Weekly Broker Wrap: Emerging Equities Optimism

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By Andrew Nelson

Since last October, US equities have rallied about 20%, but investors around the world have been more dragged into the market rather than having jumped in happily. However, positive economic data are building and local brokers are starting to cautiously predict more equities upside, at least in emerging markets (EM) and an undervalued Europe and US.

Analysts at Citi note that while the run in equities markets over the past few months could be signaling a period of consolidation is near at hand, they nonetheless believe there is more upside to come. The broker points out that government bond yields are not rising and thus not stifling off the equity rally, with equity funds now starting to benefit from inflows, which they feel will help sustain the current rally.

On Citi’s numbers, a further 11% gain in global equities could well be on the cards.

The research team at Macquarie are also on board with this sentiment, now fully of the belief the global economic cycle has hit bottom, citing the trend in key indicators such like global PMIs and a steady flow of upward earnings revisions. The broker also thinks the ECB’s Long Term Refinancing Operation (LTRO) has helped to remove a significant amount of risk perception from Europe, which should help increase appetite for risk. A solid level of returns from risk assets in January simply supports the broker’s view of an economic upturn.

As the current upturn gathers pace, the broker thinks investors should turn their eye to previously ignored risk assets, like emerging markets equities, given they tend to generate stronger returns after an upturn. The broker recommends investors take this chance to up their risk exposure, switching at least part of their portfolio from US equities to Emerging Asia.

Samsung Electronics, China Minsheng Bank, Bharti Airtel and Kasikornbank are the stocks in Asia to be looking at, says the broker. That said, Macquarie is also more positive on European shares, noting that while US equities are still cheap, the larger European markets of the UK, France and Germany are offering better value at present.

Citi is also liking the look of EM equities, noting that the bulk of equity inflows are already heading towards emerging markets, with inflows already making up for 40% of last year’s outflows. The broker expects that inflows, in general, will remain strong and that emerging markets will be the main beneficiaries of easing central bank policies and improving risk appetite. Conversely, the broker expects little in the way of inflows for more developed markets.

The team at BA-Merrill Lynch are also on board with this view, noting the robust policy response in Europe coupled with better-than-expected macro data around the world have already seen a significant increase to EM exposure over the past month. The broker also points out that the rise in EM exposure comes on the back of falling risk levels and increasingly positive expectations for global growth.
 
While pessimism has ruled the assessment of China’s outlook over the past few months, the broker points out fund managers in the region now believe the outlook for Chinese growth is the strongest it has been since November 2010. As far a barometer for general EM sentiment goes, the broker thinks this is arguably the most important, given China is the most favoured EM market as of February, at least on the broker’s numbers.
 
Turkey and Mexico also improved strongly. Indonesia remained overweight despite underperforming the rest of the EM in the recent run, while the broker also notes a big surge in Indian equities. Asian Tech and Energy stocks are still the market darlings, as they have been for the past three months, says Merrills, who notes much of the money flowing in has pulled out of the consumer sectors and insurance.

However, the team at BA-Merill Lynch thinks Australian equities will be doing it a little tougher, citing an ongoing tightening in financial policy and seeing some emerging risks to Chinese fixed asset investment (FAI) given an increasing decline in the Chinese property market. Continued declines in Chinese steel prices also don’t help the local outlook.

Unfortunately, notes the broker, the Australian market is more closely tied to China than it is to a western world recovery. Thus, local shares are more likely to continue to underperform.

The good news is that broker notes that one of the indicators that would make it turn more optimistic is starting to show some signs of life and that is improving global PMI. This suggests the outlook in the western world is now getting better than it otherwise could have been.

Merills thinks that liquidity will play a crucial role in an overall recovery, noting the Fed, BoJ and the ECB are either talking about or already undertaking quantitative easing. One of the main ways to play this is through exposure to base and precious metals, says the broker, who has added Oz Minerals ((OZL)) and Worley Parsons ((WOR)) to its list of stack to watch. The broker also likes an increased exposure to Newcrest ((NCM)) and more direct plays on a western world recovery via News Corp ((NWS)), Amcor ((AMC)), Westfield ((WDC)) and Incitec Pivot ((IPL)).

Ultimately, the broker thinks an Australian equities recovery is being impacted right now by the specter of interest rate rises and the still high AUD. Given the broker believes the RBA wants to see things get a little worse before it intervenes, domestically exposed stocks will probably suffer as the local economy deteriorates.

Thus, while the broker notes a large number of stocks in the consumer, media and transport sectors may look cheap, it feels the catalyst for outperformance is missing. The broker cites Fletcher Building ((FBU)), Toll Holdings ((TOL)) and Seven West ((SWM)) as being supported by good valuations, but notes that Seek ((SEK)) is at risk from rising unemployment, while developers Stockland ((SGP)) and Mirvac ((MGR)) are most at risk given the likelihood of delays in the interest rate cycle.

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