Monday, October 26, 2009

The week of the US Dollar and the Euro

This week it was about the US Dollar and the Euro, with the latter reaching its annual high versus the Greenback. For the first time in ages the Euro reached a value of more than USD 1.50. But unlike what we witnessed in previous weeks, it was not pure dollar weakness that caused the Euro increase. When looking at chart 1, with the currency overview, we see - when comparing things with last week - that most Emerging Markets currencies lost a bit compared to the USD. On an 8-week basis most are still in positive territory.

Chart 1; EM Currencies versus the USD; weeks 36-43 2009 

The Russian Ruble and the Brazilian Reais are the strongest currencies, with an almost 10 percent appreciation versus the USD during the most recent 2 months. But the Brazilian currency has seen appreciations in excess of 10 percent already. And the Brazilians weren't too happy with it. Actually, Brazil introduced a tax on investment money entering the country this week. It was not a big tax (2%), but still. This is quite a substantial increase in transaction costs for investors and the markets in Brazil reacted. Especially BMF Bovespa (our holding in the Brazilian Stock Exchange itself) was hurt, but we don't find it necessary to reduce our Brazil exposure. This kind of measures have been introduced before in developing countries and Lula's Brazil is doing it with an itself 'good story' as explanation. This was not some kind of kleptomanic tax to make foreigners pay for a financial mess. No, what was worrying Brazil is the following. The Chinese chose to link their currency to the US Dollar. Result: Dollar weakness translated into a strong Chinese position in export markets. Brazil is also an economy whose economic potential is to quite some extent directly linked to successes in export markets. 

With Western markets still struggling with the Global Crisis aftermath, Brazil felt that too much Western capital (both FDI and portfolio investment capital) was flooding Brazilian markets and sectors. Result: this demand for Reais led to a) appreciation of the currency that went so far as to hinder the competitive position in export markets. The Brazilian government hopes that this levy will help control the inflow of money and the value of the Reais. We are confident that the Brazilians did not go too far.

When looking at our four model portfolios, the Morningstar Favorites portfolio that consists of stocks recommended by top asset managers specializing in Emerging Markets strategies had a poor week. Partly because it has quite some Brazil exposure (13.1%), and partly because it wasn't a fantastic week for stock market investments in general. All major benchmarks showed either small negative (MSCI Frontier Markets and MSCI World) or small positive (MSCI Emerging Markets) returns. Not surprising, taking into account a) the important Brazilian tax news; b) the uncertainty about what is going on in Iran with its nuclear facilities; c) profit taking after a good period; and d) uncertainty about the USD - Euro exchange rate. Added to this we can also refer to the growing uncoupling of oil and gas prices: with oil prices recovering substantially recently, we see that developments in gas markets seem to be less correlated than they have been for quite some time. So far this has not hurt Gazprom: the Russian giant is at the moment actually the best performing stock in the EM MORFAV portfolio with a cumulative return of 26.35% in 8 weeks! But in an earlier blog entry we quoted Gazprom CEO Miller who already expressed his fears about the Ukraine and other clients' capacity to a) pay for their gas; and b) keep demand at the same levels as last year.

Chart 2; MORFAV portfolio versus relevant benchmarks; week 36-43 2009

With a cumulative return of 10.36% the MORFAV portfolio is still our best performing model portfolio albeit that its return lags the MSCI EM benchmark considerably. The MSCI EM posts a cumulative return of 13.68%. However, the MORFAV portfolio invests 5.4% in Money Market Cash and has an overweight in larger, more mature Emerging Markets and within these markets in larger, more solid stocks. So in and of itself it is not that surprising that this and other model portfolios lag the benchmark in an exuberant period in which the index increased by almost 14 percent in 2 months. As we stated earlier on several occasions: our model portfolios are constructed in such a way that they also show resilience when market developments are less positive.

The second best portfolio on a cumulative basis is EMNXT11 consisting of large-cap stocks from countries that are part of Goldman Sachs's Next-11 selection of countries that are expected to grow at an above-average rate when the BRIC nations mature. Chart 3 shows that the EMNXT11 model portfolio posted a cumulative return of 9.03%. The most relevant benchmark index, the MSCI FM index scores a cumulative return of 5.38% over the 8-week period from week 36 to week 43, 2009.

Chart 3; EMNXT11 versus relevant benchmarks; week 36-43 2009

The performance of the EMNXT11 portfolio is basically explained by three stocks doing a good job: a) National Bank of Pakistan (our winner of the first weeks); b) Posco (the South Korean steel maker); and c) Orascom Construction Industries (Egypt). The Egyption construction firm did poorly in the first weeks, but recently Africa is showing recovery and Orascom benefited from that. All three stocks appreciated between 18 and 20 percent in value during the past 8 weeks. Also positive: not a single (!) EMNXT11 stock depreciated in value during the End-of-August - October 23, 2009 period.

Our third model portfolio is EMLOS, the portfolio consisting of stocks from countries that had the worst performance on an annualized basis in the 12-month period ending August, 28 2009. Gazprom, National Bank of Pakistan and Saudi Basic Industries are the three winners in this portfolio. Its overall performance over the period from week 36 to week 43, 2009 is 7.83%. Chart 4 shows the comparison with major indices.

Chart 4; EMLOS versus relevant benchmarks; week 36-43 2009

The model portfolio consisting of stocks from the countries that showed the best cumulative performance over the 12-month period ending August 2009 (EMWIN) shows the poorest performance so far (7.00%), albeit that this performance is still far better than that of the MSCI World (the index of the developed nations). This is indicative of the strength of recovery in Emerging Markets when comparing it with the situation in Western nations. Petrobras from Brazil is the best performing stock in this portfolio. As you know, we just added Petrobras to the MORFAV portfolio as well. Petrobras had a poor week, albeit that it clearly outperformed the Bovespa index in this lousy week for Brazilian stocks.

Chart 5; EMWIN versus relevant benchmarks; week 36-43 2009

Interesting to see, but so far the MSCI EM index is a tough cookie to beat for our four model portfolios. But with the market climate being exuberant we are not that surprised. It is a well-known phenomenon that this is the type of climate where indices do a great job. Investors want to be back in the market and every good asset manager has difficulties catching up with the benchmark. Actually, 'good', 'solid' stocks with long-term potential do less of a job than short-term sensational recovery stories. And the latter are not part of our portfolio. We want to have solid, long-term EM exposure plus some downside protection with a 5-10 percent allocation to money market cash that we can increase when needed. The latter is obviously costing performance: as you can clearly see in our charts, cash is the worst performing asset class. Our decision a couple of weeks ago to diversify between USD and Euro cash was a good one though. Cash performance has gone up quite a bit due to the Euro appreciation vis-a-vis the USD.

But all in all, it was a rather boring poor week. Our top-3 of best performing stocks changed quite a bit. The top-3 consists now of:
    1. Gazprom (RUS) 26.35%
    2. TPV Technology (HKG) 23.28%
    3. ICICI Bank (IND) 23.12%
The bottom-3 consists of:
    1. Teva Pharmaceuticals (ISR) -1.46%
    2. MTN Telecom (SAF) -1.11%
    3. China Mobile (HKG) -1.03%

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