IDEA of the month: Buy ETF “MSCI Emerging Markets”
The equity markets have continued their favourable performance in recent weeks,
and the reasons for the uptrend have not changed in our view. The equity rally has been driven by rising risk appetite, low interest rates and yields, high liquidity and ongoing low inflation, and all of these factors are still in place. Moreover, economic indicators have continued their uptrend, and the transfer of risks from private to public-sector balance …….
sheets is an additional factor which increases investors’ risk appetite, as the economical fallout of the deep recession has been small so far. Consensus forecasts for GDP growth and earnings have continuously been revised upward.
Our economists expect GDP growth to remain strong until at least the middle of next year due to a turn in the inventory cycle, easier credit conditions, further fiscal stimulus and steadily low interest rates. They believe both risk-free and risky assets are likely to remain well supported over the next six months or so, and a financial-assets mini-bubble may form, so “markets” could well remain in a sweet spot. Thus valuations on most equity markets look set to remain attractive in 2010.
On our scorecards, equity markets are still the most attractive asset class, despite their strong performance, as the macro variables and valuation indicators have performed even better than the equity market itself.
On our scorecards, Europe and the US look relative attractive. Asia (excl. Japan) also got a relatively good score, and only Lat-Am seems less attractive after the strong rally. Given this fundamental assessment and our scorecards, we stick to our current 10% stake ETF “DJ Stoxx Global select dividend 100” and “MSCI USA TRN”. Additionally, we buy the ETF “MSCI Emerging Markets TRN”.
From our vantage point, the fixed-income markets seem very vulnerable. Real economic indicators continue to perform very well, and leading indicators support the idea of a Vshaped recovery. Thus, shorter durations in particular have become relatively expensive both in our view and according to our score cards, as the central banks might start to discuss how to give up their very accommodative monetary policy in the next few months. Moreover, bond market prices do not seem to fully reflect the rising fiscal deficits and higher government debt issuance yet. For that reason we stick to the “IBOXX Euro Sovereigns Eurozone short” in order to benefit from a rise in yields on the European bond markets.
However, the scorecards also indicate that our position in the “db x-trackers iBoxx Euro Sovereigns Eurozone 15+ TR Index” is still attractive in view of the high total score. From our fundamental vantage point it makes sense to stick to this position as well. First, even though Euroland HICP inflation is very low at the moment (of -0.3% in September), inflation expectations are significantly higher (around 2% yoy) and at least part of the higher expectations should be priced in. Thus, an ongoing low-inflation environment – which we expect – should support the longer end of the bond yield curve. Second, the yield curve has become rather steep in recent months and investors are positioned to benefit from this steepening trend. If the central banks start to tighten their monetary policy or simply announce plans to do so, a large share of these positions might be unwound. In that case the long end should significantly outperform the short end of the yield curve. However, we have reduced our overall position in the fixed-income segment slightly, as we currently see more value in global equities.
Overall, we have again increased our equity exposure, despite the strong equity-market performance in recent months. However, in our view the drivers of the ongoing equity market rally are still in place and should support the equity markets going forward. Moreover, the cash position of European equity funds is still above the average – a fact which could be supportive for the equity-market performance in the last weeks of the year. Furthermore, the Q3 reporting season got off to a good start and flows into the global equity markets have remained strong. We therefore stick to our positive outlook for equities overall. However, these factors weigh on the fundamental environment for the fixed-income market. Therefore we remain in general very cautious about this segment. However, we have implemented a synthetic flattener position in our portfolio, as we believe the risk of an underperformance of the short end of the curve is rising.
IDEA of the month: Buy ETF “MSCI Emerging Markets”
We buy the ETF “db x-trackers MSCI Emerging markets TRN” with 20% weight. On our scorecard equities continues to be the most attractive asset class . With the new investment we increase the equity share in our portfolio from 30% to 50%. Reasons for the increased weight of equities include the ongoing high liquidity, low interest rates and ongoing government support which should help to support equity markets. Also the Macro strategy group and economists of Deutsche Bank expects risky assets to do well for some time, but they don’t expect this positive environment to be sustainable. Within equities the scorecard suggests that Asia-ex-Japan is attractive, but Lat-Am is less attractive.
