Emerging Market Stocks Losing Allure: Carry Trade Reverses

Investors are taking money out of the emerging market stocks after more than $90 Billion was pumped into emerging market funds in 2010. The results of fund outflows can be seen in broader stock indices. The developed country stock markets are in positive territory this year, but the MSCI Emerging Markets Index declined more than 1.5%. India’s Sensex Index declined 10.3%, Brazil’s Bovespa Index declined 3.3%, and China’s SSE Composite Index lost 2% in 2011. Inflation is climbing and interest rates are going up in these countries. The results haven’t been pretty for foreign investors.

India raised borrowing costs this month in response to large increases in inflation. High food prices are driving overall inflation in India. Food inflation is above 15% there, while overall inflation was above 8% in December. Higher borrowing costs have been pushing Indian shares down, and the costs are expected to increase further this year. Banking shares especially went down: ICICI Bank (IBN) declined 12.3%, and HDFC Bank (HDB) lost 12.5%. The results were mixed for technology shares. Infosys Technologies (INFY) declined 9.2%, but Rediff.com (REDF) and SifyTechnologies (SIFY) have both gained so far in 2011.

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Exchange traded funds following Indian companies also plunged in 2011. iPath MSCI India Index ETN (INP) lost 15%, giving back nearly all of its 2010 gains (21%). WisdomTree India Earnings Fund (EPI) declined 12.7%, PowerShares India Portfolio (PIN) lost 12.4% and iShares S&P India Nifty 50 Index Fund (INDY) declined 12.5%. Analysts are expecting a 22% increase in earnings in Indian companies in 2011, but recent increases in interest rates combined with input price inflation might jeopardize these estimates and push Indian stocks further down.

Another emerging market that’s in turmoil is, unexpectedly, Turkey. Turkey was one of the fastest growing countries in 2010, managing to reduce the inflation rate to 6.4% despite the breathtaking growth. Nevertheless, the Istanbul Stock Exchange lost 4.2% this year. Two thirds of those losses came today. The Turkish lira also lost around 4.2% on the US dollar, compounding the losses for foreign investors. The Turkish Central Bank revealed that it’s pursuing devaluation of the Turkish lira by reducing interest rates while increasing bank reserve requirements. This sudden policy change created unease among foreign investors, who in response started selling their investments and leaving the country. Turkey’s Treasury Secretary and former Merrill Lynch director, Mehmet Simsek, indicated policymakers aren’t concerned about the declines in the stock market or the Turkish lira.

“We don’t want the current account deficit to exceed 5%. We are using the tools we have to achieve (long-term) stability,” said Simsek.

iShares MSCI Turkey Index (TUR) has lost 11.3%, and Turkish Investment Fund (TKF) has declined 7.7% so far this year. Turkey’s market leading bank, Garanti Bankasi (TKGBY.PK), lost 15.5%. We usually don’t get involved in OTC stocks, but Garanti is an exception. It has a $18.3 Billion market cap and a P/E ratio of 8.9. It had been consistently profitable during the Great Recession and it’s one of the fastest growing banks in Turkey. Turkcell (TKC), which is Turkey’s largest wireless company, is down 10.3% this year.

It seems emerging market stocks are losing their allure because of temporary monetary tightening. There are some hedge funds that are short China, but most investors don’t doubt the emerging markets’ growth prospects. We think it’s a bit early to jump into emerging market stocks, but we are long term bullish about both Turkish and Indian banks.

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