Category Archives: emerging markets

what makes emerging markets different (II): market dynamics

August 29, 2013 By in Asian economic development, Constructing a Portfolio, economics, emerging markets Tags: , , , , Leave a comment

Yesterday I wrote about emerging countries.  Today, it’s their stock markets.

There are two important factors to consider, in my opinion, before taking the plunge in any given emerging market.

1.  The engines of an emerging country’s economic growth may not be available on its stock market   …and if they are, foreigners may not be able to buy them.  There are a number of reasons for this:

–generally speaking, every country, emerging or developed, has limits on foreign ownership of key industries, usually media, telecommunications and transport

–also, in general, there’s no reason to think, as many do, that there’s a close correspondence between the structure of a country’s economy and the structure of its stock market.  There usually isn’t.

But, for emerging economies in particular:

–a country, understandably, won’t want to allow foreigners to gain control of its economic crown jewels for what would be seen a decade down the road as a pittance.  So foreigners may be relegated to non-voting shares or limited in the percentage of any company that they, as a group, may own.  Depending on the rules, “foreign” shares may have far different performance from “local” ones.  That can be either very good or very bad, again depending on the rules.

–local investors, many times an ultra-wealthy elite, may regard stocks as a particularly risky kind of bond.  If so, they may be only willing to buy shares in mature companies with limited growth prospects but large free cash flow generation–and therefore rising dividends.  This difference in risk preferences may slant the local market away from the kinds of stocks foreigners find most rewarding.

I’m not saying don’t buy emerging markets stocks.  My view is quite the opposite.  But you have to look before you leap.

2.  Many emerging markets have very little local trading support.  Brokers are dependent for their commissions on the kindness of foreigners.

In a country where average annual income may be, say, $5,000 a year, the ordinary citizen is lucky to have a bank account.  He has no interest in the stock market.  His employer probably doesn’t offer a pension plan or retiree health care, either.  So, in addition to the absence of retail support for the market, there are probably no large pools of local institutional money interested in stocks, either.

Therefore, under most circumstances, there’s no local guy eager to take the other side of the trade when foreigners want to transact.  So when foreign money wants to enter, stock prices skyrocket.  When it wants to leave, the bottom falls out of the market.  (By the way, a stock market like Germany’s was like this in the 1980s.)

Again, I’m not saying don’t invest.  Quite the contrary.  But expect a lot of volatility.  On the brighter side, there’s significant money to be made by timing the swings in foreign sentiment correctly.

 

what makes emerging markets different (I): politics/economics

August 28, 2013 By in economics, emerging markets, EU financial crisis Tags: , , , , Leave a comment

A widespread selloff in emerging markets is currently in progress.  This is partly the result of portfolio realignment by veteran fund managers who believe that economic growth there is slowing, while growth in developed markets–weak as it is–is beginning to accelerate.  They’re reacting to what they perceive, rightly or wrongly, to be a change in momentum.

It’s also partly the result of novice investors, many of them retail, working out the risks in what they bought when they rolled the dice on an emerging markets fund a couple of years ago.

why emerging markets?

Conceptually, foreigners invest in emerging markets for two reasons:

–the possibility of very rapid economic growth in these countries, and

–the chance  that foreigners’ knowledge of how growth has occurred elsewhere to make superior stock selections.

The first point probably gets you to try an emerging markets index fund.  The second sends you looking for a seasoned emerging markets portfolio manager who can beat the index.  I’ve done both.

they’re different, though

But emerging markets aren’t just like, say, the US, only the people speak a different language.  There can be major differences in countries’ economic health, as well as in the types of stocks available for purchase.

Tomorrow, I’ll write about stock markets.  Today, I’m going to write about countries.  (NOTE that in all of this I’ve taken off my hat as a human being and put on my hat as a portfolio manager.  I’m not writing about what’s right or wrong;  I’m writing about what a foreigner has to think about to protect his investments.)

Three topics for today:

1. political stability

This is not something investors typically think about in developed markets.  We take it for granted that shareholders’ rights will be preserved, and that the legal conditions for companies doing business won’t change arbitrarily.

