Market Outlook For Emerging Markets

On the Edge Financial Daily: Mobius: Outlook for emerging markets remains positive

• KUALA LUMPUR: The outlook for emerging markets remains positive to their relatively strong fundamental characteristics and faster growth than their developed counterparts, says Mark Mobius.
  
  Mobius, who is Templeton Asset Management Ltd executive chairman, said on July 8 while some emerging economies contracted in early 2009, most are expected to return to positive growth by end-2009 or 2010.
  
  “In the face of the global economic slowdown, the major markets of China and India continue to record exceptionally robust growth rates. China and India are expected to grow by 8% and 6%, respectively, in 2009,” he said.
  
  Emerging economies are in a much stronger position to weather external shocks following the accumulation of foreign exchange reserves.
  
  The growing middle class in emerging markets is an important and strong contributor to growth, he added. Emerging markets account for more than 80% of the world’s population, providing them with a strong purchasing power and the ability to spend their way into growth. At the forefront are markets such as China, India and Brazil.
  
  Another area that is poised to support economic growth in emerging markets is investment, particularly in infrastructure.
  
  “This is another area in which we have seen governments boost public spending in markets such as China and India. More importantly, the current valuations of emerging markets remain attractive,” he said.
  
  In his assessment of the second quarter of 2009, he said emerging markets surged with the MSCI Emerging Markets index returning 34.8% in US dollar terms.
  
  Mobius said part of this return was due to weakness in the US dollar. A return of confidence in emerging markets, the desire for higher returns and the search for undervalued companies support the markets’ uptrend.
  
  Latin American and Eastern European markets were among the strongest performers during the quarter while most Asian markets also recorded strong double-digit returns.
  
  A rebound in commodity prices and stronger domestic currencies supported markets in Latin America. Asian markets continued to attract significant portfolio inflows allowing markets such as China, India and Thailand to outperform their regional counterparts.
  
  In Eastern Europe, Hungary returned 69.7% in US dollar terms in part due to a strong Forint. Poland returned 37.0% in US dollar terms, while Russia ended the quarter up 37.8%.
  
  Turkey was among the top emerging market performers with a return of 57.2% in US dollar terms. A stronger Rand led the South African market to end the three-month period with a 31.3% gain in US dollar terms.

Chart of EEM.

From Apollo Investment Management, Claire Barnes were rather cautious in her 2Q report despite her stellar fund performance. Here is a snippet from her comments.

• Three months ago we reported an abundance of quality/growth options at attractive prices. Many of the more promising participated fully in the market's surge. By end-June, we had net gains of 36%, 99% and 164% on the three stocks which we added in 1Q. Several leading companies report that they see no signs of green shoots, but have anyway doubled in price. Valuations are now much less compelling. We are back to carefully weighing the relative resilience and prospects of businesses for the long haul, against a backdrop of economic turbulence which we expect to continue, and possibly to intensify.

LOL!

How very true! Have we not seen it here? Despite the no signs of green shoots, some of them shares simply rocketed to the moon!

• Governments, disappointingly, have 'wasted a good crisis'. Not only have they thrown away unimaginable amounts of taxpayers' money, postponing necessary adjustments, and impoverishing future generations. Not only have they missed opportunities for intelligent reform and appeared to be victims of 'regulatory capture'. Not only have they flouted the established hierarchy of creditors, imposing unwarranted losses on the prudent, and distorted the allocation of capital. They have also failed to seize the opportunity to reexamine market fundamentalism, to lead intelligent debate on the appropriate goals of societies, and to forge a new consensus on effective moves towards a more sustainable future.
  
  Perhaps such leadership takes longer, and will emerge in due course, as adrenaline-fired weekly panics give way to consideration of the longer-term issues. The 2009 Reith lectures offered a worthy start to a necessary debate.
  
