Poised for gains with growth in emerging markets

Robust consumer demand and sustained global demand for natural resources will underpin growth in emerging markets this year. In particular, growth in India and China will be a tonic for commodities-producing emerging countries. Non-Asian emerging markets are poised for another good year in 2011. Their economies will grow much faster than those of their developed counterparts and their stock markets are expected to deliver strong returns, albeit not as strong as those of the past two years.

Even with the big gains of last year, valuations are still reasonable. Stocks are trading at about “the middle of the range, based on 10- to 20-year highs and lows — at two times book value and about 12 to 13 times forward earnings,” says Mark Mobius, executive chairman of Franklin Templeton Investments Corp.’ s emerging markets group in Singapore.

Growth is being fuelled by strong consumer demand and sustained global demand for natural resources. Growth in China and India, he says, “will have a positive knock-on effect on commodities-producing emerging countries.”

The only setbacks, says Tom Leventhorpe, portfolio manager with J.P. Morgan Asset Man-agement in New York, would be rising inflation, higher interest rates or a quick U.S. economic recovery that causes capital to leave emerging markets for the U.S.

However, Mobius feels these are “not very salient issues at this stage of the game.” He notes that some markets, such as Brazil, have instituted capital controls to prevent the overheating that can lead to spiralling inflation.

Performance will vary. Latin America should stand out, with Brazil the leading performer. The region, says Leventhorpe, is “benefiting from sound macroeconomic policies put in place during the past decade.”

Eastern Europe will be the laggard, although Russia may very well end up being a star in 2011. “The region is in trouble,” warns Mobius, partly because of its huge debt “in foreign currency-denominated loans” to fund pre-crisis development.

Eastern Europe is playing catch-up to the rest of the emerging world and its capital markets are not well developed, adds Bob Gorman, vice president and chief portfolio strategist with TD Waterhouse Canada Inc. in Toronto.

In Africa, South Africa is the most favoured country. And the Middle East offers selected opportunities in different countries.

Leventhorpe notes that although these regions will grow faster than the developed world, their governments have to deal with cutting deficits and fiscal tightening that could moderate growth in emerging markets. In the Middle East, for example, anticipation of rising oil prices has led to substantial overspending on infrastructure.

Leventhorpe has a “bias away from cyclical and commodities businesses”; he favours the consumer staples and consumer discretionary sectors, which have “more predictable cash flows.” He is also overweighting banks that had little or no exposure to the U.S. subprime mortgage mess.

A look at some favoured stocks:

> Latin America. Brazil is “the single biggest story,” says Gorman. It is a beneficiary of strong prices for both soft commodities, such as soybeans, and hard commodities, such as oil and metals — and that has created good prospects for consumer spending and banking.

Gorman likes Banco Santander (Brasil) SA, Brazil’s third-largest private bank, which has shown good earnings growth and profitability.

Mobius likes Itaú Unibanco Holding SA, the largest bank in Brazil by assets, which is benefiting from robust consumer spending, and Petróleo Brasileiro SA, the largest oil company in Brazil.

Pickings are slimmer in Mexico, which, Gorman notes, is “running a significant trade deficit that has impeded consumer consumption.” Nevertheless, he has found opportunities, including Walmart de Mexico, the largest retailer in Latin America, which continues to do well despite slower consumer spending.

Mobius likes America Movil SAB, a cellphone provider with operations across Latin America, and CIA de Biebidas das Americas (Ambev), a producer and distributor of bottled beverages in the Americas.

> Eastern Europe. Russia and Turkey are the favourites. In Russia, Gorman likes Novatek, the country’s largest independent natural gas producer, which will benefit from a government decision to “wean industrial users off artificially low-priced natural gas.”

Mobius likes raw materials producers in Russia — especially Gazprom, one of the world’s largest energy companies, and Lukoil, the country’s largest oil company.

Outside of Russia, Gorman is participating indirectly in eastern Europe by investing in Tesco PLC, the fourth-largest retailer in the world by revenue. It sells groceries and general merchandise and has operations in Poland, Slovakia, Czech Republic and Hungary.

> Middle East. Gorman likes Israel Chemicals Ltd., one of the world’s leading fertilizer and specialty chemicals’ company.

Mobius favours property companies in Dubai; investment companies and banks in Qatar; and consumer-based and chemical companies in Saudi Arabia.

> South Africa. Mobius likes Anglo American PLC, a major producer of diamonds, precious and base metals, and coal; ABSA Bank, one of the country’s largest banks; and Massmart Holdings Ltd., a large wholesale and retail chain.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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