Optimism stays

Fund managers betting on emerging markets in 2004

"A trend is a trend
But the question is
When will it bend
Will it alter its course
Due to some unforeseen force
And come to a premature end?"

""Lord Cairncross,
Fellow of the Royal
Statistical Society

The trend in 2003 has been clear enough""""-a flood of money pumped into the equity markets by foreign institutional investors (FIIs), sending stocks rocketing.

Will this trend bend? To answer that question, it's best to turn to those who will put their money (and other people's money) where their mouths are.

A few days ago, Merrill Lynch carried out a survey of global fund managers responsible for a trillion dollars worth of investors' funds. 71 per cent of the managers said that world equity markets will be higher a year from now.

The best news is the outlook for emerging markets, which is uniformly positive. 32 per cent of those surveyed said that the outlook for corporate profits was most favourable for emerging markets, as against 28 per cent who opted for the next favourite, the US. 37 per cent said that emerging markets were the most undervalued markets, the next favourite being the Eurozone at 22 per cent.

Answering the question, "Over the next 12 months, which region would you most like to overweight?", 34 per cent preferred emerging markets, the Eurozone being a distant second at 24 per cent.

In terms of global sectors, fund managers are the most overweight in basic materials and industries, followed by tech and energy. They are most underweight in utilities and staples, followed by autos and retailers. However, they also feel that tech is the most overvalued sector. Pharma, energy and insurance are seen to be undervalued.

Investments and Pensions Europe surveyed more than 100 institutional investors in recent weeks. 82 per cent of those surveyed said that Asian equities (other than Japan) would rise in the next 6-12 months. Only 66 per cent believed that US equities would rise.

Going by the way the India story has been sold, the strong rise in corporate earnings anticipated, the macro bounceback (India, China, Vietnam and Thailand are expected to be the countries with the highest GDP growth in 2004), and the improvement of relations with Pakistan, there don't seem to be any current impediments to the continuation of FII inflows.

Commodities in 2004

The early part of 2003 was a period of caution for metals, especially in the wake of an inventory pile-up in China. Belief took some time to set in that the rally was actually a long-term one and not a flash in the pan. But those doubts have now been laid to rest and the increasing shortages in the entire manufacturing chain of metals is here to stay.

For instance, the high level of inventories on the LME has been cited as a deterrent to sustained increases in the price of aluminium. Nevertheless, aluminium prices on LME have gone up 15 per cent during 2003 owing to the shutdown of smelters in the US following high power costs.

Despite excess-supply globally, the jump in aluminium prices has been mainly a domino effect of an increase in alumina prices. China is short of alumina but has excess capacity in aluminium.

As a result, the increased demand for alumina in a balanced demand-supply scenario globally is resulting in a cost-push impact on aluminium prices, apart from the growing demand for aluminium in China.

In copper, there was a genuine deficit of around 3,90,000 tonne in January-September 2003 leading to a 43 per cent jump in copper prices during 2003. But that has not reflected in the margins of copper producers.

In fact, shortage of copper concentrate has led to a contraction in treatment and refining margins (TC/RC). Compared to TC/RC charges of around 5.1 cents/lb in January, the refining charges have touched around 1.9-2 cents/lb in December.

Thus, the shortage has become greater. This shortage in copper concentrate is not likely to ease in the near-term, due to shut down of plants.

Steel has been the best performing commodity globally. Driven by Chinese consumption, prices of product across the steel manufacturing chain have gone up.

But this has not led to any contraction of margins in any segment of the steel chain since the surge in demand has justified the increases in steel prices. China continues to be in deficit of raw materials like coal and coke and with demand growing, there appears to be further upside to steel prices.

A common thread running across all the above sectors is that there are capacities which were shut down and which have yet to come onstream. But a couple of factors hinder the restart of these plants. First, the high raw material costs owing to the extreme shortage, may make production unviable.

Secondly, the abnormally high freight costs due to a dearth of tonnage have meant that exports to China from countries like Brazil and Australia for products like iron ore are now uneconomical. This rally is here to stay for a while.

With contributions by Sameer Ranade