  We mentioned that the economic crisis may intensify. Papering over cracks serves only to obscure the necessity of remedial action while the problem gets worse. The patchwork of quick fixes will have unintended consequences. Crises in pensions, insurance, government finances, housing foreclosures, etc, may be visible long after their worsening becomes inevitable, long after they become impossible to avert - but long before they reach bottom. The same will at some stage prove true of energy resources, and environmental damage. The timetable for these is less forecastable: they could be decades away, but the possibility that they may intensify suddenly should be borne in mind. Planetary and bureaucratic overload, like military blowback, lend themselves to the models of catastrophe theory, and may reach tipping points with little warning.
  
  How to plan for energy and environmental contingencies, we are not at all sure. Fortunately, it seems likely that there will be better times to act. The stampede for inflation hedges may be premature (forced and voluntary deleveraging may outpace the printing presses for a while). Exchange-traded funds have made the establishment of long positions in commodities more convenient for many, and more investors now seem to be viewing commodities as appropriate for large asset allocations, changing historic price relationships. In John Hussman's phrase, it may be 'hard for investors to sustain a durable sense of doom about inflation risk', if we have a period of subdued prices or deflation meanwhile. Likewise for resource shortages: some 1970s analysis still reads well, but many market participants would regard three decades 'too early' (even if intended as a warning) as tantamount to being wrong. However, early warnings are valuable. Investor views on appropriate long-term strategies would be welcome.
  
  Meanwhile, the attempt to recreate the market economy of 2007 seems both doomed and foolhardy. Many industries will not quickly return to 2007 levels: some will never be the same again. We are wary of future predictions for most 'luxury', several types of retail and consumer goods (spending patterns may change for decades), the auto industry, many types of capital machinery, and construction equipment... among others. We nevertheless hold some shares in these sectors, if the risk-reward proposition remains reasonable, but many of our holdings are in other sectors where business is relatively predictable - supermarkets, fast food, consumer finance, aircraft maintenance, basic telecommunications - and life, for the time being, goes on.

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Weekend Reading

Posted on Claire Barnes's Apollo Investment Management ( here ) :

• 'Is your pension fund a dump for toxic waste?' asks Paul Tustain, in the best single article I've seen on this most important of all financial issues.

Do click on that article. Great reading for the weekend.

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Rates Rally Gives Bounce to Markets

The Dow had a nice day as the Bulls fight back and FSO Market Commentator, Chris Puplava notes that the Interest Rate Rally May Be Over Short-Term, but Ripple Effects Will Only Worsen Housing Situation.

• The bond sell-off that began last month with the 10-year UST rising from a low of 4.602% on May 11th to a high of 5.316% yesterday may have reached a short-term top with the RSI near 90, the highest level seen in more than 20 years. Readings over 70 have marked peaks in interest rates previously (as marked below), and the current reading near 90 hints at either a pause or a pullback in rates.
  
  
  

Lastly, do give Ms. Claire Barnes, of Apollo Investment Management made the following remarks.

• Some commentators were reassured that US first quarter reporting passed without financial disaster, and concluded that new age financing had painlessly dispersed systemic risk. My suspicion, on the contrary, was that market-fundamentalist accounting is postponing the emergence of problems: judgment is no longer required to be exercised in provisioning, and prudence is deemed old-fashioned - instead we have "fair value", relying either on a mechanistic marking-to-market, by reference to last trade. The nature of niche markets is that when problems emerge, they first become illiquid (and even more easily manipulated); only later when other options have been exhausted can a single distressed-seller cause prices to fall off a cliff. I then discovered that US accounting rules require holders of CDO paper to value it with reference to questionable models (such as the aptly-named Monte Carlo simulations) from the far-from-disinterested rating agencies. 'I knew it was bad but...' says John Succo (must read). 'The levels at which investors are carrying [mortgage-backed securities] paper is not reflecting underlying reality as the holders simply hold their collective breath and the rating agencies ignore a worsening environment.'
  
  Before buying a money market fund or structured product, remember the old maxim:
  
  'More money has been lost reaching for yield than at the point of a gun.'
  
