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Glovista Global Emerging
Market Perspectives
Monthly Newsletter for Emerging Market Investors Issue 50 February/14 This issue :
Emg Mkt. Sector Performance P.2 S&P 500 Sector Performance P.3 Ccv and Cmdty Performance P.4 Dr. Carlos Asi lis
Tel: (305) 333 0012
GeopoliticalDevelopmentsand
[email protected]
Darshan Bha tt, CFA
Tel: (212) 336
1542
[email protected]
CyclicalDynamicsReinforceOurEM
CountryandSectorTilts
Country‐wise Performance (Gross) ‐ (US$) January 2014 0.2% Taiwan
Over the past several weeks, economic releases out of the
world’s largest economic blocs have underwhelmed
consensus estimates, particularly in the USA and Japan.
As discussed at some length in our accompanying Glovista
Global Perspectives column, multiple factors, of a
transitory nature, may be at play, including (1) an
unusually adverse winter in the US Northeast and parts of
Asia, (2) the timing of this year’s China’s Lunar Year and
(3) inventory correction dynamics in the USA and Europe.
Notwithstanding the possible role of transitory factors in
the softness of recent economic releases out of the
developed world, asset markets have responded to such
underwhelming statistics by discounting a higher
probability of a more durable economic slowdown in the
months ahead. For example, equity prices of cyclical
sector indices within the global equities space, Antipodean
currencies’ US Dollar exchange rate crosses, and
Enri que Figuer oa, CFA, CFP government yield curves’ steepness have reacted in such
manner over the course of 2014.
India
‐3.8%
‐5.5%
South Korea
‐5.6%
Malaysia
‐5.8%
Poland
‐6.5%
MSCI Emg Mkts
‐6.5%
Mexico
‐6.7%
China
‐10.1%
South Africa
‐10.1%
Russia
‐10.6%
Brazil
Tel: (650) 378 1246
[email protected]
As the economic calendar in the developed world has
weakened these past several weeks, emerging market asset
prices, particularly those country and sector indices most
susceptible to cyclical swings in the global economic
calendar, have underperformed developed market peers
(e.g. Brazil) while others (e.g. India, Poland, Taiwan) have
sustained relative outperformance of several developed
market peers on account of both global and country
specific factors. In the balance, the mosaic of
outperforming sector and country tilts within EM accords
closely to the set of sector and country tilts that have been
Source: MSCI & Bloomberg
Glovista
Investments
‐ 1 ‐ kept at overweight exposure in Glovista’s managed emerging market equity portfolios.
From a macro perspective, the growing return performance dispersion across emerging market country and
sector indices is rather encouraging for the outlook of emerging market equities’ relative performance versus
developed peers. First, a growing number of emerging market central banks are finding greater flexibility to
discontinue the succession of interest rate hikes prevalent throughout much of last year, and even begin to
cut policy interest rates as inflationary pressures abate. In turn, the deceleration of inflation dynamics for a
selection of emerging market countries is the result of a significant improvement in current account balances
(e.g. India, Poland, Chile, among others) that have helped bring about much needed exchange rate stability.
A second macro dynamic that is proving rather supportive for a selection of emerging market countries
(most notably, Taiwan, our largest overweight market) is derived from the strengthening of demand
conditions for information technology products and services globally. Consequently, emerging market
information technology stocks are undergoing a much stronger revenue and earnings growth acceleration
than most other sectors.
Sector Wise Performance (Gross) ‐ January 2014 ‐1.6%
‐4.2%
‐4.8%
‐5.9%
IT
HC
UT
‐6.2%
IN
‐6.5%
Emg Mkts
‐6.6%
MT
‐7.8%
TS
‐7.9%
FI
‐8.6%
CS
‐9.4%
A third macro dynamic that is becoming increasingly important for the outlook is that of China’s economic
transformation away from export-led to domestic consumption-focused growth. Consequently, our
longstanding bearish outlook towards the industrial metals space is reinforced by Chinese economic releases
and Chinese policy decisions confirming the Chinese leadership’s willingness to withstand lower growth
rates for the country’s GDP as a cost to pay for laying the foundations for sustainable long-term economic
growth.
CD
Finally, from a policy perspective, the recent politico-economic crises in Ukraine, Argentine and Venezuela
serve as a reminder of emerging market countries’ heterogeneity so that while some countries (such as
China and Mexico) are well under way in the adoption of deep-rooted economic reforms highly constructive
to those countries’ medium- and long-term outlooks, other countries (Argentina, Venezuela, Ukraine and a
handful of others) have fallen prey to the toxic forces of populism and government intervention in daily
economic activity.
