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Thursday, September 12, 2013

An Update on Those Emerging Markets

I can't count the number of articles like this one that I found during Mid - late July:


·         CHINA NEWS
·         Updated July 24, 2013, 10:59 p.m. ET

The $91 Billion Caofeidian Industrial Zone Is Mired in Debt and Unfulfilled Promise

Recently headlines like this one have been more common:this one also from the WSJ

Stronger Economic Data Point to Capital Inflows

My August 2 blog entry was entitled

Emerging Markets ...It's Not Time to Give Up

One year chart of China ETF FXI

Note the price action on both since those late july articles

and GMF: emerging asia

Saturday, August 3, 2013

Emerging Markets Stocks...It's Not Time to Give Up

Investors would be making a big mistake if they eliminate holdings in emerging market stocks.  Instead of giving up on emerging markets investors should adjust to take advantage of China’s new economic focus on consumer spending rather than infrastructure.
Many articles have declared the “end of emerging markets” .Massive outflows from emerging markets funds and ETFs indicate that in fact many investors agree. Moving out of emerging markets and into the US market is a common case of chasing performance ytd emerging markets (VWO) are down 9.3% vs. a 20.9% gain for the US (VTI )
Chasing performance is seldom a strategy for good long term returns. With emerging markets at low relative valuations to the US it is more likely to be an opportunity long term investor to buy stocks at good valuation “when blood is on the streets” rather than follow the herd that is selling.
The main reason behind the emerging market slowdown is no doubt the “slowdown” in economic growth in China. Chinese economic policy has shifted from big spending on infrastructure projects to policies to stimulate consumer activity. The slower economic growth is now forecast at” only” 4-5% down from 7% or more. GDP growth at 7% is over 3x the current US growth rate.
What is the right way to invest in emerging markets in the period of China moving from consumption to infrastructure focus?
Investing in Emerging Markets for the New Era
1.       Forget the BRIC (Brazil, India, and Russia China) strategy. The category BRICs (BIK, BKF) never made much sense from an investing point of view. Each country has its distinct economic and political issues. Investing in these countries as a group does not make sense.
2.       Underweight Latin America for the long term. In my previous position in international finance a common refrain was that Brazil (EWZ) and Mexico (EWW) were the countries of the future…and always will be. They are characterized by poor economic and political management and dependence on exports of natural resources (copper for Brazil, oil for Mexico). Peru and Chile are also highly dependent on natural resource exports. With China slowing down infrastructure products a major importer of natural resources  all of these countries in Latin America will lose their main export market.
3.       Don’t miss out on South Korea. Two of the major broad emerging markets ETFs (EEM and VWO) have switched their benchmark index as a consequence South Korea has moved from emerging to developed markets. Thus both EEM and VWO have a no holdings in South Korea that. For broad emerging markets exposure the better case is IEMG which has a 15% allocation the South Korea and at 3% Samsung is the largest holding.
4.       Tilt towards Emerging Asia. Asia has just the opposite profile of Latin American with little dependence on natural resource exports. Just as one could avoid Latin America because of its dependence on natural resource exports. The China and Emerging Asia growth story still exists with high growth relative to developed markets. A pickup in US consumer spending will help China and the other countries in Emerging Asia: Taiwan, Indonesia, Hong Kong and Malaysia.
Furthermore as China’s wage costs have risen some of these companies now have become the lowest cost producer from many exporters.
The emerging Asia ETF (GMF) covers all of these countries but has its highest country weighting in China.
For those seeking to underweight China they could purchase a mix of country funds: Taiwan (EWT), South Korea, (EWS), Malaysia (EWM) would be a few examples.

5.       With Chinese economic policy shifting to stimulating consumer spending rather than infrastructure it makes sense to look at emerging market ETFs that are more weighted towards consumer stocks This is the case for EEMV the minimum volatility emerging markets in large caps and in small caps EWX
For those with access to the fund through their 401k or an advisor DEMSX may be an attractive alternative.

6.       Two stocks worth investigating in light of the shift in Chinese economic policy that have ADRs that trade in US markets:

Baidu (BIDU) is the largest internet search provider in China the stock is volatile and has had a long run up of late but still merits a look.

China Mobile (CHL) the largest mobile phone service provider in the world’s largest cell phone market. It trades at a P/E of 11 well below the P/E of comparable US companies or the overall US market.

