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Dolls And Dogs: Our List Of Emerging Markets To Invest In (And To Avoid)
With one-third of 2016 already behind us, we review the major stock market indices in frontier and emerging countries. Where were the returns strongest – and more importantly, what are the best ways for investors to get involved? After a long period in the darkness, investors in emerging markets have lately had reason to perk up. Contrast that with last year, when global equity investors had few places to hide. US markets barely broke even in nominal terms, and even incurred a small loss when factoring for inflation. Pain was evident in other developed markets, as major European indices also ended the year lower. Yet these lackluster performances paled in comparison to the bloodbath in emerging markets. Note the comparisons below, as displayed with the most liquid ETFs that track each relevant index: Ticker Name 2015 Performance (%) SPY SPDR S&P 500 ETF Trust 0.02% VGK Vanguard FTSE Europe ETF -4.83% EEM iShares MSCI Emerging Markets Indx ETF -18.01% FM iShares MSCI Frontier Markets 100 ETF -19.19% Data calculated as of market close on 5 May 2016 The opening days of 2016 saw that malaise transform into outright fear, as January proved to be one of the most brutal months in recent memory. US Fed Chairwoman Yellen’s decision to raise US rates at the end of December (an ill-advised tactic, as I wrote back in October) sparked a rush for the exits of stock exchanges around the globe. US and European markets lost nearly 10% of their value, while the carnage in major emerging and frontier indices was even worse. Click to enlarge Source: Money.net There is an old market adage: “As goes January, so goes the market.” Yet an interesting trend has played out since that Fed-inspired selloff. Most major indices traded lower in February, then moved higher and are now positive for the year. (Of course, the exception to this rule is Europe, which is grappling with a most likely insurmountable heap of problems – most of them self-inflicted). But most of the emerging and frontier markets rallied from their mid-January lows and have never looked back. In fact, despite a fierce selloff this week in the emerging markets (note: nearly 25% of EEM’s holdings are in Chinese equities, where many large institutions cut their holdings this week), both of these indices have outperformed those tracking the US and Europe. So what is driving these gains? Unfortunately, it isn’t economic growth, as few countries expect to produce higher growth rates in the current year. Instead, investors seem to be rotating back into emerging market currencies which have been heavily sold in recent months. Remember last year when the ‘smart money’ was forecasting an unprecedented dollar bull market as the Fed began to raise rates? Take a look at this chart for the PowerShares DB USD Bull ETF (NYSEARCA: UUP ) (an ETF that seeks to track the Dollar Index): Click to enlarge Source: Money.net Here’s a question for the technical traders out there: If this chart were for a stock, would you want to own it? (Hint for non-traders: No). Investors have begun to realize that the Fed has painted itself into a corner, with no conceivable way to follow up their rate-raising rhetoric with action. Consequently, emerging market currencies have been on a tear as investors move back into bonds issued by developing countries in an increasingly desperate search for yield: Click to enlarge Source: Money.net Of course, much of this growth can be attributed to ‘bottom-fishing’. This year’s winners are the same countries where investors sold off every asset class a year ago. Factors that contributed to the selloff were quite serious – Western sanctions (Russia), unprecedented corruption and scandal (Brazil), and presidential incompetence (South Africa); and the fear was compounded by a commodities bear market in reaction to waning demand from China. It is quite possible – likely, even – that emerging markets investors are in the midst of a bear market rally. There certainly are few macro fundamentals that can spark excitement – in any market. Nevertheless, as another old adage goes, “There’s always a bull market somewhere” – an old saw that has stuck with me ever since I watched the Sri Lankan stock index increase over 125% in 2009, while the rest of the world was self-immolating. With that in mind, let’s take a look at the five best – and five worst – equity market indices in the emerging and frontier market spectrum so far this year. We track all indices that are included within the MSCI country classification list for frontier and/or emerging markets. We’ll also take a look at ETFs or ADRs that are a generally accepted way for investors to get direct access via one of the US stock exchanges. As you can see, Latin America is dominating the field: The Five Best Country MSCI Classification Primary Index YTD Peru Emerging S&P/BVL Lima General