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11 December 2013
GEM Equity Strategy Outlook 2014
that investors should lighten holdings even if they do not share our
pessimistic view about the likely endgame for the Chinese economy
and equities. Of all the markets in GEM, the risks of extreme outcomes
on both the upside and the downside are highest for Chinese equities
in our view. The downside risk would materialise with a sudden stop
in financing as the debt trap facing local government and the
corporate sector becomes more obvious, while there would be
significant upside if Beijing could present a credible plan for a
complete overhaul of local government finances, which would also
include Beijing led consolidation in key manufacturing and
commodity-related industries.
Russia; This is by far the cheapest market within GEM on almost any
valuation criteria, most notably replacement cost (Figure 7), but we do
not share the increasingly widespread perception among our clients
that governance at either the sovereign or the corporate level, is about
to get better. Indeed, we would actually suggest that any apparent
improvement is largely cosmetic given that real economic reform has
been almost entirely absent and the interests of minority shareholders
in the vast majority of listed companies are increasingly irrelevant to
those in control, be they state or private. The market is now so cheap
that certain sectors now have option-like characteristics, which can
drive sharp rallies, but given the fundamental backdrop and our
continued bearish views on commodity prices, we remain underweight.
•
Broth; Brazil has been by far the worst-performing major emerging
market over the past three years, largely because of the policy shift
towards state capitalism, which has taken place since the financial
crisis. Just as with Russia, asset-based valuations are low, so there
will inevitably be sharp rallies when everyone is bearish, but we
cannot identify any positive inflection point which might reverse the
government-induced redistribution from capital, at least until the
election(s) in the autumn. Our biggest fundamental concern is now the
underlying economy where the impact of heterodox polices is likely to
have a long-lasting detrimental impact, which cannot be easily
unwound.
Korea; This is our lowest conviction underweight but historically a
highly cyclical market with a pronounced exposure to Chinese demand
and vulnerable to any further depreciation in the yen. Korea, along
with its North Asian counterparts, China and Taiwan, has been the
beneficiary of sustained inflows on foreign capital due to its perceived
status as a safe haven, through the current account surplus and so
might prove vulnerable to potential redemptions from EM equity funds.
Korea is possibly the biggest consensus overweight among active
GEM managers although most concede that it is difficult to find
compelling stock ideas.
Otdftwelght
•
Taiwan; Being one of the best-performing major EM markets over
2013 to date, it owes this status to its perceived defensive qualities
and the relative lack of interest among GEM-dedicated investors
before taper talk began in May. It has also been the most direct play
on US growth via the dominant IT sector, though the non-IT stocks
have generally performed better. We have been overweight for over
eighteen months as the counterpoint to our stance on Korea, but the
positive attractions of Taiwan have diminished, along with the
dividend yield and valuation relative to the rest of GEM.
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