  And before assuming that a money market fund will be liquid when you need it, consider the Paper Chase.

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How Now Brown Cow?

Saw this very interesting comments posted by Ms.Claire Barnes of Apollo Investment Management. ( website: http://www.apolloinvestment.com/index.html )

6 Mar 07:The possibility of 'reversing Indonesia's anti-corruption drive' may set off a few warning bells for investors in a stockmarket which has more than quintupled over 4.5 years. Institutional integrity is not only important to economic efficiency; the number of problems over the years relating to security of company ownership and enforcement of contracts suggests to us that the valuation of shares should be discounted relative to other also-imperfect South-East Asian markets. More fundamental legal reform than ever seemed likely would have been desirable, but even the progress which was made now seems to be fizzling. Other market participants clearly take a different view of the risk-reward balance, but the fund is out of Indonesia for now - for stock-specific reasons, as ever, but there seem to be more promising places to seek replacements. Dissenting views, anyone?

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View On US Consumer

Chris Puplave has a very interesting commentary on the US Consumer: A Bird's Eye View of the U.S. Consumer: 7th Inning Stretch or 9th Inning?

The point that very much worth highlighting is the following issue:

• Seventh Inning Stretch or Ninth Inning?

  The importance of the growth in debt can not be overstated as the fuel for our service and financial economy that supports the U.S. consumption appetite that has grown to 70% of GDP as shown by Figure 1 shown again.

  
  

  Figure 1

  
  

  
  Source: Moody’s Economy.com/BEA, Federal Reserve Board (FRB)

  
  

  When consumer and corporate appetite for more debt contracts a retrenchment in consumer spending and capital investment ensues that leads to a recession. Since1950 there has only been one period when there was a sharp contraction in household debt growth that didn’t lead a recession, and also only one period of a contraction both corporate and consumer debt growth that didn’t lead to a recession -- only one exception in over a half century.

  
  

  The exception with household debt growth without a resulting recession occurred in the middle 1960s. What helped prevent a recession was the corporate sector picking up the slack as corporate debt growth remained in the high single to low double digit rates. When the corporate debt growth rate began to slow, a rebound in consumer debt growth was already underway preventing a recession.

  
  

  In the 84/85 mid-cycle slow down, both consumer and corporate debt growth contracted significantly at the same time without a resulting recession. The likely reason for a recession not resulting was due to the levels from which both dropped and fell. Both fell from the high teens to high single digit rates, still strong growth rates. It was only when rates fell sharply to low digits, or even negative rates in the case of corporate debt growth, when a recession resulted in 1990. When both have contracted to low single digit rates we have had a recession, no exception.

  
  

  As is shown below, household debt growth has contracted sharply, principally due to a drop in mortgage debt as seen in Figure 19. This is likely sending us a recessionary warning as there has only been one exception to contracting household debt growth without a recession as mentioned above (mid 1960s). What is alarming is corporate debt growth looks like it is rolling over and if corporate debt growth and subsequent spending contracts, the alarm bells will be loudly ringing as there has been no exception of the absence of a recession when both fall to low single rates.

  
  

  Figure 21

  
  

  
  Source: Moody’s Economy.com/FRB

  
  

  The YOY rate of change is a relative number expressed in percentage terms. The relative trends in consumer and corporate debt growth is alarming, but the absolute debt growth in corporate and consumer debt growth is downright frightening. Take a look.

  
  

  Figure 22

  
  

  
  Source: Moody’s Economy.com/FRB

  
  

Claire Barnes of Apollo Management carried the following note on her website.

• 12 Feb 07:The US 'housing finance breakdown: a saga of corruption, stupidity, and government complicity' is now being tracked by The Mortgage Lender Implode-o-Meter. The Apollo Asia Fund owns no HSBC shares.