Index 34.68% Brazil Emerging Ibovespa Sao Paulo Brazil 19.19% Argentina Frontier Buenos Aires SE Merval Index 14.33% Morocco Frontier Casablanca MASI All Shares Index 13.71% Colombia Emerging Colombia COLCAP Index 11.91% Source: Bloomberg Peru: Amidst an ongoing presidential election, the Lima Index went near-vertical in early April after the reigning leftist candidate failed to secure enough votes to qualify for a runoff. Best equity plays: iShares MSCI All Peru Capped ETF (NYSE: EPU ). For ADRs, Southern Copper (NYSE: SCCO ) is a US-listed copper miner that generates 43% of its revenues in Peru. Brazil: No tangible bull case here, other than it has been oversold amidst the worst recession in a century and the unprecedented Petrobras (NYSE: PBR ) scandal. A slight bump in depressed oil prices have also contributed. Look for a further rally if the Senate pushes out lame-duck president Rousseff later this month. Best equity plays: iShares MSCI Brazil Capped ETF (NYSE: EWZ ). Honestly, there’s not much to love here. Argentina: We currently receive more enquiries about Argentina than any other frontier market, except Iran. This is a definite value play – after years of financial isolation, the country just closed its first bond offering in over a decade and is about to proceed with its first IPO. As we’ve written previously , though, it pays to be cautious here. Best equity plays: Global X MSCI Argentina ETF (NYSE: ARGT ). Some interesting ADRs include integrated oil company YPF (NYSE: YPF ), Banco Macro SA (NYSE: BMA ) and Grupo Financiero Galicia (NASDAQ: GGAL ). Morocco: The tiny Casablanca Stock Exchange’s All-Shares Index has been on a tear over the past two weeks. Positive sentiment is building in the North African country after Bank of China announced it would base most of its African operations there. Best equity plays: Not easy for US investors. No Moroccan companies carry ADRs; the closest proxy is the WisdomTree Middle East Dividend ETF (NYSE: GULF ) which currently has a 13% weighting in Morocco. Its largest holding is Maroc Telecom ( OTC:MAOTF ), at 10% of total weighting. Colombia: Coming off a very bad year in 2015, underpinned by the one-two punch of high inflation and lower commodity prices. Higher prices for oil have helped to ease investors back into the Bogota Stock Exchange, while US real estate investors are beginning to discover opportunities here. Best equity plays: Global X MSCI Colombia ETF (NYSE: GXG ); ADRs include Bancolombia SA (NYSE: CIB ) and Ecopetrol SA (NYSE: EC ). And finally, let’s take a look at the worst-performing frontier and emerging markets so far this year. Remember that volatility is generally higher in emerging markets, and particularly in frontier markets. Today’s dog could be tomorrow’s darling, and vice versa: The Five (Actually Four) Worst Country MSCI Classification Primary Index YTD Ukraine Frontier Ukraine PFTS Index -8.85% Ghana Frontier Ghana SE Composite Index -9.44% Nigeria Frontier Nigerian SE All Share Index -10.75% China Emerging Shanghai SE Composite Index -17.68% China Emerging Shenzhen SE Composite Index -18.94% Source: Bloomberg Most of the names on this list are widely expected, as we show here: Ukraine: No explanation needed. Rampant inflation, non-existent economy, and did I mention a low-intensity conflict on its eastern flank? I’ve been hearing about opportunities on the ground for the truly adventurous, but that’s about it. Ghana: Weak currency, coupled with rising inflation. The Ghanaian economy has begun to show symptoms of ‘Dutch disease’ as government revenues move to support recent oil discoveries while leaving other industries to rot. Nigeria: Take the Ghana explanation mentioned above, and ramp up the intensity by 10x. The current president is resisting calls to devalue the currency, the naira. China: This is the proverbial ‘elephant in the room’ – not just for emerging markets, but globally. Stocks in the world’s second-largest economy have sold off aggressively this year amidst speculation of looming corporate bond defaults and concerns over economic growth. Continued weakness here may begin to spill over into the global economy. In conclusion, a prudent investment strategy with regard to emerging and frontier markets might include the following: Consider weighting more heavily toward EM and particularly selected FM as dollar weakness continues to push assets into these markets. Region, and even country, selection remains important. Keep an eye on Latin America – but beware the siren song of the bear market rally. Keep an eye on the data. Much of the recent gains have been driven by value investors picking up oversold assets. Without clear indicators of actual economic growth, this rally may be short-lived. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
Third Point 1Q’16 Letter – We Crowded Into Short Trades In The RMB