Monday, July 22, 2013

Robert Arnott on Emerging Markets

Bob Arnott well know figure and creator of Fundamental Indexing had this to say about emerging markets in an interview with indexuniverse.com

IU.com: Interesting. Any other thoughts you might want to share that I've not even come close to touching upon?
Arnott: Well one thing that I think is fascinating is we’re in a business where customer demand evaporates as soon as there's a bargain.
What's going on with emerging markets, you’ve got emerging markets trading at a Shiller PE ratio of 13 when U.S. stocks are at 24. Back in 2007, emerging crested at 37 Shiller PE at a time when U.S. was at 26. So it's been a complete about-face, from an 11 points higher price to 11 points lower price. And now people are scared of putting money into emerging markets. To me, this is a wonderful-—this is the closest thing to low-hanging fruit I've seen in the global stock market since February 2009.
IU.com: Right. It’s all about expected returns. And they sure outsize there in the emerging markets, is what you're saying, right?
Arnott: Exactly. And most investors simply extrapolate from the past. Emerging markets have been pretty disappointing for three years. And they’ve been downright awful for six months, and downright scary for two months. So people look at that and say, “I didn’t sign up for this. I'm outta here.”
The correct response should be, “These are interesting prices—unless I want to postulate that a China slowdown turns into a China meltdown, and conflict in Syria and Egypt turns into a Middle East conflagration; are those things possible?” Of course they are. That’s why we’ve got bargains. Are they likely? Maybe not. Are they likely to have an effect that spans the whole emerging economy of the world? Absolutely not. But it’s affecting pricing all over the world.
Now, add to that the fact that growth has beat value in emerging markets by upwards of 1,000 basis points this year to date, and a Fundamental Index is looking really cheap. Fundamental Indexing for emerging markets is currently priced at a 9 Shiller PE ratio.
IU.com: And are the numbers apples to apples when you look at the Shiller PEs? Or do they have a different scale altogether?
Arnott: Well, a Fundamental Index clearly has a value tilt. So the presumptive growth rate is going to be slower. But the valuation multiple is one-third off of a market that’s already nearly half off relative to the U.S. To me, that’s a really easy investment choice. It’s not a comfortable one, but you don’t get rewarded for comfort.

On the other hand investors seem to be moving their international investments away from emerging and into developed markets

The two largest emerging markets ETFs—the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) and the iShares MCSI Emerging Markets ETF (NYSEArca: EEM)—have lost more than $11 billion in assets in 2013.
On the other hand, the Vanguard FTSE Developed Markets ETF (NYSEArca: VEA), the PowerShares QQQ Trust (NasdaqGM: QQQ), the SPDR S&P 500 ETF (NYSEArca: SPY) and the iShares MSCI EAFE ETF (NYSEArca: EFA) have collectively seen more than $13 billion in inflows over the first seven-plus months of the year.

Thursday, July 18, 2013

Investors (Finally) Moving to Short Term High Yield

I have written many times about moving high yield exposure to the shorter term instruments...seems some people are making the move albeit a bit late

From ETF Trends

Investors looking for a balance between yield and protection from rising interest rates have been moving into ETFs tracking speculative-grade corporate bonds with shorter durations.
PIMCO 0-5 Year High Yield Corporate Bond Index (HYS) andSPDR Barclays Short-Term High-Yield Bond ETF (SJNK) have gathered $602 million and $318 million, respectively, since the beginning of May, according to WSJ.com’s MoneyBeat blog.[These High-Yield Bond ETFs Protect Against Rising Rates]
The largest junk bond ETFs, iShares iBoxx High Yield Corporate Bond (HYG) and SPDR Barclays High Yield Bond (JNK), together have seen more than $3 billion move out the door over the same period as Treasury yields climbed. [High-Yield Bond ETFs Recovering from Taper Tantrum]
In the shorter duration junk bond ETFs, HYS has an SEC 30-day yield of 4% and an effective duration of 2 years, according to PIMCO. SJNK has a yield of 5.1% and a modified adjusted duration of about 2.3 years, according to State Street Global Advisors.
“Shorter-term junk bonds are lower volatility, so in a downdraft there’s a lot less downside than regular junk bonds,” said Chun Wang, co-portfolio manager at Leuthold Weeden Capital Management, in the MoneyBeat post.

The article doesn't mention HYLD which now has a yield over 8% and a duration of a bit over 3 years. A combination of HYS and HYLD might offer a nice balance of risk/return in terms of interest rate risk.
Below are  ytd returns and volatility measures for sjnk , hys and Hyld as well as the intermediate term HYG and JNK

Wednesday, July 17, 2013

German Stocks…Time to catch up….Again?

The WSJ writes here 

of the prospects for German corporations to replace the decline in exports to China with sales into the US market.
 Last year German stocks as measured by EWG outperformed the US market. A strong rally in the second half of 2012 spurred the outperformance (Germany in blue) By the end of the year EWG outperformed VTI by 32.5 vs. 16%.

Here is a one year chart note the US outperformance during the worst (so far) of the European crisis last year and then the German outperformance as concerns were lowered. There hasn't been a big change in the European situation since then so perhaps the Chinese slowdown is the explanation for the recent performance. Given the latest trend in German exports(see below) one may ask if it is justified.

And here is a 10 year chart note the German outperformance during the US financial crisis and the US outperformance during the peak of the european crisis.