These are reasonable assumptions in large, mature economies.  But not necessarily elsewhere.

–Egypt, for example, has had two changes in government over the past year or so.  Protests forced a dictator to step down.  His successor was removed by the army.

–Thailand’s system of administration change through bloodless military coups blessed by the king has recently broken down into violent confrontation between the army and advocates for a different system.

–During the Asian Crisis of the late 1990s, as one of a number of measures to protect politically connected insiders, Malaysia arbitrarily refused for about a year to allow foreigners to repatriate funds from stock sales.

On a deeper level, in some countries the political debate is still open as to whether, and to what extent, capitalism should be allowed. In others, the question is whether the same proections afforded to local investors should be extended to foreigners.  In most cases, the answer to the latter question is “No!!,” at least until a crisis requiring foreign capital happens.

Political issues aren’t necessarily deal-breakers, but they are risk factors.

2.  macroeconomic stability

–India is a current case in point.

The economy is heavily dependent on monsoon rains.

The government is running a large current account deficit.  It’s being made worse by the fact that many people there either can’t afford or don’t trust banks, so they save by buying gold–which must be imported.  In addition, Delhi heavily subsidizes the price of petroleum products–again an import–meaning people use a lot more than they would if they had to pay world market prices.  The difference between what India buys from the rest of the world and what it can pay for through its own exports has become large enough to reach a tipping point where investors fear the country won’t have enough foreign currency to meet its obligations.

India is also a place where the capitalism/socialism debate is still not settled.  As a result of that and of the presence of very powerful industrial groups, the central government is dysfunctional.

–What about the rolling currency crisis in smaller Asian countries during the late 1990s.

–Greece.

Debt crises aren’t only a factor in the developing world.  Look at the US financial crisis or the EU.  But the latter two have the financial wherewithal to fix their problems.  That’s not always true in emerging markets.  And, unless you’re paying close attention, the difficulties there can fly under the radar for a long time.

3.  accounting methods

Personally, I’m not an advocate of having a single world accounting standard for financial reporting.  My point isn’t that the books in emerging markets are constructed using different systems than US GAAP or the IFRS of the EU.

I’m also not talking about occasional frauds, like Enron in the US or Polly Peck in the UK.

The issue is that in some emerging markets, there is either not enough information disclosed, or that the disclosure has little to do with reality.

This doesn’t mean you can’t get solid information about a company.  It just takes a lot more legwork + time and experience observing how a given company operates.  Think of all those bogus Chinese companies that have listed in the US over the past few years.  There’s a reason they didn’t list in Shanghai or Hong Kong, which are their natural markets.  Why not list in Asia?  It’s because investors there knew who the companies and the reputations of their backers were and would have refused to buy the shares.

Tomorrow, emerging stock markets.

pricing out a low-end shirt: investment implications

May 21, 2013 By in Asian economic development, comparative advantage, Current Market Thoughts, economics, emerging markets, Industry Analysis, Retail Tags: , , , , , , 1 Comment

A while ago, I wrote about pricing out a polo shirt that retailed for $150 then ($175 now).

Today’s post goes to the other end of the fashion spectrum:  pricing out a “fast fashion” shirt that might sell at H&M or Zara for, say, $15.  The source of my information about Bangladesh is an op ed column, “The Economics of a $6.75 Shirt,” by Rubana Huq, who owns a garment business there.

Just for reference, the factory gate cost of the KP MacLane  luxury polo is:

–materials           $10.35

–manufacturing          $11.05

= $21.40.

These figures are unusually high for a shirt, mostly because of the small initial lots involved.  The unit price could easily be below $15 now, depending on how successful KP MacLane has been in its sales efforts.

in comparison, costs in Bangladesh…

…for an order of 400,000 fast fashion shirts:

materials      $5.75

–cotton cloth           $4.75

–labels, other          $1.00

manufacturing     $.875

–wages          $.38

–finishing          $.15

–utilities, factory rent          $.11

–overhead          $.11

–debt service (for manufacturing equipment)          $.125

= $6.625

The selling price at the factory door is $6.75.  Therefore, the per garment profit is $.125.  The total order earns the manufacturer, before paying himself (or, in this case, herself), $50,000.  In the example Ms. Huq gives in her op ed column, this order represents about five months business for the factory.

what I find interesting

Although the KP MacLane polo and the fast fashion t-shirt sell for wildly different prices at retail, the material costs aren’t that different.

