The next Emerging Market bubble? :: UBS

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The next Emerging Market bubble?


Growth concerns and debt deflation fears in the West still loom large despite the
imposition of super loose monetary policy and ample fiscal stimulus. Moreover,
policy makers are fast running out of options in their battle to reflate and boost
growth. The Fed has hinted at further unconventional monetary policy – ‘QE2.’
The BoE may well follow after announcing public sector spending cuts.
Elsewhere, the BoJ has stepped up its FX purchases. All in all, these policies are
intended to hold down both currency and interest rates for longer.
This is a game changer for emerging markets and many GEM policy makers
will understandably be worried about speculative capital inflows and their
impact on domestic assets, currency and the wider economy in general. Indeed,
Brazil and Thailand have already imposed some form of capital controls to deter
hot foreign money. This is not the first time this has happened. Our colleagues in
FICC (Bhanu Baweja) and Economics (Jon Anderson) have already covered the
topic of capital controls in detail1.
In this note, we look back to the occasions when the Fed eased policy rates
aggressively and the consequences for GEM equities, currencies and valuations
in order to draw parallels with the current circumstances. We also highlight a list
of opportunities to play this theme. Our main conclusions are as follows:
􀁑 During Fed easing, GEM equities perform the best after the trough in
Fed funds rate. Using data since 1990, this has been the case in all three
occasions of prolonged easing of monetary policy by the Fed: 1991-1994,
2001-2004 and 2008 to date.
􀁑 2010 shares many characteristics with both 1993 and 2003. The Fed
eased to kick start growth, but arguably 2010 is more like 2003. Valuations
today better reflect 2003 levels, likewise commodity prices are on the rise.
GEM balance sheets are strong and currencies undervalued. Although we
recognise that global growth today is more fragile, another round of Fed
easing should be very positive for GEM assets.
􀁑 Opportunity knocks. Within emerging markets we highlight exposure
through Brazil, China, Russia, South Africa, and ASEAN countries.
Likewise, within sectors we advocate overweight positions in Pharma,
Energy, Banks, Household Personal Care and Food, Beverage and
Tobacco. For stock pickers we highlight our UBS GEM Select most
preferred list.
􀁑 No major positioning risk. The much talked about wall of capital inflows
has yet to arrive; rather we see just a reversal of the outflows since 2008.
Furthermore, GEM equities are still fundamentally undervalued trading on a
P/E of 11.4 times versus our fair value estimate of 15 times. In addition,
Global investors are still some 7% underweight GEM equities within their
benchmark