Look to Emerging Market Equities: Analysts


NEW YORK (TheStreet) -- Emerging market equities may present one of the best opportunities for investors looking to take advantage of rising oil prices and a weakening dollar, according to investment strategists.

"Any investor who has the view that the dollar will go down in real terms must effectively sell the dollar and buy non-dollar denominated assets," said Nicholas Smithie, UBS global emerging market strategist, at a luncheon hosted by UBS and the New York Society of Security Analysts this week. "So, international, global and emerging market equities will have that effect. You will diversify out of the dollar if you buy international, global and more emerging market equities."

"For those who have a positive view on oil, frontier markets correlate to oil rather than to global equities." And "within the emerging markets, Russia and Russian oil companies are highly correlated to oil," he said.

The Vanguard MSCI Emerging Markets ETF ( VWO)and WisdomTree Emerging Markets Equity Income Fund ( DEM) are examples of mutual funds that provide diverse exposure to emerging markets equities, while the Market Vectors Russia ETF ( RSX )is an example of a fund the offers exposure specifically to Russian equities.

Individual stocks with strong emerging markets exposure include sports apparel company Nike ( NKE), Brasil Foods ( BRFS), Chinese Internet search provider Baidu.com ( BIDU) and Latin American wireless communications company America Movil ( AMX).

Smithie recommends that retail investors avoid buying single, emerging market stocks because that would deprive them of the protection derived from diversification. Mutual funds would be preferable, giving them a pool of collective diversification at a relatively low cost, says Smithie.

Kate Moore, Bank of America Merrill Lynch's global equity strategist, told TheStreet, following her company's outlook conference this week, that her investor client base still has a "big home country bias," where 80% of their equity holdings are in U.S. stocks. "One of the biggest messages we can give to private clients at this point is when you're considering increasing your equities, make sure you look outside of the U.S. There are outstanding, high-quality, high-growth global companies that they can still buy easily as a U.S.-based investor." Many of these companies have American Depositary Receipts that can be bought in baskets.

Emerging markets will continue to show good growth through 2012, according to the International Monetary Fund. An IMF report projects growth in sub-Saharan Africa at 5.5% in 2011 and 5.75% in 2012. Growth in developing economies in 2011 and 2012 is expected to remain "buoyant" at 6.5%, a modest slowdown from the 7% growth registered last year and broadly unchanged from the IMF's Oct. 2010 outlook. Activity in advanced economies is projected to expand by 2.5% in 2011 and 2012, which the IMF said is still sluggish considering the depth of the 2009 recession, and insufficient to create a significant dent in high unemployment rates.

Global Oil Outlook

Francisco Blanch, head of Bank of America Merrill Lynch's global commodity research team, believes the substantial drop in oil demand growth over the past six months will continue into the second half of the year.

Blanch forecasts average Brent crude oil prices of $102 a barrel in the second half of the year.

Meanwhile, the International Energy Agency's 60 million barrel reserve release has put further downward pressure on the price of oil, the analyst added.

However, "next year is a different story," Blanch said. "I think the market will be a lot tighter if Libya doesn't come back on line. So our view for 2012 depends on the Libyan oil supply disruption getting resolved."

The IEA estimates that the civil war in Libya took 132 million barrels of light sweet crude oil offline by the end of May. Supplies have been off the market since February, around the beginning of the uprising against Libyan leader Muammar Gaddafi.

U.S. Dollar Outlook

Paresh Upadhyaya, Bank of America Merrill Lynch's head of Americas G10 currency exchange strategy, told TheStreet that the strongest upward driver of the U.S. dollar has been the deceleration of global growth.

Although the verdict is still out on whether there will be a more dramatic decline in global growth, the dollar has been rallying because of a flight to quality for treasuries.

"In that environment, the dollar is a counter-cyclical currency, so since 2000, you've noticed that when global growth starts to slow, the dollar actually starts to rally," Upadhyaya said.

That said, Upadhyaya thinks the U.S. dollar will resume its decline after what he views is a mid-cycle, "mini slowdown" that will pass with the end of the global manufacturing supply shock that took place after Japan's massive earthquake and tsunami in March.

The analyst notes a strong correlation between the widening U.S. deficit since the 2000s and a lower dollar value.

"One final thing I'd add is there's the central bank diversification that I think is also a big driver here ... why it'll be tough for the dollar to rally on a sustained basis."

Despite Europe's woes, demand for euros is steady, with China indicating that it will continue to be a big buyer of European debt. Upadhyaya says China's pain threshold on European debt depends on the region's ability as a whole to maintain a triple A credit rating.

Interest Rates, Economic Outlook

Bank of America's Global Research team believes that the Federal Reserve will begin hiking rates in September of 2012, given that inflation is still not strong enough to start a tightening cycle and consumers continue to be in deleveraging mode.

Over the past four years, the U.S.' net debt to gross domestic product has widened by 40%, and it will be two more years before the U.S. housing sector and state and local governments experience a full road to recovery, the team estimates.

Meanwhile, Blanch warns that with global energy consumption as a share of gross domestic product reaching a high level of almost 9%, the global economic recovery is at risk. Consumption as a percentage of global GDP was around 9% in 1980, the year where a global recession took hold.

Over the summer, the team will be paying close attention to how the U.S. debt ceiling debate -- the "bomb," they call it, pans out; the debt situation in Greece and the rest of Europe; and the effects of the completion of the Fed's second round of quantitative easing at the end of June, involving its purchase of $600 billion of long-term securities. The Fed has purchased more than $2.1 trillion worth of Treasurys and other securities since March 2009, with the goal of bolstering asset prices as a main motive behind QE2.

Bank of America analysts believe that the financial and systemic risk Greece's debt crisis poses is small from a historical context.

The more worrying problem, they say, is if European debt contagion spreads to Spain. This, they predict, coupled with a continued slowdown in global growth and the fact that Europe's largest economy, Germany, holds 50% of overall European peripheral debt, could push the euro below $1.20.

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-- Written by Andrea Tse in New York.

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