BRICs See No Relief Even as Rally Lures Stock Bulls

By Michael Tsang and Michael Patterson

Nov. 3 (Bloomberg) -- Forget last week’s record 20 percent gain in emerging-market stocks. Hard times are ahead for equities in Brazil, Russia, India and China, some of the world’s biggest money managers say.

Even with developing-nation shares trading at their cheapest levels in a decade, financial crises in Hungary and Pakistan that required international rescue packages and concern that economies from Turkey to Argentina are also teetering prompted investors to pull out of emerging-market funds at a record pace.

RBC Capital Markets cut its estimates on Oct. 23 for 2009 economic growth in Brazil to 2.5 percent from 4 percent and Russia to 4 percent from 6 percent. That may undermine analysts’ forecasts for a 14.5 percent increase in earnings at a time when the global credit crunch seized up lending from Sao Paulo to Seoul and a slump in 24 of 25 developing-nation currencies last month inflated the costs of repaying dollar-denominated debt.

“I’m not brave enough to jump on to the bandwagon,” said Franz Wenzel, deputy director for investment strategy at Axa Investment Managers, which oversees $655 billion in Paris. “We have seen the first dominos to fall with Hungary and Turkey, and we might see other shoes to drop.”

As bank losses and writedowns tied to the collapse of U.S. subprime mortgages grew to more than $680 billion and the American economy began to shrink, investors pulled a record $40 billion from emerging-market stock funds this year, including $7.1 billion last month, according to EPFR Global, a Cambridge, Massachusetts-based fund research firm.

Back to Zero

Forced sales by hedge funds and other money managers that piled into emerging-market stocks exacerbated the decline, which wiped out all the gains generated by developing countries this decade, said Andrew Milligan, head of global strategy at Standard Life Investments in Edinburgh, which oversees $260 billion.

“Their economies have been shown to be far more linked than people were hoping,” said Mark Konyn, Hong Kong-based chief executive officer at RCM Asia Pacific Ltd., which oversees $15 billion. “The massive boom in international capital overseas has come to a crashing end.”

No doubt emerging-market stocks look attractive. Equity valuations in China and India fell by more than 70 percent over the past year as plunging commodity prices and recession concerns erased $9 trillion from developing-nation shares. PetroChina Co., which became the world’s first $1 trillion company in November 2007, lost 79 percent of its value through last week.

One-Week Wonder

Depressed prices sparked a 20 percent rise in the MSCI Emerging Markets Index last week, part of a global rebound that lifted the Standard & Poor’s 500 Index by 10 percent and Europe’s Dow Jones Stoxx 600 Index by 12 percent. The developing-nation index is still down 56 percent from its peak in October 2007.

The MSCI Emerging Markets Index climbed 2.4 percent to 584.36 at 4:31 p.m. in New York today. India’s Bombay Stock Exchange Sensitive Index added 5.6 percent as the central bank lowered its benchmark interest rate for the second time in two weeks. South Korea’s Kospi Index advanced 1.4 percent on the government’s 14 trillion won ($10.8 billion) plan to boost to the sagging economy. China’s CSI 300 Index lost 0.6 percent.

One year ago, the MSCI Emerging Markets Index stood at an all-time high of 1,338.49 after a five-year rally produced a more than fivefold increase and added $12 trillion to the value of developing-nation markets.

Safest Assets

As emerging economies grew a record 8 percent in 2007, investors pushed stock valuations above industrialized nations for the first time in more than seven years on speculation their equities would be insulated from the fallout of the worst U.S. housing slump since the Great Depression.

It also lifted six companies from emerging markets into the ranks of the world’s 10 largest by value.

Since then, developing-nation shares tumbled as much as 66 percent. Investors sold everything but the safest assets as credit markets froze and banks hoarded cash after Bear Stearns Cos. and Lehman Brothers Holdings Inc. collapsed.

Chinese stocks in the MSCI fell to 6.55 times profit last week, the lowest since August 1998 and an 80 percent drop from a year ago. Investors in Brazilian and Indian stocks tracked by MSCI were willing to pay an average $6.69 and $9.29 per dollar of profit respectively, the least for both since at least 1995.

At the beginning of the year, shares of companies in the MSCI India Index commanded more than $35 per dollar of profit.

Fire Sale Prices

Peter Schiff, who oversees $1 billion as president of Darien, Connecticut-based Euro Pacific Capital, says the collapse in valuations makes this an even better buying opportunity than in 1998 -- the last time emerging-market stocks were this cheap.

Less-developed economies have a record $785 billion in current-account surpluses this year, compared with deficits of $109 billion in 1998, data from Washington-based International Monetary Fund show. Foreign debt fell to 24 percent of the gross domestic product, compared with 40 percent a decade ago.

China’s economy, which has increased by at least 7.5 percent in each year in the past decade, may grow 9.3 percent next year, according to IMF data. In the U.S., where concern the economy is in a recession helped Barack Obama widen his lead over John McCain in national polls before the presidential election tomorrow, growth may slip to just 0.1 percent.

“You’ve got fire-sale prices,” Schiff said. “Once you take America out of the equation, you’re going to see the biggest economic boom that we’ve ever seen.”

Not Convinced

That optimism helped emerging markets break out of a so- called bear market, as the MSCI index surged 26 percent in four days last week.

David Cornell, a London-based money manager at New Star Asset Management, which oversees about $30 billion, isn’t convinced the gains herald a bull market in developing countries. Even with emerging-market economies forecast to rise at the fastest rates in the world, the IMF’s prediction for 6.1 percent growth in 2009 would be the slowest in six years.

ICICI Bank Ltd., India’s second-largest lender, last week reported quarterly profit that missed analysts’ estimates as deposits fell and it set aside more money for bad loans and investment losses. The Mumbai-based bank is 72 percent below its January share-price peak, even with last week’s 29 percent jump.

“The needle has really hardly budged at all” after last week, he said. “We wouldn’t say that we’ve turned the corner.”

Domino Theory

The Federal Reserve agreed last week to provide $30 billion each to the central banks of Brazil, Mexico and South Korea to help alleviate the credit freeze in emerging nations.

Hungary secured a 20 billion euro ($25.5 billion) rescue package from the IMF, the European Union and the World Bank last week as its currency plunged 14 percent in October. Turkey is in talks with the fund, while Pakistan expects to get money to cover its balance of payments deficit for the next two years, Ashfaque Hasan Khan, an adviser at the finance ministry, said Oct. 31.

The same day, S&P lowered its rating on Argentina’s foreign- currency debt for the second time since August on concern the worsening financial crisis will lead to a default.

Morgan Stanley said today that its bear case for emerging market equities now incorporates a “hard landing” scenario that would drag the benchmark index down to 415 by the end of June, or a 27 percent decline from last week’s closing price.

“The recession is going to be fierce and it will have a dire outlook for earnings,” said Axa Investment’s Wenzel. “That isn’t yet in the prices.”

To contact the reporters on this story: Michael Tsang in New York at mtsang1@bloomberg.net; Michael Patterson in London at mpatterson10@bloomberg.net