Besides the quantitative scorecard we find many qualitative arguments for emerging markets as an attractive equity region, short term and long term. Reasons in favour of many of the major emerging markets include attractive demographics, superior GDP growth (a strong Q3 GDP growth of 8.9% reported by China in this tough economic environment, stands as a case in-point), improving skill levels, huge FX reserves and active SWF funds, large stimulus packages, higher fund inflows and a banking system that is largely unaffected by the financial turmoil. Our economists expect emerging markets to grow by 5.4% in 2010E compared to 2.0% for the developed world. The points above are discussed in more detail in the report Globalisation after the credit crisis, 9 September 2009. The report discusses the relation between demographics and asset prices. The more favourable demographics in many emerging markets compared to developed countries suggests also a more favourable development of asset prices in the longer term. The report also discusses the structural power shift from the developed/Western world towards the emerging world and emerging market companies in detail. Therefore emerging market companies could well benefit from continuing globalisation over the next years more than they did in the past 10 years. In the past, emerging countries were viewed primarily as a platform for Western companies: a platform for cheap production and as a new marketplace for the sale of their products. In recent years, emerging market companies have played a much more active role and this trend should well continue.
During the past decade, the increasing global integration was reflected in intensifying global trade, rising global capital flows, and higher foreign direct investments and a continuing recovery could well bring the globalisation (i.e. global trade etc.) back to the pre-crisis level relatively soon. Globalisation is supported by the growing mutual interdependence between countries, global/regional production clusters, the existence of numerous global standards, the huge differences in labour costs and skills, and industrialisation and urbanisation in the emerging markets. A higher degree of political openness, new forms of communication (internet, e-mail, etc.), the use of English as common business language and improved transportation technologies have supported globalisation as well. The global integration has led to industrialisation in the emerging markets and de-industrialisation in the developed countries. From this trend the large global players in the developed countries have benefited in the last decade. But the emerging market companies may well seek to compete more aggressively with the developed countries in the next decade and benefit from rising skills sets in emerging markets as well as the strong growth rates in their home countries.
The MSCI emerging market index has outperformed the MSCI World and the MSCI Europe on a 20-year view . However, since the start of 2008 as well as during the crisis and during the recovery since March 2009 the MSCI emerging market index has performed very much in line with the MSCI World and the MSCI Europe despite the fact that many emerging markets have come through the crisis in relatively well shape.
Consensus earnings for the MSCI emerging market companies are expecting to grow by 26.5% in 2010E and by 20.7% in 2011E after a moderate decline of 2.5% in 2009E and 8% in 2008E. A comparison of pre-crisis earnings 2007 with the 2011E earnings best illustrates how much better emerging market companies have coped with the crisis and are expected to recover compared with companies from developed countries. Emerging market earnings 2011E are currently expected to come in 37% above the 2007 level whereas European earnings 2011E are expected to come in 2% below the 2007. This underpins that Emerging market companies are expected to come out of the crisis much better than the companies from developed countries. In addition, the current earnings momentum for emerging markets is clearly better than for the developed countries. Emerging markets have seen upgrades of 2010E earnings of 6.0% over the last three months compared to Europe with upgrades of 1.6% and the US of 1.1%.
Emerging market funds have seen a net inflow of 4% of total assets over the last twelve months and 9% over the last 6 months, clearly ahead of the developed countries.
Individual emerging markets may well have a higher risk than developed markets and
therefore regional diversification is in particular important. The tables below give the regional and country weights of the MSCI emerging market index. We note that, regionally, Asia ex-Japan constitutes more than 50% of the total weight of the index. At the country level, China, Brazil, Korea, Taiwan; India, South Africa and Russia have the largest weight in the index.
