latest Greek sovereign debt and political crisis did not lead to contagion in Central Europe and Baltic/ Balkan nations like Estonia and Romania eked out small gains despite the emerging markets bloodbath of August 2015.

Even if the Marxist leftist bloc in Syriza is jettisoned in the Greek elections, I believe it is premature and highly speculative to bottom fish in Athens, even though it has fallen 50 per cent. Turkey has geopolitical risk as its air force bombs ISIS in Syria and Kurdish secessionist PKK training camps in Iraq while its banking system/corporate external debt spikes with the free fall in the Turkish lira. Economic growth has declined to three per cent, inflation has risen to eight per cent and the central bank in Ankara is dependent on offshore hot money to finance a six per cent current account deficit.

GCC stock markets have fallen by 20-35 per cent from their peaks due to the oil shock, dollar surges and exodus of offshore capital from the regional stock exchanges since April 2015. However, I believe value has emerged in certain sectors/companies in the GCC as the sell-off was indiscriminate and thus irrational. Emaar Properties is now inexpensive at 12 times forward earnings and 1.2 times price/forward book value. Emaar's revenue model is no longer dependent on property development alone but also includes ownership of some of the finest hotels and leasing assets in the Middle East. Emaar has slashed its net balance sheet debt since 2008, boosted margins from 35 per cent to 60 per cent since the financial crisis, floated its stakes in Emaar Malls and Emaar Misr and even pre-sold 95 per cent of its delivery schedule. A credible buy/sell trading range for Emaar could well be 6-9 AED.

While India is still expensive at 16.5 times forward earnings and vulnerable to retail redemptions from emerging market funds in the Western world, the fall in August consumer price inflation below four per cent means it is almost certain that the Reserve Bank of India will cut its repo rate at least twice this winter. A steeper rupee yield curve is a huge ballast for the profits of ICICI Bank in the private sector and the State Bank of India, two of the cheapest bank shares in India that have significant restructuring potential, despite current non performing loan growth woes. I am also bullish on Indian IT firm Infosys, whose margins and profit growth benefits from a depreciation in the Indian rupee (costs) while US economic growth accelerates (revenues).

Indian pharmaceutical shares are also immune to China risk. However, India is still the largest consensus overweight in global emerging markets and Dalal Street will be hit if offshore capital from this battered asset class exits in a future panic selling wave.

China's Politburo has been unnerved by the global shock waves from the Shanghai/Shenzhen stock market crash and the PBOC decision to devalue the yuan. China is in the midst of a deflation shock since the debt/GDP ratio is 250 per cent and the Middle Kingdom is the leading export destination for four dozen Asian countries all over the world.

The Chinese central bank has injected more the $100 billion into its Big Four banks, exactly as it did when exports plunged in the post Lehman global recession in autumn 2008. Beijing will also unveil a fiscal stimulus to keep the illusion of the Politburo seven per cent GDP growth target intact. This could actually lead to a bear market rally in MSCI China, whose valuation has been derated to seven times forward earnings. Chinese banks like ICBC or Bank of China trading at 6 times earnings, could well benefit from the Beijing "reflation trade"!

GCC stock markets have fallen by 20-35 per cent from their peaks due to the oil shock, dollar surges and exodus of offshore capital from the regional stock exchanges since April 2015

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Publication:Oman Economic Review (OER)
Geographic Code:9CHIN
Date:Oct 20, 2015
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