beyondbrics

A gloomy view from three EM specialists at UBS. In EM currencies, bonds and equities the message is stay out – at least until the eurozone crisis is resolved.

In equities, Nicholas Smithie, global EM equity strategist, said at a meeting with journalists that EM equities were now very under-valued by historic standards – cheaper in price/earnings terms than at almost any time since records began. EM shares have been valued above the current forward p/e of nine for 93 per cent of the time, crises included, he said.

On a 12 or 18 month view EM shares were a buy – but the next three months looked difficult with the eurozone in trouble, said Smithie.

He emphasised that EM shares were driven not by EM economic growth but by global growth. “This correlation is at an all-time high…80 per cent of moves in EM are due to non-EM factors.”

Reinhard Cluse, economist for emerging Europe, the Middle East and Africa, said the economic outlook was not black but “grey” with world economic growth forecast at 3 to 3.5 per cent in 2011 and 2012.

But his comments on the eurozone were dire. UBS’s best case was an orderly default for Greece in early 2012 – to which the bank assigns a probability of 50-70 per cent, “but only if Greece is ringfenced”.

But EU politicians could not deliver even this solution unless financial pressures increased. “We need to get political approval and [for that] things will have to get worse.”

The alternative was “a disorderly default, financial crisis and a recession perhaps not only in the eurozone but also in the world.” Not much encouragement for EM investors there.

Bhanu Baweja, head of EM fixed income and foreign exchange strategy, said bluntly: “We are negative on EM FX across the board.” EM bonds in central and eatern Europe, the Middle East and Africa, too, were a sell, he said.

Since 2009 investors had seen the boost in global liquidity reducing risk premia around the world and pushing up EM currencies and bonds.

But now developed world policy makers were running short of capacity to boost liquidity further, he said.

Some investors still believed Ben Bernanke, chairman of the US Federal Reserve, could succeed in his de facto plan to depreciate the US dollar (to boost the US economy) – but perhaps he could not, said Baweja. “I believe dollar appreciation has further to go. Perhaps much further to go.”

That would be bad news for investors in EM currencies and, by extension, EM bonds.

With so much gloom around, the only comfort came from Smithie, who reminded his audience that at the start of 2011, the consensus had been for good performance in EM equities, driven by global recovery.

If the experts were wrong then, perhaps they are wrong now. But with Greece looming so large, it is hard to see how.

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