The markup over production cost is 718% for KPM, 140% for the tee.  As I mentioned in my earlier post, a Hermès polo sells for $455, or about 2.6x the price of the KPM one.  Hermès’ production costs are probably lower than KPM’s, so the markup is likely higher than 1800%.   In both cases the buyer is clearly paying primarily for the branding, not the garment.

The operating model for classic luxury goods is far different from that of fast fashion.  The former sells far fewer items-most of which have very long shelf lives–at huge markups.  The latter sells huge numbers of items with short shelf lives at low markups.

The two styles demand different skills.  Fast fashion, in particular, has little room for error in design or sourcing/pricing from manufacturers.

the Bangladesh situation

First of all, we have to remember that the data Ms. Huq present come from a manufacturer in Bangladesh, hardly a disinterested party.  Certainly she will want to put her best foot forward.  Still, I’ve found the situation she describes to be typical of the garment industry over the decades, whether located in New York City, Japan, Thailand, China or Bangladesh.

Bangladesh employs 4 million garment workers, the vast majority of them women, who are the chief breadwinners in households totaling 20 million.  They earn US$70 – $80 a month, which is far more than an unskilled laborer could expect in any alternative employment in Bangladesh.  Although their families are barely surviving, the greatest fear of these workers is doubtless that the garment industry will shift away from Bangladesh to other low labor-cost countries, like Vietnam, leaving them unemployed.

The garment manufacturer in Bangladesh may make $100,000 a year if everything runs smoothly.  But that could be considerably less if he’s inefficient or if he encounters production delays that, say, require him to pay for shipment by air.  So one can certainly understand–not condone, just understand—the temptation an unscrupulous owner may feel to lower rent by turning a blind eye to safety violations.   It’s not clear how much leeway fast fashion has to alter its operating model by raising prices, either (look what happened to JCP).

In theory at least,  consumer pressure on international retailers for a keener eye to worker safety when sourcing garments may solve that issue–although the same problems seem to recur decade after decade and in country after country.

The more difficult issue to reconcile are the ideas that income of $70 a month is a good situation to be in, which in Bangladesh it is, and that well-intentioned efforts to improve it may make the workers’ lot considerably worse.

a falling gold price–what does it mean?

April 15, 2013 By in emerging markets, Gold, Industry Analysis, Recent Market Action Tags: , , , , , , , , 3 Comments

Back in the day, I was, among other things, a gold mining analyst.  That period left me with an enduring fascination, not about the yellow metal itself, but about gold “bugs”–the people who are obsessed with gold and who buy it as an “investment.”  I have the same complex mixture of feelings about gold bugs that I have about survivalists, Civil War reenactors, model railroad buffs and people from Brooklyn.  It’s not exactly “There but for the grace of God…”, but that’s the general direction.

I really don’t get gold as an investment.  Yes, it’s shiny and there may actually be gnomes in Zurich.  Until the mid-1970s, gold did serve as a kind of money worldwide.  But no longer.  One exception:  developing economies where either there are no banks for businesses to use, or where people don’t want/trust banks to know about their finances.

Contrary to what I think is popular belief in the US, virtually all the demand for gold comes from the developing world.  The US accounts for 5% of purchases, the EU 10%.  Japan is a non-factor.  Last year, as usual, India was the #1 buyer of gold, at 28% of the total.  Greater China took 25%.

Before the Great Recession, the large bulk, maybe 3/4th, of the world’s demand for gold was for jewelry (although much of this did double duty as chuk kam 99.9% gold trinkets). 10% was for technology or dentistry.  The rest was gold bars and coins bought as an “investment.”  The bulk of that demand was supplied by mine production, with the rest coming from recycling and steady selling by central banks in developed countries.

