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Fear and loathing in emerging-market equities

Investors should focus on countries with a stable banking system, unvervalued currencies and cheap valuations, writes Matein Khalid

The world's emerging markets have been savaged by multiple economic, banking, currency and political shocks since 2011. Global emerging markets are far too diverse and nuanced to be analysed as a single asset class but now trade at a 24 per cent valuation discount to developed markets. The financial markets now price draconian scenarios for earnings, exports, sovereign credit, industrial production and economic growth. The shortage of US dollar liquidity due to unhedged foreign debt overwhelms countries like Brazil, Turkey and Indonesia. There has been capitulation in dedicated Western funds as retail investors redeem in panic. Commodities as diverse as crude oil, Dr Copper, iron ore, aluminium, nickel and lead face 20-25 per cent downside risk. Standard & Poor's' sovereign credit downgrade of Brazil to speculative junk (BB+) debt means Russian, Turkish, South African and Colombian debt are at grave risk.
I believe investors should focus on countries with a current account surplus, stable banking systems, undervalued currencies, technological excellence and cheap valuations. This leads me to the People's Republic's Renegade Province; Taiwan has a 10 per cent to GDP current account surplus, the stablest banking system in the Pacific Basin, minimal inflation, low corporate leverage, world-class technology exporters leveraged to Silicon Valley (TSMC, Acer, Hon Hai, Au Optronics, etc). Taiwan is not expensive at 12 times forward earnings.
I believe the Sensex/Nifty are still overvalued at 16.4 times forward earnings, a colossal and unjustified 45 per cent premium to the Morgan Stanley Asia ex-Japan index. Dalal Street is also vulnerable to capital outflows since India is a 500-basis-point crowded overweight for global emerging market fund managers. The only other emerging market I like is Poland, a proxy for German industrial growth. In the Arab world, the UAE is cheap after its 30 per cent correction at 12 times earnings. I have no interest in either the Bovespa or the Brazil Real, which I predict will fall to 28,000 and 4.35. This means the Brazil Index Fund could easily fall from its 74 peak to 10 as Ursa Maximus guts the "samba trade".
I was stunned to see Jeff Currie, Goldman Sachs's legendary commodities king, predict the tail risk of $20 crude oil in his forecasts. I remember arguing in 2007 with a (then) star member of Currie's team who called for $250 crude amid an energy super-cycle. Peak Oil was a cruel illusion and has morphed into a three mbd oil glut. Oil market volatility has soared to 52 per cent and spot Brent is $47 as I write so, yes, $20 Brent is no Six Sigma event (which despite their one in 10 billion probability occur all too often on Wall Street, from LTCM's failure to Black Monday!). The oil market has been savaged by a supply shock (US shale, Iraq, offshore West Africa, post-sanction Iran), demand shock (China, Brazil recession, etc) and Saudi Arabia's refusal to play the role of the Opec "swing producer". Arab oil importers like Morocco, Jordan, Lebanon and Egypt do not benefit from lower oil prices since they are dependent on petrodollar aid from the Gulf. Taiwan is a far more relevant "oil windfall" investment theme, as it is one of the most industrialized economies in Asia, with IT almost 57 per cent of the Taipei Index.
MSCI China has now derated to eight times forward earnings. This proves that Premier Li Keqiang's claim at WEF Dalian that China will achieve the Politburo's seven per cent target is just not credible. My abacus take from iron ore prices, freight/power generation, an August PMI below 50 and eight per cent slump in July export tells me that the Middle Kingdom's growth rate is two to three per cent, nowhere near President Xi's target. So is it time to hold one's nose and buy Chinese equities on the eve of the mother of all fiscal and monetary stimuli? Yes, if value is defined as Hong Kong H shares, not Shenzhen's phony, inflated companies like Tiger Balm Number One Tatoo Parlors Inc. Macau and Chinese E-commerce/search used to be my twin themes in the PRC. Macau is kaput for now but Alibaba at 60 is half is post-IPO peak. Could Alibaba's cyclical bottom be 52-54 or 16 times earnings once the 1.6 billion insider share lockups expire?

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