Bloomberg News

Emerging Stocks at 35% Discount Luring Goldman as Rates Drop

November 30, 2011

(Updates prices starting in second paragraph.)

Nov. 22 (Bloomberg) -- Emerging-market stocks are trading at levels 35 percent cheaper than their 15-year average as rising profits and falling interest rates from Brazil to Indonesia buoy investor confidence.

While the MSCI Emerging Markets Index’s 9.7 percent gain from this year’s low on Oct. 4 lifted its price-earnings ratio to 10.3 from 9.7, the gauge is still trading below its mean since 1996, according to data compiled by Bloomberg. The measure jumped an average 35 percent after developing-nation policy makers began cutting interest rates in 2003, 2005 and 2008.

Investors pulled $26 billion from emerging-market mutual funds in the first nine months and the stock indexes sank about twice as much as advanced nations after Indonesia, Poland and Brazil raised interest rates. Now borrowing costs are coming down as policy makers seek to spur expansions at a time when export growth and inflation are slowing. The MSCI index may rise 30 percent in a year as record earnings outweigh Europe’s debt crisis, more than 17,000 forecasts compiled by Bloomberg show.

“You still have great relative growth advantages for a lot of the underlying economies and very cheap stocks,” David Donabedian, who oversees about $17 billion as chief investment officer at Atlantic Trust, said in a Bloomberg Television interview. “We’ll begin to see better performance out of the emerging markets over the next three or four months and the reason is we’re going to see some positive policy changes.”

Petrobras Gains

Federated Investors Inc., which oversees about $352 billion, has been buying developing-nation equities in the last few weeks, Philip Orlando, the firm’s chief equity market strategist in New York, said on Nov. 10. Shanthi Nair, a global strategist at Nomura International Plc in London, lifted her recommendation on emerging stocks to “overweight” from “underweight” on Nov. 6. Goldman Sachs Group Inc. advised clients the same day to bet Chinese shares will rally.

Energy and raw-materials companies have led gains in the MSCI emerging-market index from this year’s low as Rio de Janeiro-based Petroleo Brasileiro SA, Brazil’s state-owned oil producer, and Hong Kong-listed Zijin Mining Group Co., China’s biggest gold producer by market value, rose more than 15 percent.

Petrobras was valued at 0.6 times net assets in September, the lowest level since 1999, according to data compiled by Bloomberg. Zijin, located in Fujian province, fell to 1.5 times net assets, the lowest since October 2008, the data show.

Inflation Slows

The MSCI emerging-market index is down 21 percent this year, compared with a 12 percent drop in the MSCI World Index of advanced-country shares. The Hang Seng China Enterprises Index has lost 24 percent, the BSE India Sensitive Index sank 21 percent, Brazil’s Bovespa declined 19 percent and Russia’s Micex slid 18 percent.

Central banks in seven of the 10 biggest emerging economies increased borrowing costs in the first half to slow inflation as a rally in commodities pushed the S&P GSCI Spot Index to an almost three-year high in April. The index of raw-materials has since dropped 16 percent as the global economic expansion cooled, reducing inflation from 2011 peaks in every major emerging economy except Turkey and South Africa.

Brazil has cut its benchmark Selic interest rate by 1 percentage point since August to 11.5 percent and Indonesia unexpectedly lowered its reference rate by half a percentage point to 6 percent on Nov. 10. While Poland and Mexico left borrowing costs unchanged at their latest policy meetings, interest-rate futures show that traders are betting on reductions in the next 12 months. Traders in India are also wagering on lower rates even after the central bank increased borrowing costs on Oct. 25.

Europe’s Crisis

Easing monetary policy “has often been a good signal that it’s time to allocate more to emerging stocks,” James Paulsen, who helps oversee about $333 billion as chief investment strategist at Wells Capital Management in Minneapolis, said in a Nov. 7 interview on Bloomberg Television.

Lower borrowing costs have reduced the attractiveness of some emerging-market currencies, fueling faster inflation and higher foreign debt servicing costs. Turkish policy makers, who cut interest rates to a record in August, doubled some borrowing costs for banks on Oct. 26 after inflation accelerated to the fastest pace in a year. Hungary may boost interest rates to support the forint after its slide to an all-time low made foreign-currency debt more expensive, Stockholm-based Nordea Bank AB wrote in a Nov. 11 research report.