“db xtrackers MSCI USA TRN” ETF 20% weight
We had bought the ETF “db x-trackers MSCI USA TRN” for three reasons: 1) Our economists expect an ongoing strong recovery of the US economy. 2) Our US equity strategist expects a continuing performance of US equities. 3) A recovery of the US-Dollar would be supportive for the performance. Also most US economic data has continued to come in strongly over the last weeks. In addition, US Sales and production generally move synchronously. But since the start of the crisis production fell far in excess of sales which have been stable for some time. This gap could bring the potential of a strong bounce back of US industrial production.
Also the US housing sector seems to have bottomed and that it will begin to modestly add to real GDP going forward. Main risks for buying the ETF “MSCI USA TRN” are a weakening of the US-Dollar, negative news flow from the US economy, major earnings downgrades for US companies and declining US equity markets. (for more details on the “MSCI USA TRN” ETF see ETF: Ideas and Flows, 21 September 2009).
“DJ Stoxx Global select dividend 100” ETF 10% weight
We own the ETF “DJ Stoxx Global select dividend 100” with 10% weight. The “DJ Stoxx Global select dividend 100” ETF includes 100 stocks with high dividend yield from US (40 stocks), Europe (30 stocks) and Asia (30 stocks). Companies must have a non-negative historical five-year dividend-per-share growth rate and a payout ratio (dividend to earningsper- share ratio) of less than or equal to 60% in Europe and the Americas and 80% in Asia/Pacific. This restriction is reasonable to ensure that the earnings base is sufficient to underpin the dividend payments. Risks: 2009 is a difficult year for many companies and this may lead to dividend cuts in 2010. Some companies have already cut their dividend payments in 2009, but more dividend cuts are likely for the dividend season 2010. However, it is debatable whether for stocks with high dividend yield a dividend cut is more at risk than for a broad universe. Dividend yields for the overall markets look currently high relative to bond yields in the US as well as in Europe. (for more details on the “DJ Stoxx Global select dividend 100” ETF see ETF: Ideas and Flows, 13 August 2009).
“db x-trackers Currency valuation” ETF 20% weight
In currency markets the majority of the participants are “liquidity seekers”. “Profit seekers” are a minority in currency markets and can generate returns on the expense of the “liquidity seekers”. Profit-seekers can generate returns by buying “under-valued” currencies and shorting “over-valued” currencies. A widely used measure to determine “under-valued” and “over-valued” valuation for currencies is the concept of “Purchasing Power Parity” where “fair” exchange rates are calculated by comparing the prices of a basket of goods in different countries. The ETF “db x-trackers Currency valuation” buys each quarter the three currencies with the “lowest” valuation out of the universe of the G10 currencies and sells the three currencies with the “highest” valuation using the PPP concept. In addition, the correlation to equities and bonds is very low and therefore the currency valuation index helps to diversify our ETF portfolio. The index is currently long in the US Dollar, New Zealand Dollar, and the British Pound whereas the index is short in the Swiss Franc, Swedish Krona and the Norwegian Krona. Risks to the investment include that currencies movements become less rational again. Especially increased uncertainty about the economic development could trigger a flight back into expensive currencies like the Swiss Franc or the Japanese YEN .
We bought “db x-trackers MSCI Emerging markets TRN ETF” with 20% of the portfolio weight and reduced our exposure to “db x-trackers IBOXX € Sovereigns €-ZONE 15+ TR Index ETF” and “db x-trackers Short IBOXX € Sovereigns €-ZONE TR Index ETF” each by 10% points. Each of the bond index ETFs now bears a 15% weight in our portfolio. The trading portfolio below reflects the changes discussed above. The portfolio targets absolute return and has the EONIA index as benchmark.
Source: Trading Ideas ETF: Ideas and Flows – Deutsche Bank AG