“Is it safe to come back to emerging markets yet?” says Jonathan Anderson of UBS. Until recently, the answer was a clear no, but after the fourth-quarter carnage, “we are more willing to consider that the very worst is now over”. There’s little support for a dramatic recovery, but some regions and assets may have reached a point where the downside risks are “relatively limited”.
Most clearly in the doghouse is emerging Europe. The outlook is grim, says BNY Mellon: Hungary has already been bailed out by the EU and IMF, while the Baltic states teeter on the edge of big devaluations, “which, given their very high levels of household and corporate foreign denominated borrowings, would be very damaging for their economies”. Russia “is facing the worst crisis in a decade” amid a declining rouble, slowing growth, deficits, social unrest and “Western investors’ continuing mistrust”, says Pierre Briançon on Breakingviews. The only good news: “so far, its government has given no sign that it wants to go back on the main achievement of the last ten years: it’s opening to global markets.”
In Latin America, expect “a two-stage year”, says Geoffrey Dennis of Citigroup. A new relapse in early 2009 as the worst of the economic news comes in should be followed by a strong rebound from the middle of the year (although this is based on expectations of a mid-2009 US recovery). Earnings are likely to fall 50%, but economic fundamentals are generally better than usual: central banks have flexibility to cut interest rates, while healthier than normal budget and trade balances “provide scope for counter-cyclical fiscal policy”.
Brazil and Chile are the safest bets while things remain tough, while Mexico would become appealing if the Bolsa falls to the 18-19,000 level. Traditionally defensive Columbia is exposed to the risk that low oil prices will bring the economic crisis to Venezuela, a key trading partner, while Argentina should be avoided. “We expect the country to be demoted to ‘Frontier’ market status by MSCI, while the risk of economic crisis and even default is rising.”
Emerging markets: Asia is now very cheap
In Asia, we should expect “the classic post-boom and bust trading pattern”, says Michael Hartnett of Merrill Lynch: sideways trading within a large range. “Asian 2009 upside is constrained by the weak global growth, the downside protected by excess pessimism and cheap valuation.” He prefers “cash-rich” China to “an Indian corporate sector dependent on foreign capital”, while for contrarians, under-owned Korea looks a better bet, despite the weak economy, than tech-heavy Taiwan. Markus Rosgen of Citigroup agrees that the region is cheap on a price/book value of 1.3 times: “stocks have been more expensive than this 93% of the time”.
US dollar weakness and re-inflation would be catalysts for Asia to move higher, since these conditions would help the region’s asset-intensive, low-pricing power business model the most. But with first-half news flow set to be weak, “markets will go lower before closing higher by end-2009 on anticipation of a 2010 recovery”. And while the crisis continues, be careful of South Korea, says Anderson. It has the highest levels of domestic debt and leverage among major emerging economies so is susceptible to deleveraging pressures. Given its size and importance in Asian markets, “investors would be advised to keep an eye on this”.