Khaleej Times

Enjoying the euphoria in EMs

Matein Khalid on why Russia, Pakistan are among best bets

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Emerging markets have been the winner asset class in 2017, up 42 per cent in the past year and the flagship index fund EEM was up nine per cent in January alone.

Emerging markets have been the winner asset class in 2017, up 42 per cent in the past year and the flagship index fund EEM was up nine per cent in January alone. Valuation is a terrible timing indicator but the MSCI emerging market index now trades at 13 times forward earnings, the highest since 2010.

The ballast for emerging markets are varied: the plunge in the US dollar index from 102 to 89 since Trump’s election, the 60 per cent rise in Brent crude after the Saudi Russia output cut pact, Russia and Brazil’s emergence from recession, a bull market in metals (Dr Copper rose 32 per cent in 2017) a spectacula­r rerating of Chinese Internet/e-commerce colossi (Alibaba, Tencent), structural reform in Indonesia, Egypt, India, etc, and the best earnings momentum since the global financial crisis. The IMF has upgraded its forecasts for Asian economic growth and the Digital Age is now in full swing.

Historical­ly, periods of US dollar weakness have coincided with a quantum increase in fund inflows from Wall Street, Europe and Japan into emerging markets, trigger for liquidity driven bull runs. Even though Trump withdrew from the Trans-Pacific Partnershi­p, Asia EXJAPAN was up a stellar 43 per cent in 2017, the best-performing province of the emerging markets constellat­ion. His threats and tariffs against China have had no real impact on the “animal spirits” of the bulls in Shanghai and Hong Kong, where the Hang Seng index scaled 32,000 points. As Pyongyang has eased its geopolitic­al threats against South Korea ahead of the Winter Olympics, the Kospi has surged well above 2500. I had thought that the rise in the 10-year US Treasury bond yield would hit Brazil’s Bovespa index but I was wrong, since Lula’s criminal conviction means the carnival in Sao Paulo continues, with the Bovespa above 82,000 as I write.

Sadly, GCC markets grossly underperfo­rmed emerging markets indices in 2017. This sets the stage for a bull run in Saudi Arabia, driven by structural reforms, $35 billion in tracker funds once MSCI upgrades the kingdom’s Tadawul index to emerging markets and the most expansiona­ry state budget I have seen in my adult life.

I have been long the Vaneck Vectors Russia ETF since last July, when it bottomed at 20. The Russia index fund rose 25 per cent, thanks to the oil deal with Saudi Arabia, successive central bank rate cuts, dividend hikes by Sberbank and the increasing certainty that Vladimir Putin will be reelected president and thus become the longest reigning post-Romanov autocrat in the Kremlin since the death of Stalin. I believe Russian equities are cheap relative to both the price of oil/industrial metals and the valuations of the MSCI emerging markets index.

True, Trump’s bromance with Putin did not lead to any rapprochem­ent with Washington. In fact, Russia escalated its military interventi­on in eastern Ukraine and Syria while Western sanctions have not been lifted. It is not prudent to expect a geopolitic­al valuation rerating (such things happen — remember Macri in Argentina, Modi in India and Macron in France?) in Russia as long Putin and his ex-KGB siloviki clan rule the roost in the Kremlin. Putin will win re-election for a new six-year term in March.

So I find Moscow unjustifia­bly cheap at 7.6 times forward earnings and a dividend yield of 5.2 per cent at a time when the global macro zeitgeist gave me the green light to invest in a high-beta, late-cycle commodity-rich emerging market Cinderella. I see no reason to scale back my exposure to Russia as long as the political wind on the Moskva River does not turn toxic.

I took advantage of the steep sell off in Pakistani equities after the Supreme Court’s dismissal of Prime Minister Nawaz Sharif to accumulate shares in the Global X MSCI Pakistan index tracker. Apart from a lovely 12 per cent dividend, this New York-listed, US dollar product (Interactiv­e Brokers Zindabad!) gives me access to some of the most deeply undervalue­d banks, cement and steel companies in a country whose 200 million population offers a “demographi­c dividend” even as it pivots to become China’s new client state in South Asia with CPEC, the new East India Company with chopsticks. The rupee mini-devaluatio­n is a ballast for the US dollar earnings of Karachi’s energy shares. Habib Bank’s New York branch money-laundering scandal enables me to accumulate some of the cheapest, highest returns on equity banks in the world. It is time to revisit the green lawns of the Sind Club, the haunt of my boyhood, in the shadow of the Victorian mock — Gothic red sandstone hall that commemorat­es the memory of Sir Bartle Frere!

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 ?? AFP ?? The mini-devaluatio­n of the Pakistani rupee is a ballast for the US dollar earnings of Karachi’s energy shares. —
AFP The mini-devaluatio­n of the Pakistani rupee is a ballast for the US dollar earnings of Karachi’s energy shares. —

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