Prospects for Improved Exports

As noted in the WSJ article prospects for German exports out of Germany seem up beat as seen in this table

The weaker Euro is likely to continue as the European Central Bank has indicated a continued policy of low interest rates, while the US interest rates trend higher. This makes German exports more competitive. With the stock market higher, housing on a comeback particularly in higher end markets and a weaker dollar it isn’t surprising for this outlook from Daimler Benz:,
U.S. sales ofDaimler AG's DAI.XE -1.19% Mercedes-Benz luxury automobiles rose sharply in the first half of 2013 from the previous year, putting them on track to exceed 300,000 cars this year.
U.S. demand has been "great," Daimler Chief Executive Dieter Zetsche told reporters last week in Canada, "and it seems the momentum will sustain." In contrast, Mercedes' China sales were flat, though they improved in the second quarter after a soft start to the year.
In the past year both Germany and the US have had p/e expansion . However thelarge P/E expansion for the US has been far grearer(rather than growth in earnings) and has been behind the US market rally... The S+P 500 P/E has increased 25% over the last 12 months while the total return is a bit over 28%...in other words virtually all the increase in the S+P 500 over the last 12 months comes from P/E expansion and is over 25% over its long term average.

 The DAX (German) P/E has expanded quite a bit recently but is still well below its long term average .Germany trades at a P/E discount of over 35% vs. the US

The price/book for the DAX top ten holdings is 1.45 vs. 2.1 for the sp 500 and price to cash flow ratios are...67 and 1.39 respectively.

Looking at all of this it seems a strong case can be made for at least a partial repeat of last year’s pattern of a strong performance for German stocks in the second half of the year, particularly if the export numbers give a rationale for rethinking the impact  of the Chinese slowdown on German companies. And it doesn’t require German stock returns even equal to those of the US for the year to mean significant gains for ETFEWG for the rest of the year.

If price eventually reverts to value or close to it we may see a repeat of last year’s strong performance by German stocks in the second half of his year.

Here are some more interesting charts

S+P 500 P/E

DAX P/E And Dow P/E

Thursday, July 11, 2013

Individual Investors Buying High and Selling Low...Again ?

Bloomberg July 3, 2013

Bond Funds Losing $60 Billion Foreshadow Risk of Fed Exit

Investors have pulled about $60 billion from U.S. bond funds since Federal Reserve ChairmanBen S. Bernanke rattled markets by outlining his plan to end the central bank’s unprecedented asset purchases.....
Retail investors, who fled volatile stock markets to pour about $1 trillion into the perceived safety of bond funds since the beginning of 2009, reversed that pattern in the past month in anticipation of rising rates.

Wednesday, July 10, 2013

More From the It Was An Accident Waiting to Happen Club

wsj March 6,2013

Advisers Find Income Alternatives in Mortgage REITs

As stock real estate funds strive for a fifth-straight year of gains, a hybrid type of investment offering plumper dividends is off to an even better start.
Real estate investment trusts that buy mortgage-backed securities rather than buildings or land are posting double-digit returns and attracting strong investment flows.
The $1.1 billion iShares Mortgage REIT Capped (REM) exchange-traded fund enters Wednesday ahead by 12.5% so far in 2013. In the past 12 months, the ETF has attracted nearly $727 million in net inflows through last week, estimates New York market researcher XTF Global.

Wsj May 29, 2013

Mortgage REITs Hit 52-Week Lows on Rate Fears

Mortgage REITs borrow money using short-term debt and use the funds to buy longer-term mortgage securities, earning the spread between the rates. They also use leverage to boost their returns. The low interest- rate environment greatly reduced their borrowing costs and enabled them to make more money off their bond portfolio. In addition, the low rates drove investors into REITs that promise high returns......

The mortgage declines were part of a broader rate-induced selloff as REITs underperformed the broader market. The closely followed MSCI US REIT Index was down 3.1% while the S&P 500 slid nearly 1%......
David Toti, an analyst at Cantor Fitzgerald, said REITs have long benefitted as an alternative to bonds because of their higher yields. The low interest-rate environment has also been instrumental in helping REITs raise inexpensive capital to repay debt and build war chests for acquisitions.
“Guess what? REITs don’t like the higher cost of debt,” Toti said.

But over at seeking alpha hope springs eternal

In this article, I will be focusing on agency mREIT preferreds and my top selections in the agency space. Hybrids will be addressed in another article and investors are encouraged to blend the two as part of an income focused portfolio (as they are often influenced by some differing factors). The specific agency mortgage REITs I will look at are the larger in the space as they are more likely to have preferred stock. Specifically, they are:
  • Annaly Capital Management ,
  • American Capital Agency Corp. (AGNC),
  • Armour Residential REIT (ARR), and
  • Hatteras Financial Corp. (HTS)