China Boosts Growth

Europe’s debt crisis may weigh on emerging markets should the region’s banks reduce lending to preserve capital, said Myles Zyblock, the chief institutional strategist at RBC Capital Markets in Toronto. Yields on Italy’s government debt jumped to the highest level since the euro’s introduction in 1999 this month, while the country’s banks increased borrowing from the European Central Bank in October.

European lending of $3.4 trillion to developing nations is almost triple credit from U.S. and Japanese institutions combined, according to Bank for International Settlements data through March 2011.

“If the lending wheels in Europe seize up, you’re going to see a lot of activity slow in emerging markets,” Zyblock said in a Nov. 10 interview on Bloomberg Television.

In China, the biggest developing economy, policy makers are acting to bolster growth even after leaving the key lending rate at a three-year high of 6.56 percent since July. The central bank has pumped cash into the financial system this quarter and new lending by the country’s banks jumped by more than analysts forecast in October. Inflation has dropped for three straight months, according to government data.

Reversing Positions

China’s economy grew at a 9.1 percent annual rate in the third quarter and the International Monetary Fund estimates it will expand 9 percent in 2012. That compares with a 6.1 percent growth forecast for developing nations and 1.9 percent for advanced countries, the Washington-based fund said in September.

“The market may be poised to continue to shift from the pricing in of hard landing scenarios to the pricing in of some policy-driven relief and reacceleration,” Noah Weisberger, a strategist at Goldman Sachs, wrote in a Nov. 6 e-mail. The New York-based bank advised clients to bet the Hang Seng China Enterprises Index will beat the Standard & Poor’s 500 Index.

The MSCI emerging-market index outperformed the MSCI World gauge by an average 20 percentage points in 12 months after interest rates peaked in Brazil, Russia, India and China, known as the BRICs, according to data compiled by Bloomberg since 2003.

Earnings Climb

Technology companies, automakers and retailers led the advance as interest rates began falling in 2008. Samsung Electronics Co., the Suwon, Korea-based maker of semiconductors and smartphones, Dongfeng Motor Group Co. of Wuhan, China, and Cia. Hering, the Blumenau, Brazil-based clothing retailer, all climbed more than 50 percent in 12 months.

While Samsung has gained 17 percent since the end of June, the stock’s price-earnings ratio of 11 is still 54 percent below its historical average, according to data compiled by Bloomberg.

Dongfeng trades at a 50 percent discount to the average valuation of global peers after the shares fell 22 percent since the second quarter, the data show. Hering shares, up 6.2 percent during the period, may gain another 16 percent in 12 months, according to the average of nine analysts’ share-price estimates compiled by Bloomberg.

Emerging-market companies posted sales growth of 27 percent in the third quarter, about four times faster than in advanced countries, according to data compiled by Bloomberg. Profits in the MSCI developing-nation index climbed an average 2.7 percent during the period, compared with a decline of 0.3 percent in the MSCI World measure, the data show.

Fund Flows

Earnings will increase 14 percent to a record in the next 12 months, according to analyst forecasts compiled by Bloomberg. Price forecasts for individual emerging stocks suggest the MSCI index will advance to 1,190 in the next year from 909.94 yesterday.

The gauge’s price-earnings ratio of 10.3 compares with the 15-year average of 16 and is lower than the MSCI World index’s level of 12, according to data compiled by Bloomberg. The Hang Seng China Enterprises Index trades for 8.1 times profits, a 40 percent discount to its mean since 2001, the data show.

The decline in valuations is luring back mutual fund investors, who poured $7 billion into developing-nation equities in the past five weeks after three months of redemptions, according to data compiled by Cambridge, Massachusetts-based research firm EPFR Global.

“People gradually are getting comfort that we’re heading to some kind of soft landing,” Jonathan Garner, chief Asia and emerging market strategist at Morgan Stanley in Hong Kong, said in a Nov. 11 interview on Bloomberg Television. “There’s a good chance the markets have already troughed for this cycle.”

--With assistance from Lisa Murphy and Ye Xie in New York and Susan Li in Hong Kong. Editors: Philip Revzin, Laura Zelenko.

To contact the reporter on this story: Michael Patterson in London at mpatterson10@bloomberg.net

To contact the editor responsible for this story: Laura Zelenko at lzelenko@bloomberg.net


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