EN
‐12% ‐9% ‐6% ‐3% 0%
Source: MSCI “…a growing number of emerging market central banks are finding greater flexibility to discontinue the succession of interest rate hikes prevalent throughout much of last year, and even begin to cut policy interest rates as inflationary pressures abate.” GlovistaGlobalPerspectives
Weather, Economic Calendar and Heightened Central Bank Policy
Uncertainty Cloud Intermediate‐term Equities’ Outlook; Glovista
SustainsDefensivePortfolioStance
Thus far in February, global equities have partially retraced the sharp price declines recorded in January. Of
greater interest to the Glovista investment team, the anatomy of the recent stock price rebound stands out on
multiple levels. Most notably, the recent rebound in equity prices presents a very different sector leadership
than what obtained throughout much of the second half of 2013. Specifically, as illustrated in Figure G-1 and
Figure G-2, defensive sectors have led cyclical sectors, not only in the US equity market context (Figure G1) but also at the global level, as evidenced by Japanese equities’ year-to-date return underperformance
versus both developed and emerging market peers (Figure G-2).
The Glovista investment team finds of interest that corresponding year-to-date market dynamics in other
asset classes, most notably commodities, have confirmed the defensive tilt present in equity market internals.
For example, thus far in 2014 precious metals prices, including gold and silver, have recorded technically
meaningful rebounds, with the gold price breaking above its 200 day moving average for the first time since
February 2013 (Figure G-3). Likewise, developed countries’ government bond yield curves have undergone
bull flattening moves, also confirming the macro implications reflected in equity market internals and
precious metal prices (Figure G-4).
In the balance of this monthly commentary, we lay out the Glovista investment team’s assessments of the
macro underpinnings behind global markets’ recent price dynamics together with selected implications on
overall portfolio strategy. ‐ 2 ‐ FigureG‐1.USDefensiveSectorsOutpaceCyclicalPeersEarlyin2014 S&P500 Monthly Sector Performance – Jan' 2014 % Change FY1 PE Ratio Energy ‐6.33% 12.5 Materials ‐4.66% 16.0 Industrials ‐4.53% 16.2 Cons Disc ‐5.97% 18.3 Cons Stap ‐5.30% 16.8 Sectors Technology ‐2.59% Source: Bloomberg *YTD Performance Data through February 25th 2014 14.9 Healthcare 0.87% 17.0 Financials ‐3.73% 13.0 Utilities 2.88% 15.5 Telecom ‐4.16% 13.8 S&P500 ‐3.56% 15.2 FigureG‐2.JapaneseEquitiesUnderperformGlobalPeersEarlyin2014
(Chart:MSCIJapaninUS$termsrelativetoMSCIWorld) Source: S&P Source: MSCI, Bloomberg & Glovista Calculations World Economy’s Momentum Surprises Negatively Early in 2014 Owing to
Adverse Weather, Inventory Correction and Lagged Effects from Credit
TighteninginEM
The economic calendar has met the turn of the year with a virtually universal softness, versus consensus
estimates, across all of the world’s principal geographic regions, as illustrated by various economic surprise
indicators (Figure G-5).
‐ 3 ‐ FigureG‐3.Earlyin2014GoldPriceBreaksAbovetheTechnicallyMeaningful200Day
MovingAverageLevelforthefirsttimesinceFebruary2013 January Change Oil 1244.55 19.1775 97.49 3.2% ‐1.5% ‐0.9% EUR JPY GBP CHF CAD AUD BRL MXN 1.3486 102.04 1.6439 0.9065 1.1128 0.8756 2.4128 13.3573 ‐1.9% 3.1% ‐0.7% ‐1.5% ‐4.8% ‐1.8% ‐2.1% ‐2.5% Gold Silver Jan '14 Source: Bloomberg Source: Bloomberg& Glovista Calculations FigureG‐4.USTreasuryYieldCurve(10yr/2yr)BullFlattensEarlyin2014,Possibly
SignalingSlowdowninEconomicRecoveryDynamics Source: Bloomberg& Glovista Calculations The weakening of the world economic calendar early in the year likely reflects the sum total of multiple
factors, including:

Adverse weather: as most readers are already aware, this year’s winter in the northern hemisphere
(particularly North America) has been the most severe since 1988 owing to the occurrence of polar
vortex weather dynamics. Consequently, sectors of the economy including retail, housing,
restaurants, leisure, among others, have been impacted considerably.
‐ 4 ‐ Figure G‐5. Economic Surprise Activity Indicators Weaken across Multiple Regions
earlyin2014
(Chart:CitigroupEconomicSurpriseIndex–MajorEconomies)
Rates 1 Yr CD 5 Yr CD 30 Yr Jumbo Mortgage 5/1 Jumbo Mortgage US Govt. 10 Year 10 Yr Swap Spread January 31st Level 0.68% 1.33% 4.45% 3.02% 2.64% 0.14% Source: Bloomberg “The Glovista investment team’s assessment that consensus economic growth expectations, particularly for the USA, are likely to prove optimistic underlies the continued defensive stance we have taken in our managed accounts.“ Source: Citgroup Global Markets Inc. 

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Inventory correction: Most purchasing managers’ diffusion indicators for the developed
world, particularly in the USA, indicated elevated levels of inventory accumulation late in
2013. Consequently, some of the recent softening in business investment expenditure levels is
likely to reflect correction dynamics from such elevated inventory levels prevailing at the end
of 2013.