And oh, the US Market had another record shattering day again.

http://money.cnn.com/2007/02/14/markets/markets_0530/index.htm?postversion=2007021418

• Record-shattering day on Wall Street
  Dow industrials close at highest point ever as do utilities and transportation averages; S&P 500 hits 6-1/2-year high.
  By Jessica Dickler and Alexandra Twin, CNNMoney.com staff writers
  February 14 2007: 6:16 PM EST
  NEW YORK (CNNMoney.com) -- Stocks rallied across the board Wednesday, pushing the Dow Jones industrial average to a new all-time record, after investors cheered comments from Federal Reserve Chairman Ben Bernanke.
  
  The Dow (up 87.01 to 12,741.86, Charts) jumped 0.7 percent to close at a record high, taking out its previous record from two weeks ago. The blue-chip barometer also hit a record trading high during the session.

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The Pirates which seized the Armada

2003. That was when Bumi Armada went from a public listed company to a private company.

The following is a link to Ms.Claire Barnes (of Apollo Investment Management) notes.

• http://www.apolloinvestment.com/pirates.htm
  
  The problem lies in the Malaysian listing rules. If the controlling shareholders receive acceptances to take their stake up to 90%, they can proceed to compulsory acquisition: this is fairly standard, but I doubt they could get to that level, were they not threatening a delisting. If they reach 75%, they can vote to delist - and do so unless there is a 10% vote against. In Hong Kong, that would be 10% of the unconnected shareholders; the Malaysian rules are less clear, and it seems that the controlling shareholders may be allowed to vote, so that one would need 10% of the issued capital to block - but officials of the Securities Commission have apparently said verbally that the controlling shareholder would be debarred from voting, which comes to the same thing. However, according to the offer document, if the free float is less than 25% for six months the KLSE may do the dirty work for the controlling shareholders, and delist automatically. This is the crunch, and it is a policy which should be urgently reviewed. The particular reason for urgency is the vote at hand: many investors are not allowed to hold unlisted shares; many more are unwilling to do so, given the lesser liquidity and lesser protection of minorities in an unlisted company. If investors know that they will be forced out eventually, and have a choice between RM7 now and RM7 in 6-12 months' time, the only rational decision is to accept now. But it is not a fair choice, and the KLSE should not be assisting controlling shareholders to squeeze minorities

and...

• To go back to the merits of the shares: in the five years since we first bought Bumi Armada, revenue has tripled. This corresponds to growth of 25% per annum, which is perhaps slightly higher than the growth in other aspects of the business, but broadly reflective. In purely qualitative terms, before thinking about valuation, this is one of the gems of the Malaysian market. It has an excellent service record, it has good relations with its customers in the offshore oil and gas sector, and apart from 1997, when it recorded unrealized FX losses on an appropriately matched loan book, it has sustained returns on equity of comfortably over 20%. It is highly cash generative, and when the Land & General stake was overhanging the market we put forward an MBO-and-buyback proposal which would have seen the debt paid down in short order while generating phenomenal growth in earnings, net assets, and cashflows per share. This opportunity was not taken, but delisting aside, the shares would remain attractive; the offer is far from generous, and clearly includes no premium for privatisation. We didn't sell at RM8.00 two years ago, and Mayban Securities on Friday published a buy recommendation valuing the shares at RM12.20, which is arguably conservative.
  
  Bumi Armada reported earnings per share of RM1.01 for 2002, with an upbeat assessment of outlook for the year ahead, so is on a current-year PE of 6-7 - perhaps half that of the market, despite better-than-average business characteristics and growth prospects, although some discount is normal for illiquidity. In its recent announcement, it has however cut back on operational background, provides no details of major contracts, and omitted any final dividend despite its earnings growth. (This last has particularly incensed some minority shareholders who are surprised 'that Ananda Krishnan should be involved in such a deal'.) This reticence is unfortunate given the conflicts of interest involved.
  
  In the event of a forced delisting, we believe that there would be a legal case against the directors and the controlling shareholders for oppression of the minorities, but costly and time-consuming legal action is a last resort for investors in any jurisdiction.
  
