The Sell-Off - what do we think / what to do?
Jonathan Garner, Morgan Stanley global Emerging Market Strategist, was travelling in Rissia and Europe during the recent sell off. Below are some of his quick thoughts:
1./ We almost achieved our price target on 19th October trading up to 977 on the MXEF (our target is 985 for end H1 2010). Valuations were quite full at that level (2.2x trailing PBR and 20x trailing PER). We are already off around 8% so we are back to almost double digit percentage upside to our price target.
2./ Economies are recovering the earnings recession has just ended. On our base case for earnings recovery we got to 15.5x 2010E PER and are now around 14.0x. That is very close to the long run average forward multiple (i.e. this is not an expensive market). New bear markets do not usually begin at this point in the economic and earnings cycle but we do often enter into a range trading period. This could be what is starting now.
3./ Usually November - January are the strongest months in the performance cycle in Asia / EM with high fund inflows. However, we did not have a meaningful summer correction this year and funds flow was unusually strong all the way through August to mid October. Let's see if funds flow builds into the new year which is the usual pattern.
4./ The market seems worried about a) end of easing (Norway, India etc), b) dilution risks and more capital raise from US and EU banks, c) another Madoff type event in Europe at K1, e) Brazil's game change taxation measure, and d) US housing and consumer confidence data which was poor. But the last point surely means the US will stay easier for longer and is hardly dollar positive. Watch the DXY. A bigger rally is more of a problem for Asia / EM.
What to do?
1./ Overweight China. Top ranked in our quant model and our largest active risk position (+250bps). The safest port in any EM storm. The new QDII measures are helpful. Take a look at Malaysia, Egypt, and Israel which are classic defensives and screen as overweights for us. Our last country quant model change we took money from India to add to China and I am quite comfortable with having done that given recent events.
2./ Don't panic sell Brazil. It still screens as a solid OW for us. The tax change is not the bigger picture economic success story. Brazil has changed from a late cycle / global capital markets dependent market to an early cycle outperformer / global leader akin to Korea or Taiwan, That is a hugely positive development. Our large market UW here is South Africa which has major problems in labour and power cost pressures on profits, a new government team, a much slower economic recovery and more overvalued currency. See our recently published South Africa country guide.
3./ Hold on / accumulate into weakness the Energy names but reduce Tech further. Tech tends to outperform up to the beginning of the rate hike process globally but not thereafter while Energy does better later on in the cycle. Tech is more fully valued than energy if our house view of US$85 next year is right. Remember that in all the previous corrections Telcos behaves as the fourth defensive sector BUT faces material challenges to sustaining premium ROE over the longer term (i.e. there may be a trade in Telcos but don't make it the core of your portfolio).
3./ Use today's best business model list (attached). This is our list of the highest quality business models in each industry in EM. They are great candidates for accumuluation for longer term investors during periods of market turmoil. Using this list we sold today TSMC, LG Display. and China Railway and bought Mediatek, Hyundai Mobis and China Dongxiang.
Names on the Best Business Models list are:
Anadolu Efes, Companhia de Concessoes Rodiviarias, China Dongxiang, CNOOC, Copa Holdings, CPFL Energia, Ctrip.com, Embraer, ENRC, Hindustan Unilever, Hyundai Mobis, Implats Limited, Largan Precision, Larsen & Toubro, MediaTek, Mindray, Mobile TeleSystems, Novolipetsk Steel, Pretoria Portland Cement, PT Telekomunikasi, Reliance Industries, Sun Pharmaceutical, Tata Consultancy Services, Tencent Holdings, Tiger Brands, Wal-Mart de Mexico
