Longest BRIC Stock Rally Since 1997 Seen Doomed as Interest Rates Increase
For the first time in two years, emerging-market analysts are cutting profit estimates more than they’re raising them, consumer stocks are trailing energy producers and shares of smaller companies are losing to larger equities, data compiled by Bloomberg and Morgan Stanley show. The same reversals foreshadowed the end of the emerging-market rally in 2008.
While the benchmark MSCI Emerging Markets Index has gained 0.9 percent this year and mutual fund investors are buying developing-nation equities at the fastest pace in five months, the gauge is valued at about 2.1 times net assets, 11 percent higher than the 15-year average. Societe Generale SA and Barclays Wealth are advising clients to reduce emerging markets investments as inflation erodes record-high profit margins.
“Inflation risk is much more visible” in emerging markets than the developed world, said Kevin Gardiner, the global head of investment strategy at London-based Barclays Wealth, which oversees about $266 billion. “Growth is beginning to slow. Meanwhile, valuations look full.”
The MSCI emerging-market index retreated 1.7 percent yesterday after Standard & Poor’s cut its credit outlook on the U.S., the world’s biggest economy, to negative from stable. The gauge slipped 0.1 percent to 1,160.56 at 8:50 a.m. in London.
Inflation in China and India accelerated by more than economists predicted in March as rising commodities and inflows of capital into the fastest-growing major economies thwarted policy makers’ efforts to contain prices, government reports showed last week. Consumer prices in Brazil rose at the fastest pace in more than two years last month, while Russia’s inflation rate is 0.1 percentage point below the highest level since October 2009.
China has increased borrowing costs four times since October, while India raised rates eight times since March 2010 and Brazil boosted its rate five times. Russia lifted its main rate in February. China’s benchmark one-year lending rate is 6.31 percent, while India’s repurchase rate is 6.75 percent and Brazil’s Selic rate is 11.75 percent. Russia’s refinancing rate is 8 percent.
‘Party Is Over’
Rising costs and interest rates are starting to take a toll on company profits. Gross margin, or the percentage of sales remaining after product expenses, has slipped to an average 31 percent for companies in the MSCI emerging-market index, from 33 percent last year, the highest level since Bloomberg began tracking the annual data in 1996.
Shares of Infosys Technologies Ltd. (INFO), India’s second-biggest software exporter, posted the biggest drop in almost two years on April 15 after the Bangalore-based company predicted higher salaries will erode profitability.
Rising commodity prices are “triggering second-round effects via higher wages,” Alain Bokobza, the head of asset allocation strategy at Paris-based SocGen, wrote in an April 11 report titled “The EM Party Is Over.” He recommends switching to developed-nation equities from emerging markets.
Infosys was the seventh-biggest contributor to the MSCI index’s 2 percent retreat last week. The gauge’s decline yesterday pared the gain from its March 2009 low to 145 percent. The 21-country index has rallied for 777 calendar days without a drop of at least 20 percent, the longest stretch since July 1997, according to data compiled by Westport, Connecticut-based research firm Birinyi Associates Inc. and Bloomberg.
Goldman Turns Bullish
The emerging-market gauge’s 0.9 percent advance this year through yesterday compares with a 2.9 percent gain in the MSCI World Index of advanced-country shares and 3.8 percent for the S&P 500.
Goldman Sachs Group Inc. has turned bullish on emerging- market stocks, saying that central banks will slow the pace of monetary tightening as inflation eases. A United Nations gauge of world food prices fell in March for the first time in nine months, while the S&P GSCI Index of commodities has slipped 3.7 percent from this year’s high on April 8.
China said on April 15 its economy expanded at a faster- than-estimated 9.7 percent rate in the first quarter, a sign that demand is weathering tighter monetary policy.
“The balance of risks is shifting,” wrote Noah Weisberger, a New York-based analyst at Goldman Sachs. The bank expects emerging-market stocks to rally about 12 percent, according to an e-mailed note yesterday.
Mutual-fund investors are also reviving bets on a rally. They poured about $10 billion into developing-nation stock funds during the past three weeks, the most in five months, data compiled by Cambridge, Massachusetts-based research firm EPFR Global show. That compares with $28 billion of outflows in the previous nine weeks, EPFR data show.
Analysts are cutting more profit forecasts than they’re raising them for seven of 10 industry groups in the MSCI emerging-market gauge, with the biggest reductions on health care, telecommunications and technology companies, according to Morgan Stanley. Energy companies are getting the biggest estimate upgrades after oil prices surged 17 percent this year to near the highest levels since 2008.
Consumer stocks in the MSCI emerging-market index trailed energy companies by 10 percentage points in the first quarter, the most since the second quarter of 2008, when emerging-market equities began tumbling amid the global financial crisis. Small- cap companies, which have market values of less than $2 billion and get a higher proportion of their revenue from consumers, trailed the biggest emerging-market stocks by 5.5 percentage points last quarter, also the most since 2008.
“It’s quite difficult for equity markets to rally if you have negative revisions to the earnings outlook,” Jonathan Garner, the chief Asia and emerging-market strategist at Morgan Stanley in Hong Kong, said in an interview. “This is quite an important moment and we don’t think the situation will improve in the coming months.”
Garner’s 1,290 year-end price estimate for the MSCI emerging-market index is about 10 percent below the 1,428 average of five strategist forecasts compiled by Bloomberg.
China International Capital Corp., the country’s biggest investment bank, predicts slowing economic and earnings growth will limit equity gains in the biggest emerging stock market. The top-ranked provider of China research in Asiamoney’s survey recommends “defensive” Chinese companies including drugmakers and consumer-staples producers.
China bulls expecting a rally in stocks as the central banks nears the end of its monetary policy tightening may be disappointed, Hao Hong, the global equity strategist at CICC, said in an April 10 report.
The Hang Seng China Enterprises Index of Chinese shares listed in Hong Kong dropped 23 percent in the six months after the central bank stopped raising rates in 2007, underperforming the MSCI emerging-market index by 14 percentage points. In 2004, the H-share gauge rose about 3 percent after rate increases ended, trailing the MSCI index by 8 percentage points.
Infosys has tumbled 12 percent in Mumbai trading since the company reported results on April 15. Credit Suisse Group AG downgraded the stock to “neutral” from “outperform,” citing the company’s “poor” outlook for profit margins. The shares are valued at about 24 times earnings, compared with the five- year average of 27 times, data compiled by Bloomberg show.
Grupo Televisa SA, the world’s largest Spanish-language broadcaster, sank to a six-month low in Mexico City trading last week after first-quarter profit fell 18 percent. JPMorgan Chase & Co. analysts cut their 2011 earnings estimate for Televisa yesterday, saying that rising costs and “weak” revenue are eroding profits.
“In most emerging markets, you do have these margin pressures building,” Michael Shaoul, the chairman of Marketfield Asset Management in New York, who has been shifting investments to the U.S. from emerging markets, said in an interview. “We’re fairly convinced that this monetary cycle will end in some distress.”
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