Daily Agenda: Investors Reconsider Emerging-Markets Allocations

An array European, U.S. and Chinese macroeconomic themes have dominated global market risk narratives in recent weeks. All that time, key developments in primary emerging markets have largely been ignored by world investors. While demographics remain firmly in favor of the rapidly growing nations of the developing world, the near-term impact of capital flows driven by low commodity prices and a strong U.S. dollar have left many allocators to reconsider their exposures to the segment. On one side of the debate, many investors are banking on a mean reversion as emerging-markets equities rebound to relative valuations closer to near-term historical averages against U.S. stocks. The glass half-empty argument is that rising rates, cheap oil and geopolitical risk factors will force more major emerging-markets companies to follow the lead of semipublic Brazilian oil company Petrobras and perform housecleaning under duress, making it still to early to wade back in. In many ways, Petrobras encapsulates this dilemma since, if the Brazilian government takes decisive action, it appears to many analysts that selling in broad equity and currency markets may be overdone. If, on the other hand, no resolution arrives, the possibility of a bleed-through to the nation’s sovereign rating could mean that volatility in Brazilian real-priced assets has much more room to extend.

U.K. GDP remains largely unchanged. Revised growth data for the fourth quarter of 2014, released today by the Office for National Statistics, showed a marginal U.K. economic slowdown. Headline GDP fell to 0.5 percent from an initial estimate of 0.7 percent. In the absence of any surprise in labor and activity measures, U.K. investors remain focused on Bank of England policy guidance. Earlier this week, Monetary Policy Committee member Kristin Forbes commented that a rate hike may be on the near-term horizon to ensure financial stability.

Petrobras’s bond rating downgraded. Moody’s downgraded Brazilian oil giant Petrobras’s debt yesterday, to Ba2, two grades below investment level, citing deeply rooted corruption in the state-controlled firm as a reason for its decision. Spreads on Petrobras’s international bonds widened as much as 50 basis points.

German consumer confidence soars. GfK consumer sentiment index measures for March released today registered a 13-year high level in confidence among German shoppers. Although the reading at 9.7, up from 9.3 in February, exceeded consensus economist forecasts, analysts had anticipated that lower fuel costs would offset geopolitical and macroeconomic concerns. GfK now projects private consumption will rise by 1.5 percent for the full year, a significant tailwind for total GDP.

Antiausterity push picks up steam in Spain. Pablo Iglesias, leader of the Spanish antiausterity party Podemos, delivered a withering response to Prime Minister Mariano Rajoy’s State of the Union address yesterday. Although Podemos has only a fraction of the broad support enjoyed by Syriza in Greece, the party is among several upstarts from across the ideological spectrum that are gaining momentum in Europe on the back of economic frustrations.

U.S. economic data on deck. Consumer inflation and durable goods figures for January, as well as weekly initial jobless claims, are scheduled for release today. Consensus forecasts are for prices to slip even further after December consumer price index data registered the largest month-over-month contraction in six years, driven by low fuel costs. Any surprise in inflation figures will likely have only a limited market sentiment impact in the wake of federal Reserve chairwoman Janet Yellen’s testimony before Congress Tuesday and Wednesday, in which she reiterated prior Fed guidance.

Portfolio Perspective: Why India’s Highly Anticipated Budget is More Likely to Surprise to the Upside — Peter Kohli, DMS Funds

India’s stock market has experienced increased volatility ahead of the annual budget release set for Saturday. Investors want to see more government capital spending and reform initiatives coupled with reductions in subsidies. Should the budget disappoint, analysts expect India’s stock market to correct mildly as bond yields rise and the rupee weakens. Brokerages in India will be open for business, despite it being the weekend. I think investor anxiety over the full-year spending plan by the administration of Prime Minister Narendra Modi may be unwarranted.

Government spending in India averaged 11.4 percent to 11.8 percent of the country’s gross domestic product the past 20 years, according to the World Bank. That’s relatively low compared to its emerging-markets counterparts. Government spending makes up 14 percent of China’s GDP, about 20 percent for Brazil and 20 percent for Russia. By contrast, government spending accounts for 15 percent of U.S. GDP. In Europe, where cradle-to-grave health care and welfare programs are the norm, government spending accounts for 20 percent of GDP. So India is more likely to boost government spending rather than reduce, especially given its fiscal windfall from crashing oil prices. Already this month India announced an $8 billion plan to build out its military arsenal including six nuclear-powered submarines after years of neglect that left it weak against China and Pakistan.

Cheap crude has saved India massive amounts of fuel and fertilizer subsidies and reined in inflation expectations. Lower inflation should lead to lower interest rates, which encourages business and consumer borrowing. Given that India ranks as the world’s fourth-largest oil importer after the European Union, U.S. and China, falling oil prices have slashed India’s trade deficit. India’s trade deficit has plunged from nearly $19 billion in December to $8.3 billion as of Feb. 13, according to Trading Economics. A $10 drop in crude oil could cut India’s current account deficit by 0.5 percent of GDP and the fiscal deficit by 0.1 percent of GDP, Sandeep Nayak, CEO of Centrum Broking wrote in Indian paper The Economic Times. More cash in India’s pockets increases the country’s credit quality and reduces the need to borrow money.

All the while, remittances, which fuel consumer spending, climbed to an all-time high of $11.7 billion in the third quarter of 2014 from a record low of $6 billion just four years prior, according to data provider Trading Economics.

Peter Kohli is the CEO of Leesport, Pennsylvania–based DMS Funds, a mutual fund firm that specializes in emerging markets.