The GR changed that pattern, in two ways.  Demand for gold bars and coins more than tripled.  Central banks in the developed world stopped selling, while their counterparts in emerging economies began to buy gold like there was no tomorrow.  Between 2009 and 2011–which appears to have been the peak of this activity–the gold price doubled in US$.

Gold ETFs?  They peaked in 2009 at about 17% of world gold demand.  By 2011 they had shrunk to 4%.

What’s happening now?

The gold price has been slowly declining for two years, without attracting much attention, as panicky buying by gold bugs has waned.

What’s new is India.  The biggest drain on India’s growing trade imbalance is its citizens’ continuing demand for gold–both for jewelry and because the country’s banks don’t work.  New Delhi has decided to deal with the steady flow of cash out of the country by taxing gold imports.  At least to some degree, this will put the metal’s chief buyer on the sidelines.  That won’t stop mines from churning out the stuff, however, until/unless the gold price drops below their cash cost of production.  That’s a looong way down.

Elsewhere, “investment” demand appears to be waning.  Less significant in the short term, Chinese tastes seem to be slowly shifting away from chuk kam to fashion or statement jewelry with lower gold content.  And, of course, more dentists are using ceramic teeth and PC demand is slowing.

In other words, the supply/demand picture for gold is looking less favorable for prices.  The price decline has nothing to do with inflation fears in the US or EU subsiding, or renewed faith that either area is suddenly on a sounder economic footing.

noodle making returning to UK from China–what this means

March 14, 2013 By in Asian economic development, capital flight/brain drain, China, economics, emerging markets, the UK Tags: , , , , 1 Comment

noodles to Leeds

British Food company Symington’s, the inventor of pea flour and maker of Golden Wonder’s pot noodles, is returning its noodle manufacturing operations from Guangzhou to Leeds, according to the Financial Times.  The FT says the company cites equivalent/lower labor costs in the UK and better response times to customers’ requests as the main reasons.  (I’ve looked in vain on the Symington’s website for a press release.)

This says something about China.  

But it’s not new news.  Alerted by Hong Kong-based distributor Li and Fung and by David Pilling of the FT, I wrote  in late 2010 about the shift of labor-intensive manufacturing, like t-shirt making, away from China to places like Bangladesh and Vietnam.  As I commented back then, this wasn’t particularly new news in 2010, either.

China has run out of cheap labor on its eastern seaboard, a signal that at least this region of the country has to shift to higher value-added manufacturing.  The textbook solution for a nation facing this issue is to allow its exchange rate to rise, while holding local currency wages steady.  China, however, hasn’t followed the schoolbooks.  It has kept its exchange rate relatively stable, while aggressively encouraging local currency wages to rise.  Although this also gets the job done of forcing the most labor-intensive and low value-added businesses to go elsewhere, it runs the risk of creating a lot of inflation.  We’ll see how things turn out.  But, personally, I’m not betting against Beijing on this one.

What’s more interesting, to my mind, is what this says about the UK

Yes, the home country has won back the noodle makers.

There certainly are transportation time and cost savings.

Symington’s will doubtless use “Made in the UK” to its marketing advantage.  And there are probably political points being scored as well.

Nevertheless, this isn’t wresting high-tech business from Google, or Samsung or Amazon.  It isn’t bio-tech.  It isn’t competition for LVMH.  It’s labor-intensive work that would otherwise have ended up in a developing country further down the food chain than China.

“Reshoring” of this type is a two-edged sword.  On the one hand, it’s an illusion-shattering phenomenon for dreamers who recall the days when Britain held a privileged place as the manufacturing hub for a far-flung colonial empire–including Bangladesh.  On the other hand, it’s a place to start.  And with sterling gradually depreciating, UK labor will be in increasing demand.

as an investor…

…this may not be great news for UK manufacturing.  Nor is it a reason to be interested in this sector, because profits are likely to be slim.  But even a low-end manufacturing revival means more jobs.  That suggests that mid- to low-end entries in consumer-oriented areas like lodging, specialty retail and supermarkets may have better prospects than is currently factored into their share prices.