Emerging Markets Offer Big Opportunity in 2012

Last year was quite an interesting journey throughout the marketplace—catching many Wall Street analysts and investors by complete surprise.  The tumultuous volatility prompted multiple revisions to forecasts and opinions.

It was also a very defensive year. Safe havens such as US treasury bonds and the utility sector were two of the best performers in 2011.

As we head into 2012 we ask: Where is the next big money making opportunity?

What Worked in 2011

Is it sticking with what worked last year?  That would suggest buying safe, dividend paying stocks in the utility, consumer staples and health care sectors.  Or perhaps buying more long-term 10 year US Treasuries yielding under 2% at sky high prices.

Perhaps those are the moves to make—and you would not be alone in that thinking, as those areas hold some of the most crowded trades among the investment community.  While perceived as the safe haven of choice, these positions are not immune to losses.

The markets rang in the New Year with a broad and robust rally.  The catalyst was better-than-expected economic data throughout the global manufacturing community.  And, while virtually all risk assets participated in the gains, safe haven assets were sold and suffered sharp declines.

My point here is that, while many of these safe haven plays are indeed sound and prudent investments, it’s important to keep in mind that they have appreciated to very frothy price levels, and are vulnerable to institutional sector rotation and profit taking.

For safe haven type assets, replicating 2011’s performance gains would be a monumental achievement, and would most likely require global markets to face even worse circumstances than last year.

Headwinds and Central Banks

The biggest headwinds for 2012 continue to lie in Europe.  The sovereign debt crisis is the market’s number one concern.  Eurozone countries and European banks face massive funding requirements, and will be dependent on refinancing or rolling over their debt at reasonable interest rates.

If it were solely up to the free functioning markets, these countries and banks would be in real peril and there would be a risk of serious worldwide depression.  But the rules of capitalism have changed. The central banks are orchestrating a global liquidity-driven, back door assistance program to make sure this shell game continues for years to come.  The bet is that enough time can be bought for long term fiscal measures to be supplanted to promote a sustainable and healthy financial system.

What does that mean?

It means that the central banks will continue to flood the markets with unlimited liquidity.  If the IMF or the Eurozone bailout funds prove insufficient, the European Central Bank will have no choice but to do more.  They are already on the hook for trillions of euros.

Back in the US, the Federal Reserve will most likely telegraph to the world in the next few weeks (at their January FOMC meeting) that it will further postpone the chance of an interest rate hike, beyond their last stated minimal target of mid-2013.

The latest Fed minutes also revealed that several committee members are pushing for more asset purchases and boosting the size of the fed balance sheet (QE3).

That’s right: There is a strong chance for more easing in the midst of strengthening economic data; manufacturing continues to expand, housing data is finally showing signs of stabilization and the labor situation is improving.

The fed is building in an insurance policy that should not only help strong US corporate earnings to continue, but spark global growth as well.

Emerging Markets Could Outperform

Based on this landscape, and the assumption that coordinated efforts by the central banksters have been put in place to back stop the European debt and prevent a disorderly default or Lehman-like credit freeze, I’m looking at several emerging markets to outperform in 2012.

In particular: Brazil, Russia and China.

Last year was not very kind for emerging markets.  With all the uncertainty, headwinds and recessionary global growth fears, investors fled these spaces for safe haven alternatives.

As a contrarian investor, I tend to gravitate to value if I feel the conditions seem to be warranted.  The key here, and the secret to my success in realizing big gains, is that you have to recognize the opportunity early and get to the party before the majority of the crowd.

All three of these countries (benchmark indices) were down sharply in 2011.  Brazil was down -18%, Russia was down -22%, and China/Hong Kong was down roughly -21%.

The emerging markets were fighting a fierce battle with inflation in 2010 and most of 2011, forcing their central banks to tighten monetary policy and slow down growth and domestic consumer prices.

Now we’re seeing a shift as inflation has receded, and these countries are looking to jump start their economies again.  This shift should continue with more easing as the year progresses.  We’ve already seen Brazil cut rates several times, and China has lowered banking reserve requirements to boost lending.

Opportunities in Brazil

Brazil is the seventh largest economy in the world, and is gaining ground on the developed countries.  The country is a major exporter of natural resources like oil, iron ore and agriculture.

To get exposure to Brazil, I like the big integrated oil & gas producer, Petroleo Brasileiro (Sym: PBR).  At 26.46 the stock is trading very cheaply, especially with oil prices at elevated levels.  I also like the major iron ore and mining company, Vale (Sym: VALE).  At 23.39, it’s trading at an extremely cheap valuation.

Another option is taking a position in the iShares Brazil index fund ETF (Sym: EWZ).  This ETF is weighted over 30% in VALE and PBR alone.  Also, in the last 12 months, it has returned over 6% in dividend distributions to shareholders. (Note, dividend amounts and dates are not consistent.)

EWZ recently closed at 59.92…


Russia's Pure Energy Play

Russia is the sixth largest economy, ranked just above Brazil, and the second largest oil producer only behind Saudi Arabia, making Russia a pure energy play.  With oil prices looking to stay sticky around $100 a barrel on increased global demand as well as geopolitical unrest in the Middle East, Russia looks like a good bet for gains in 2012.

I like the Market Vectors Russia ETF (Sym: RSX).  The index is heavily weighted towards the energy producers, which are Russia’s bread and butter.

Also, a major Presidential election will be contested in early spring which should bring clarity and stability to Russia's financial markets.  The RSX has plenty of upside, especially with its oil exports and high prices.

RSX closed recently at 27.67…

 
China's War Chest

China is the second largest economy only behind the US.  The Chinese stock markets have performed horribly in 2011, booking losses of +20% across their exchanges.

The overhang of a potential economic hard landing and investor distrust in a recent bout of corporate accounting scandals has punished the Chinese equities market.

China has finally switched gears and has embarked on easing monetary policy.  They have a lot of ammunition after several rounds of tightening.  While there is fear of a banking crisis and a housing bust, the government has amassed a 3 trillion dollar foreign exchange reserve war chest, mostly in US dollar denominated assets.

There could be some major upside as China has been oversold throughout 2011.  The best and safest way to play China is through the iShares FTSE China 25 index Fund. (Sym: FXI). The ETF is comprised of big blue chip companies like Petro China and China Mobil.  In fact, 40% of the weighting is in energy and communications—two extremely important, profitable and fast growing sectors in China.

FXI closed recently at 35.45…

 

Emerging Markets saw major outflows during 2011, which left many of these securities at depressed levels.  If we gain any whiff of positive momentum this year, there is huge upside potential for big gains.  And, if we do muddle along further than anticipated, many of these securities pose minimal downside risk, as they are already trading at extremely cheap valuations.

Cheers to a happy new year!

Costas Bocelli
Contributing Editor
Channel Trading Secrets