Normalization of elevated US capex levels in 2013H2 as fiscal incentives drew to a close:
The turn of the year marked the end of several important depreciation allowances in the USA
that may have resulted in the front-loading of some 2014 capex to 2013. Consequently, payback
effects from such dynamics are likely to be present in the weakening business investment
expenditure momentum early in 2014.
Lagged effects from credit tightening in emerging markets: As most readers are well aware,
the post-May 2013 period has resulted in a considerable tightening of credit conditions across a
number of emerging market economies as central banks in those countries have met downward
pressure on their countries’ currencies with interest rate hikes (e.g. India, Brazil, Turkey,
Indonesia, among several others) so as to forestall additional currency weakness that may result
in significant violation of longstanding inflation targets set by those countries’ central banks.
Evidently, one of the corollaries emanating from such policy responses includes a weakening of
domestic demand and overall economic growth, one of whose manifestations is the reduction of
the affected countries’ trade and current account deficits.
Selected Macro and Market Implications Stemming from the Weakening
EconomicCalendar
As we have highlighted in prior monthly commentaries, an acceleration of earnings growth momentum
in 2014 has been one of the main tenets anchoring global investors’ bullish outlook for global equities,
reflected in developed market equities’ (especially USA) extended valuations relative to historical
average levels, and adjusted for prevailing extended profit margins. The Glovista investment team’s
assessment that consensus economic growth expectations, particularly for the USA, are likely to prove
optimistic underlies the continued defensive stance we have taken in our managed accounts.
In assessing the macro and market implications stemming from this year’s weaker than expected
economic calendar, we draw several conclusions, including:
‐ 5 ‐ 
“Inflation in the developed world, as well as in a large cross‐
section of the emerging markets universe (with several exceptions, including Brazil, South Africa, and others) is likely to surprise to the downside in the coming quarters…” 
Inflation pressures likely to surprise to the downside: Inflation in the developed world, as well
as in a large cross-section of the emerging markets universe (with several exceptions, including
Brazil, South Africa, and others) is likely to surprise to the downside in the coming quarters as the
softening of demand conditions early in 2014 as well as late in 2013 (recent downward revisions to
end 2013 data in the USA and Japan, for example) result in a reacceleration of the elevated levels of
slack in those economies.
Risks to economic growth outlook remain balanced around its below trend level: On the
surface, many of our readers may take issue with this assertion on our part as a reacceleration of
growth dynamics in the USA especially is quite likely once polar vortex conditions abate and potent
payback dynamics take hold in several of the affected sectors of the economy such as retail and
housing, for example. Indeed, the Glovista investment team expects such reacceleration dynamics
to take hold starting in the second quarter of the year. Nevertheless, we believe that many observers
are likely to be underestimating the adverse growth effects on developed countries’ economic
outlooks resulting from the longstanding weakening of growth momentum in several of the world’s
major emerging market economies, most notably China’s (the world’s second largest economy).
If our assessments laid out above are even partially correct, it follows that the European Central Bank’s
standing monetary policy stance is likely to prove misguided in that meaningful disinflationary dynamics
may take hold in the Eurozone region in the months to come. Ultimately, we believe the European Central
Bank will react to such developments by loosening liquidity conditions aggressively. However, the task of
handicapping such scenario remains highly challenging owing to the ECB’s political constraints, complex
decision-making apparatus and the presence of a modest reacceleration of domestic demand conditions that
lessen the urgency of such ECB policy adjustment.
At the market level, if our above assessments prove even partially correct, it follows that US equity prices
run the risk of losing considerable momentum versus other global equity peers. Specifically, much growth
has been discounted in various pockets of the US equity market that may disappoint meaningfully under a
scenario of weaker than expected inflation pressure and economic growth. We believe the sectors most at
risk include industrials, consumer staples, consumer discretionary, utilities, telecom and large cap financials.
We remain attracted to several other US equity sectors including healthcare, software technology and
regional banks.
Outside global equities, we believe a scenario with weaker than expected inflation and growth momentum
may be somewhat supportive to precious metals and selected industrial commodities. In addition, over the
past several weeks, we have become constructive towards selected areas within the soft commodities
(agriculture) space, most notably Corn.
Looking ahead, we believe global investor attention is likely to center around several dynamics, including:


the Bank of Japan’s response to the recent softening in economic momentum as the Japanese
economy approaches the month of April when tax hikes are scheduled to be implemented,
Chinese government authorities’ continued response to the heavy expiration schedule of trust
investment structures, an important share of which is likely to prove impaired – the implications on
global growth from a disorderly unwinding of such structures could be meaningful.
In conclusion, the Glovista investment team maintains a defensive portfolio strategy stance whereby we
maintain modest exposure levels to global equities (favoring Eurozone periphery markets, Japan and selected
emerging markets and US healthcare and regional banks), overweight allocations to agriculture
commodities, neutral allocations to precious metals (both gold and silver, a tactical position) and overweight
allocations to credit markets, particularly US Dollar denominated.
‐ 6 ‐ Disclaimers: 1.
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Investments
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