While most industrialised stockmarkets have been rising steadily over the past few weeks, emerging markets are surging ahead. The MSCI Emerging Markets index, measured in dollars, has gained 12% in 2009; its counterpart tracking developed countries is still down 8% on the year. The best-performing region has been Latin America, with the MSCI index up 16% in dollar terms. Long-term emerging-market favourite Brazil has led the pack, with the local Bovespa index having risen by 50% since it bottomed in October.
Global investors’ renewed appetite for risk, fuelled by the rebound in commodities and signs of improvement in China, has underpinned the latest boom. Investors also seem to have noted that parts of Latin America, including Brazil, are in far better structural shape than they were in previous crises, leaving them well positioned for a sustainable rebound once the global downturn recedes. President Luiz Inácio Lula da Silva boasts “more responsible” recent fiscal and monetary policies than Britain or America, says Martin Hutchinson on Breakingviews.
Interest rates were kept at 10% during the boom, so Brazil “avoided asset bubbles and left itself with ample room” for monetary stimulus during the downturn. And “cautious fiscal policy” has reduced the debt burden Lula inherited in 2002. The budget deficit is expected to reach just 1.5% in 2009. And large foreign-exchange reserves built up during the good times will cushion the economy against slumping capital inflows: Brazil is well placed to “ride out the external liquidity crunch”, says Markus Jaeger of Deutsche Bank. Unlike its counterparts in many other countries, the banking system is fundamentally sound and well capitalised. That means lower rates should unclog the credit channel and “re-ignite domestic demand”.
But while the long-term outlook remains solid, there is still a recession to get through. Exports, investment and private consumption have all suffered. The three-month moving average of export growth tumbled from a high of 40% year-on-year to under –20% between mid-2008 and early this year; the same figure for industrial production is at –15%, according to Citigroup. GDP growth declined by 3.6% in the fourth quarter of 2008 alone. “It’s too early to say the economy has hit rock bottom,” says Mauricio Oreng of Itau Securities. BNP Paribas has pencilled in a –1.5% GDP decline for this year, while Morgan Stanley reckons the figure could be as bad as –4.5%.
While the prospect of further earnings downgrades may be offset by hopes of more interest-rate cuts, one near-term danger is that the market is now looking “quite expensive” on a forward p/e of 13 compared with the historical average of nine, says Citigroup. More than half the equity market is made up of energy and raw-material producers, and with China and the world economy hardly out of the woods yet (worldwide “activity is contracting, even if the pace has slowed”, says Capital Economics), it’s hard to be confident the commodities rebound will last.
Finally, developing markets remain highly correlated with Western markets. These look unlikely to “catch a sustained bid” until the credit markets ease and the banks have cleaned up their balance sheets, says Michael Hartnett of Merrill Lynch. Brazil is a promising long-term story, but there are likely to be better entry points ahead.