Third Point – Review and Outlook Volatility across asset classes and a reversal of certain trends that started last summer caught many investors flat-footed in Q1 2016. The market’s sell-off began with the Chinese government’s decision to devalue the Renminbi on August 11, 2015, and ended with the RMB’s bottom on February 15, 2016, as shown in the chart below: Click to enlarge By early this year, the consensus view that China was on the brink and investors should “brace for impact” was set in stone. In February, many market participants believed China faced a “Trilemma” which left the government with no choice but to devalue the currency if it wished to maintain economic growth and take necessary writedowns on some $25 trillion of SOE (State Owned Enterprise) debt. Based largely on this view, investors (including Third Point) crowded into short trades in the RMB, materials, and companies that were economically sensitive or exposed to Chinese growth. Making matters worse, many hedge funds remained long “FANG” stocks (Facebook, Amazon, Netflix, and Google), which had been some of 2015’s best performing securities. Further exacerbating the carnage was a huge asset rotation into market neutral strategies in late Q4. Unfortunately, many managers lost sight of the fact that low net does not mean low risk and so, when positioning reversed, market neutral became a hedge fund killing field. Finally, the Valeant (NYSE: VRX ) debacle in mid-March decimated some hedge fund portfolios and the termination of the Pfizer (NYSE: PFE ) – Allergan (NYSE: AGN ) deal in early April dealt a further blow to many other investors. The result of all of this was one of the most catastrophic periods of hedge fund performance that we can remember since the inception of this fund. When markets bottom, they don’t ring a bell but they sometimes blow a dog whistle. In mid-February, we started to believe that the Chinese government was unwilling to devalue the RMB and was instead signaling that additional fiscal stimulus was on deck (an option that the bears had ruled out). Nearly simultaneously, the dollar peaked and our analysis also led us to believe that oil had reached a bottom. We preserved capital by quickly moving to cover our trades that were linked to Chinese weakness/USD dominance in areas like commodities, cyclicals, and industrials. We flipped our corporate credit book from net short to net long by covering shorts and aggressively adding to our energy credit positions. However, we failed to get long fast enough in cyclical equities and, while we avoided losses from shorts, we largely missed the rally on the upside. Unfortunately, our concentration in long health care equities and weakness in the structured credit portfolio caused our modest losses in Q1. So where do we go from here? As most investors have been caught offsides at some or multiple points over the past eight months, the impulse to do little is understandable. We are of a contrary view that volatility is bringing excellent opportunities, some of which we discuss below. We believe that the past few months of increasing complexity are here to stay and now is a more important time than ever to employ active portfolio management to take advantage of this volatility. There is no doubt that we are in the first innings of a washout in hedge funds and certain strategies. We believe we are well-positioned to seize the opportunities borne out of this chaos and are pleased to have preserved capital through a period of vicious swings in treacherous markets. Third Point – Quarterly Results Set forth below are our results through March 31, 2016: Click to enlarge Third Point – Portfolio Positioning Equity Investments: Risk Arbitrage and Pro Forma Situations “Event-driven” and activist strategies performed poorly in 2015 and in Q1 2016. We believe that the resulting redemptions and liquidations from these strategies have helped to create today’s environment, which is one of the more interesting we have seen in many years for classic event situations like risk-arbitrage and transformative mergers. Many investors are ignoring companies in the midst of deals because catalysts are longer-dated (well into 2017) which is allowing us to buy outstanding enterprises at bargain valuations on 2017/2018 earnings. Many of these combined businesses should compound in value thanks to the benefit of synergies, modest financial leverage, and strong or improved management teams that have a history of successful capital allocation. Some of the most interesting situations are described below: Dow/DuPont We are encouraged by the latest developments in our investment in Dow (NYSE: DOW ) which announced a merger with DuPont (NYSE: DFT ) in December. In February, the company revealed that long-time CEO Andrew Liveris will be stepping aside not long after the merger’s completion. DuPont’s CEO, Ed Breen, is a proven operator and capital allocator. Breen made his mark by streamlining Tyco, a long-time industrial conglomerate, splitting the company into focused units and thus created