  We were pleased to see that Mayban remains optimistic about Bumi Armada's prospects, but admit to being surprised by the timing. Maybank, its parent, was amongst those which originally jumped at the RM7. This must be proof of their Chinese walls - or of the different thought processes of bankers and investors. We are more impressed by this than by the role of RHB Sakura, which also agreed to sell its Bumi Armada shares in August, and wonder whether it was already advising the company or the buyer: as far as we know, the invitation was extended only to Malaysian banks, and not to a single foreign bondholder. Bondholders who expressed a desire to participate immediately after the deal became public were told that it was already too late - which is presumably lawful, but was certainly discriminatory, and not the sort of thing to make foreign investors think they are on a level playing field.
  
  If an offer is mandatory, it is not necessary to have bureaucrats review the decision. In this case, the controlling shareholders have to pay RM7, but they only have to pay it much later to minorities than to the favoured few. In other cases, it might suit a cash-strapped acquirer very well to avoid a general offer altogether; again, why should officialdom help him? (To avoid any confusion, we would like to be absolutely clear: if a shareholder acquires control, there should be a general offer at the same price, but minority shareholders should be free to refuse.)
  
  Information flows are important, and much more troublesome than they should be in the era of electronic communications. International investors frequently cannot obtain announcements and circulars through the global custody network in time to consider them adequately; frequently they arrive too late to meet corporate action deadlines. Listed companies should be required to copy the local stock exchange and international wire services with all announcements relevant to investors - such as announcements to Euroclear. This responsibility should not be left to companies: they respond when it suits them, and forget when it doesn't

And of course I was way too familiar with this incident. I was active in an old stock forum and the following is some postings made.

Here is an old posting from an old friend.

http://forum.nextstock.com/cgi-bin/advboard/advboard.pl?command=viewmsg&forumid=1931&msgid=1270

• Nomore and others, any information about this company? So quiet
  lately after the acquisition by Anandan Krishnan. Some remarks:
  
  - There will be a General Offer at RM7 per share. I have nothing
  against that. This is the same price that was offered to the L&G
  bondholders, they agreed, and I can understand that, since
  bondholders are an other breed then equity-investors, they just
  wanted (part of) their money back. By the way, the bondholders got
  their money long time ago, the longer the GO will take, the less
  attractive this offer will be, the company is making about RM1 net a
  year. As it now stands, I am not inclined to accept this offer.
  
  - Most likely, after that there will be a MANDATORY acquisition at RM
  7 per share; I find the price simply not enough, such an acquisition,
  whereby people are FORCED to hand over their shares, should be at a
  price, which is very clearly generous, relative to a lot of
  yardsticks (for instance in comparison to other listed companies). At
  a PE of around 7, having had a healthy growth, with a high ROE (30%)
  and ROA (17%), and with good future prospects (even considering their rather flattish recent results on the operational level), I find the
  offer clearly to low. Barmada's share has been quite cheap for a long
  time, but firstly a few years ago they were highly geared (so quite
  risky, interest cover is nowdays very comfortable) and secondly there
  was the potentiel overhang from the shares issued to the bondholders
  (people don't like to buy a share, when the market could be flooded
  by millions of shares).
  
  - Big dividends are normally offered at the announcement of the 3Q
  result, I expected this time 30ct TE (they can easily afford it, with
  a very healthy cash flow). Strangely enough, no announcement this
  time. Is it possible that they want to declare the dividend AFTER the
  Mandatory Offer, so that they can keep all the money for themselves,
  instead of giving part to the minority shareholders? If so, that
  would be REALLY disappointing, and, I think, not fair.
  
  What do you think?

Yup, there were many investors who were annoyed at how Bumi Armada was delisted from the exchange.

Let's look at Ms. Claire Barnes funds performance (this is their Investment philosophy ). You can see the performance of the fund here:

http://www.apolloinvestment.com/performance.htm

Now let's refer back to her original pirates article which was written back in 2003.

Pirates attempt to seize whole Armada: pitfalls of investing in Malaysia

Read her opening statemtent again.

