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The emerging picture

The MSCI emerging markets index fell by 0.33 per cent in dollar terms in August as fundamentals caught up with the significant price rises in the first half of the year.

Chinese equities fell as July’s statistics showed a deceleration in fixed asset investment, fewer project starts and lower levels of bank lending. Performance subsequently picked up, however, as data improved later in the period.

Poland was among the best performers, rising by 6 per cent over the month. Energy stocks also outperformed, with oil comfortably above the $70 a barrel mark.

Positive

China

Hexam believes that the stimulus measures have been effective and there are signs of a broadening out of the sources of growth. This underlines our expectation of GDP growth of at least 8 per cent in 2009 and 9-10 per cent in 2010.

The Chinese purchasing managers’ index pushed further into expansion territory, with a reading of 54 in August while industrial production (+12.3 per cent year on year) and fixed asset urban investment (+33 per cent year to date) continued to grow strongly and surprised on the upside.

Retail sales (+15.4 per cent in August) remained robust, with exports (-23.4 per cent year on year) one of the few areas to remain depressed, although year-on-year comparisons will start to look positive some time in the fourth quarter.

Conflicting concerns of asset bubbles in stock and property markets and the impact of a slowdown in loan growth/stimulus had gripped the markets in early August but the 23 per cent correction in the domestic market from recent highs has been deemed overdone by investors.

The authorities continue to reiterate that with inflation under control and while growth remains unstable and unbalanced, that policy measures will remain accommodative for now.

Some administrative measures can be expected and loan growth will obviously fall from the heady levels seen in the first half of 2009, but it appears that we are some way away from the creation of significant asset bubbles at this stage.

Israel

Israel is expected to witness a modest decline in gross domestic product growth in 2009 before posting estimated growth in the region of 2 per cent in 2010.

Inflation maintained at 3.5 per cent in July, still above the Bank of Israel’s 1-3 per cent. The BoI increased rates by a modest 25 basis points to 0.75 per cent, the first hike since August 2008, but the level still remains stimulative.

More important to our allocation remains the amount of unique stock opportunities available within the emerging markets’ universe, which offer greater earnings’ visibility and that have lagged in the rally seen this year. Israel is one of only two markets that are expected to post positive year-on-year earnings growth in 2009, the other being China.

The Tel Aviv stock exchange trades at a small discount to the MSCI emerging markets index despite such visibility this year and next. Our favoured exposure remains to those stocks in the pharmaceutical, telecoms and IT space.

Brazil

Hexam remains constructive on the outlook for Brazil. GDP growth is likely to be flat in 2009 before recovering to more than 3 per cent in 2010 but sequential improvements are being seen in the data points, with industrial production growing by 2.2 per cent month on month in July while the added impetus from previous rate cuts is still awaited.

The Banco Central do Brasil’s SELIC lending rate was maintained at 8.75 per cent at the September meeting as inflation continues to be of little concern at this juncture and year-end inflation is likely to be little changed from the current 4.4 per cent level.

Retail sales numbers continue to remain positive and we expect a further 6 per cent year-on year-number for July’s data. Trade data too is generally positive, with the trade balance posting an annualised $37bn surplus. If this trend continues, Brazil could actually post a current account surplus in 2009. Brazil as a whole trades on par with the broader emerging asset class.

Other positives include: Russia and Indonesia

NEUTRAL

India

India continues to have sound long-term economic growth prospects, driven largely by domestic demand factors. It remains one of the fastest-growing economies.

Such prospects were also clearly buoyed by the return to power of the Congress-led UPA at the general elections in May, which should afford them some freedom to push ahead with the reforms that had stalled during the previous fractious administration.

We believe, however, the actions to date have not warranted the premium that was earlier baked into valuations and despite a 7 per cent relative underperformance against the MSCI over the last three months, the market is still at an average 20 per cent premium.

Other neutrals include: Poland and South Africa

Negative

Mexico

Contrary to the consensus view, we remain underweight Mexico. While earlier aggressive monetary easing and a flexible currency provide support, the impact from the US recession is likely to persist. We expect GDP to decline by at least 5 per cent in 2009 before making only a modest recovery in 2010. June industrial production plummeted by 10.6 per cent year on year, with retail sales showing only modest improvement, declining by 5.1 per cent year on year in June.

In addition to economic factors the security situation in parts of Mexico also remains increasingly fragile.

Following a recovery in stocks, the valuation and visibility argument for Mexico is also no longer an issue given that the market trades at a 15 per cent premium to both emerging markets and Brazil for 2010. This provides added reasoning for our preference for Brazil.

Taiwan

We remain unimpressed by the outlook for Taiwan. Exports continue to be under pressure, declining by 24.6 per cent in August as visibility in end-user demand remains uncertain.

Given that exports are the primary driver of the Taiwanese economy, we are expecting a steep decline in GDP growth of some 6 per cent in 2009 before a fairly anaemic recovery of 2 per cent in 2010.

Further, the Ma administration has come under some pressure for its handling of the fallout from Typhoon Morakot, which has led to a sizeable reshuffle of the government. It has been suggested by some that the incoming prime minister has a pro-China bias, which may reignite the cross-Straits fervour that we saw earlier this year.

We remain sceptical on the speed of progress, given the lofty valuations assigned to the market, particularly given the lack of macro and micro visibility.

South Korea

South Korea is showing signs of improvement although exports still remain a clear drag, declining by 20.6 per cent in August. This figure was buoyed by technology exports where the sustainability remains in question.

Imports showed some sign of improvement as consumer confidence was at a seven-year high, leading to a sharp improvement in the import of consumer goods. This trend is expected to result in a declining trade surplus and remove any upward pressure on the won.

July data shows that both industrial production (+0.7 per cent year on year) and consumer sales (+1.9 per cent year on year) have climbed back into positive territory, which should continue to be supportive.

The market has clearly moved to price in some of these positives with many stocks trading above pre-crisis levels.

We still have some concerns on the macro outlook, including its export-orientated nature, and, given the recent positive price performance, we remain underweight but we continue to be pragmatic on our allocation in light of the macro improvements that we are seeing.

Other negatives include: Malaysia, Philippines, Thailand, Czech Republic, Hungary and Turkey

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