enormous shareholder value. He brings an unbiased perspective and is not afraid to challenge the status quo, two qualities that will be essential in leading Dow/DuPont given the histories of both of these conglomerates. We continue to believe there is potential for operational improvement at Dow that would be incremental to the $3 billion announced synergy target; in aggregate, approximately $5 billion of earnings improvement could be unlocked. The merger structure preserves both companies’ strong balance sheets which, combined with fading Sadara and Gulf Coast CapEx, should allow for meaningful capital return while maintaining a strong investment grade balance sheet. Taking all of these factors into account, we believe the pro forma entity is capable of generating $5.50 – $6.00 of EPS in 2018. Given that these earnings will consist of contributions from several focused spinoffs, we also believe that multiple expansion is likely. Conglomerate structures often breed unintended consequences like misaligned incentives and suboptimal capital allocation. Going forward, segments in both companies will no longer have to compete for capital with disparate businesses. They will become liberated and empowered to create their own targets with their own incentive plans. More work needs to be done to ensure that the split results in focused, pure-play businesses, in particular because the current structure still has basic petrochemicals and specialty businesses housed together. Re-jiggering the split structure may in itself unlock incremental synergies as more specialty product businesses would benefit from being managed together. A major step forward has been achieved with the appointment of a new merge-co CEO and a strategy to split the business. Now the focus shifts toward creating the optimal split structure and ensuring the proper leadership and governance in each split entity is put into place. With the right management, structure, and a synergy target that looks conservative in light of the prospect for more sweeping change, we believe we have a compelling long-term investment in Dow/DuPont. BUD/SAB/TAP The long-awaited acquisition of SAB Miller (NYSE: SAB ) by Anheuser-Busch InBev (NYSE: BUD ) announced late last year created two interesting pro forma situations. The deal, expected to close in the second half of 2016, will combine the two largest global brewers and create an unrivaled player with strong pricing power in an increasingly consolidated global industry. It will also transform Molson Coors (NYSE: TAP ) into a stronger regional competitor following the acquisition of certain SAB assets that must be sold for anti-trust reasons. Starting with BUD, we think the stock ought to grow nicely over the next several years as the true earnings power of the new company is revealed. Part of the gains will come from improving the underlying profitability of SAB, as operational control of its assets is transferred to BUD’s highly regarded management team led by CEO Carlos Brito. Another part will come from the capture of deal-related cost and revenue synergies, as duplication is eliminated and BUD’s global brands like Budweiser, Corona, and Stella are rolled out to legacy SAB markets in Africa and Latin America. Finally, the rest should come from financial engineering as BUD’s under-levered balance sheet is monetized to help finance the transaction. We also think the new company will likely command a higher valuation as SAB’s emerging market exposure will be accretive to top line growth over time. TAP, on the other hand, stands to benefit greatly from acquiring divested assets. The company is picking up the remaining 58% share of the MillerCoors US joint venture that it does not already own, the perpetual rights to import legacy SAB global brands such as Peroni in the US, and the global rights to the Miller brand. The transaction is highly accretive for TAP given the sheer size of the acquired assets. It also gives the company full control over its most important market, something that ought to improve operational effectiveness and increase the long-term strategic value of the company to a potential acquirer as the global beer industry continues to consolidate. As is the case with BUD, we believe TAP will compound nicely over the next several years as the market more fully appreciates the earnings power and strategic optionality of the pro forma company. Time Warner Cable/Charter Communications Charter Communications (NASDAQ: CHTR ) is a domestic provider of voice, video, and high-speed data. In May 2015, Charter announced the acquisition of Time Warner Cable (NYSE: TWC ). This is a transformational deal that quadruples the company’s scale while driving substantial operating efficiencies. Importantly, the pro forma company will be led by Charter’s current CEO, Tom Rutledge, who we view as one of the best operators in the industry. New Charter is well positioned to capture market share from satellite and