• There are many attractions to living in Malaysia, but we cannot muster the same enthusiasm for investing here (a change from July 99, when we were defending our decision to hold; our major investment then as now was Bumi Armada). Our recent experience has been far from encouraging, and it seems timely to provide an update.

Her 'pitfalls of investing' in Malaysia.

Now look at this.. "The 2Q report has been posted."

In that report, her fund gives a report of their equity percentage per country. Look at the percentage of how much of her funds is invested in Malaysia.

See how privatisation of listed stocks is simply a no-no?

And in fact the story does not end just like this.

May 24, 2005 Corporate: AK's Bumi Armada to list again

Two words. How can?

Back then, Bumi Aramada came up with an extremely long list on why it wanted to be privatise. So if they do list again, isn't it an admission of contradiction of their earlier reason why it wanted to be privatised?

So far, there is no updates on this issue but I hope this company should not be granted listing at all.

Local saying: "Suka-suka list, suka-suka privatise. Macam-macam ada! Apa pun boleh!"

And if so.. what's left of the integrity of the stock market?

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Déjà vu..?

Here is an interesting snippet from AIM's (Apollo Investment Management) 1st Quarter 2006 report.

• The most irritating of the three duds was until recently a small-company gem, with ROE and EPS growth both over 20%, supplying services to the offshore oil and gas sector... déjà vu? remember the Pirates?... and once again we were mugged by Malaysians. This was an unpleasant surprise, since the company, Total Automation, was Singapore-based, excellently run by its founder-managers, and they were reporting no interference from their Malaysian shareholders - until the latter decided to sell the whole business to Wartsila of Finland. They did so on a PE of 11 for the year just ended, and on our estimates 8-9 for the current year, a strangely low valuation. The disposal announcement made no mention of distributing the cash proceeds: it said the board would ponder other businesses in which to invest. All executive directors resigned immediately, with no apparent thought of fiduciary duty to minorities. As startled investors who had bought the shares for its niche engineering business studied the diverse interests and dismal track record of listed companies in the controlling Melewar group, Total Automation shares slid to a discount of 25-30% to the expected cash. Seven weeks after the initial disposal announcement, having cancelled the routine analysts' briefing after the results and been parsimonious with access meanwhile, the company did announce an intention to distribute 75% of the proceeds, which may be sufficient to reduce protest - most investors will just curse and move on - but remains unfair, since the share price remains well below the level at which we believe it would have been trading if continuing with its existing business (7 times EPS for '06?), and the implied value attributed to the 25% balance implies no confidence in the directors. The pattern of trading and disclosure has been no credit to Singapore (nor of course to the Melewar group), and we were surprised to be told that minority shareholders would have no effective say. For the controlling shareholders to vote on the sale is fair enough, since unconnected, but we would have thought the decision should require a 75% majority, and/or that there should be a requirement for an immediate unconnected-shareholder vote on distribution of proceeds.

Well, I have blogged on Melewar before. (see Melewar and Melewar: Part II ).

Remember the blog posting Philip Fisher: Management Integrity.

Let me repeat here again.

• On the issue of integrity, this is a simple no-brainer. Does it make sense to go into a business-partnership with someone you do not trust? It is hard to imagine why anyone would want to go into a business partnership with someone who would most likely cheat us the minute we turn our back.
  
  According to Fisher, the management of a company is always for closer to its assets than its shareholders. And without even breaking any laws, there are number of ways that the management can benefit themselves and their families at the expense of the minority shareholders, for example employing their relatives, buy-and-selling of properties between relatives at above market rates or the issuing common stock options.
  
  It's not only the dislike for dealing with unscrupulous people but Fisher believes that companies managed by people of dubious integrity will definitely meet with failure. (Don't you agree?) For those in control would attempt to make money at the expense of the minority shareholders for these minority means nothing to them but mere other people's money who are there for them to abuse!

ps...

How does one value a company one cannot trust?

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