telco competitors given its advantaged high-speed data product. In addition, Mr. Rutledge’s track record of boosting video penetration, driving down service costs, and executing large network transformations at legacy Charter makes us optimistic about his leadership of the new entity. There are several operational benefits awaiting the New Charter. The company’s increased scale will help facilitate a continued turnaround at both Charter and Time Warner Cable and the deal also creates new revenue opportunities in business services and wireless. Additionally, Charter should have increased negotiating leverage with content providers which should deliver substantial cost savings over time. Substantial free cash flow per share growth will be driven by accelerated revenue growth, margin expansion, synergies, lower capital intensity, significant tax assets, and substantial share repurchases. As a result, we believe Charter’s share price can compound at ~25-30% over the next two years. Chubb Chubb Ltd.(NYSE: CB ) is the product of ACE Limited’s acquisition of The Chubb Corporation which closed in January. The deal combined two world-class operators that have consistently put up ~90% combined ratios – almost 900bps better than North American peers – and have compounded book value at 10%+ the past decade, more than double that of peers. The new Chubb is the largest public pure-play P and C company by underwriting income. It also has a number of factors we look for in a pro forma situation: an A+ CEO in Evan Greenberg; complementary fit across products, distribution, and geography; and a plan that is less focused on short-term cost savings than long-term strategic opportunities for growth, which are abundant. Chubb’s scale and focus on growth could not come at a better time as certain competitors scale back operations to satisfy shareholder demands. We are willing to forego short-term cost cuts or buybacks to own a franchise that is a long-term winner with the premier franchise in US high-net-worth insurance, #1 share in global professional lines, and an enviable global platform with leading A and H and personal lines in Asia and Latin America. We view Chubb as a high-quality compounder in the financials space, with double-digit earnings growth potential over the next few years. Critically, this earnings power is far less sensitive to rates and credit quality than fundamental execution. Danaher Industries Danaher (NYSE: DHR ) is a diversified multi-industrial company with an increasing exposure to life science and healthcare-oriented businesses. Operating across five different business segments and built up through over 400 acquisitions over the company’s history, the cornerstone for Danaher’s successful integration and value creation strategy has been the Danaher Business System (DBS). Adapted from Japanese principles of kaizen, DBS has evolved into a set of processes and corporate culture revolving around continuous improvement, helping to drive organic growth and annual margin improvement across Danaher’s portfolio. In May 2015, Danaher announced the acquisition of a filtration industry leader, Pall Corp. (NYSE: PLL ), as well as the subsequent split of Danaher into two companies. The split, to be effectuated Q3 2016, will highlight value at both New Danaher – a collection of Danaher’s life science, medical and lower cyclicality businesses – and the spin-off, Fortive – an industrial focused “mini-Danaher”. New Danaher, representing the large majority of post-split value, will have 60% consumables sales mix, 4% organic growth, 100bps of annual margin expansion, and > 100% FCF conversion, an algorithm that will continue the Danaher tradition of compounded earnings growth. The attractive end-market mix, earnings growth, and deep bench of DBS operators will make New Danaher a premium life sciences company that should trade at the high end of its peer group. Fortive, akin to what Danaher originally looked like two decades ago, will have greatly increased M&A optionality and the ability to deploy free cash flow into assets which have historically received less focus within the Danaher portfolio. With the same DBS roots and team of disciplined operators, Fortive will also provide a multi-year compounding opportunity. We initiated a position following the announcements last summer which mark a transformational step in Danaher’s decade-long efforts to continuously improve its portfolio of businesses. Despite Danaher’s portfolio of businesses looking more attractive than ever, its current valuation premium to the S&P 500 is modest and remains well below its ten-year historical average premium. Over the last ten years, Danaher has compounded at 2x the rate of the S&P 500. We recently added to the position after a meeting with the company reinforced our confidence not only in their operations but also in the company’s culture and importance of their values and principles in driving future success. Disclosure: None