Alan's Finance Blog

This Ignored Country is Booming

Emerging markets have been the success story of 2009.

While more developed economies such as the United States and Europe have struggled to recover, countries like Brazil, Russia, India and China are on a roll.

Another emerging economy is also rocketing. Morgan Stanley Capital International has upgraded this market, and it will make the coveted leap to “developed” market status in May of 2010.

It’s Israel. This tiny nation on the Mediterranean Sea might not be the first place that comes to mind when investors think about international diversification, but it should be at the top of the list.

The Tel Aviv 100, a benchmark of Israel’s 100 largest stocks, is up +69% this year.

Israel’s currency, the shekel, has gained ground against the dollar.

Investors may be reluctant about shouldering political and geographic risk. Israel is surrounded by enemies and has been plagued by the constant threat of violence. Yet that has been true since its founding in 1947, and Israel has nevertheless developed into one of the world’s most innovative economies.

Israel’s workforce is among the most educated and is renowned for its entrepreneurial spirit. The country has one of the highest numbers of patents filed in the world and is crawling with start-up companies. The World Bank notes it consistently ranks near the top in per capita research and development spending.

After years of GDP growth at about +5.0%, Israel’s economy — along with the rest of the world — experienced a mild recession last year. Now, it’s rebounding: GDP grew +2.2% in the third quarter of this year and should grow by +2.9% next year, according to a Barclays Capital forecast.

The downturn in Israel was brief enough to make the Bank of Israel the first major central bank to raise short-term borrowing rates, a sign of strength signaling confidence in the economy. The central bank has held the rate steady the past two months, but could announce another rate hike by the end of the year.

Part of Israel’s success can be attributed to its status as the Silicon Valley of the Middle East. Tech has been the best performing sector in the market this year, gaining more than +55% compared with the S&P’s +23%. About 75% of Israel’s exports are technology products, so it should be a prime beneficiary if this trend continues.

Two funds offer the best broad exposure to Israel: iShares MSCI Israel Capped Investable Market (NYSE: EIS), an exchange-traded fund, and First Israel Fund (AMEX: ISL), a closed-end fund.

Each of these funds offers broad exposure to the Israeli market, with both funds holding many of the same securities.

EIS is a bit top-heavy: Its top five holdings comprise more than 50% of the portfolio. ISL is more balanced: Its top five holdings make up 33% of the holdings. The fund trades at a -7% discount to net asset value, meaning investors get a dollar of assets for 93 cents. Considering that the TA-25 Index is trading at 34 times earnings and the TA-100 Index at 44 times earnings, cost-conscious investors may want to pick up ISL.

Brad Briggs
Staff Writer
StreetAuthority

How to Trade China with ETFs

by Ron Rowland

Right now, China is celebrating 60 years of Communist party rule. Most of the party-goers aren’t old enough to remember anything else, of course, but that isn’t stopping the nationwide festivities.

The sheer scale of China is mind-boggling! Just think about it …

• 1.3 billion people — more than 4x the U.S. population …

• 3.7 million square miles …

• And borders that touch 14 other nations!

Communist China Turns 60.

Back in the 1970s, the Chinese government figured out that the whole “central planning” thing wasn’t working so well. And communist ideology gave way to a pragmatic mix of state ownership and entrepreneurial capitalism.

It worked … China’s economy is now 70 times bigger than it was in 1978, when the economic liberation began. Depending on how you calculate, China is either the second or third largest economy in the world!

The vast industrial base, concentrated in the coastal regions, is transforming China. Farm workers from the massive interior are drawn by the relative high pay of factories. New cities spring up out of nowhere to house these workers and provide for their needs …

… And now many of the products that were once immediately shipped to the U.S. or Europe are staying at home, snapped up by China’s newly-prosperous middle class.

A middle class in a communist society? Hard to believe, yes, but there really is such a thing in China now. And there’s an entire younger generation that now knows what they’re missing — and they’re working hard to reach the next level.

China’s new middle class is on a shopping spree.

So if long-term rewards are what you’re looking for, China represents an amazing investment opportunity. But how do you play it?

First, recognize that anything China-related is going to be a roller-coaster ride, just as it has been the last few years. Therefore don’t invest unless you’re prepared for the bumps and jerks.

Second, know how much risk you’re taking. Individual Chinese stocks can deliver amazing profits, but they can be hard to trade. That’s why I think exchange traded funds (ETFs) are the best way for most investors to get involved in China’s hot market. And you have several choices — some diversified, some more specialized.

Here’s a quick summary:

Broad-Based China ETFs

U.S. investors can pick from four ETFs that track diversified Chinese stock market indexes:

• iShares FTSE China Index Fund (FCHI)

• iShares FTSE/Xinhua China 25 Index Fund (FXI)

• SPDR S&P China (GXC)

• PowerShares Golden Dragon Halter USX China Portfolio (PGJ)

Each of these ETFs takes a slightly different approach to constructing a China portfolio. FXI holds the 25 largest Hong Kong-listed companies that are available to foreigners. FCHI and GXC are similar but add some mid-cap stocks to the mix. They’re a little more diversified than FXI. All three are capitalization-weighted.

PGJ takes a somewhat different tack. First, it includes only Chinese stocks that have a listing on U.S. exchanges. Second, PGJ uses a tiered-weighting method, which results in the sector mix being a little different from the others.

Specialized China ETFs

If you want to get a little more aggressive, Claymore offers two China ETFs that have a tighter focus:

• Claymore/AlphaShares China Small Cap Index ETF (HAO)

• Claymore/AlphaShares China Real Estate ETF (TAO)

HAO is a good way to get exposure to small, fast-growing Chinese companies. These stocks tend to be less dependent on exports and more related to China’s domestic economy. TAO gives you an opportunity to profit from China’s real estate and construction boom.

China is growing like crazy.

Inverse and Leveraged China ETFs

What if you think that China’s stock market has gone up too far, too fast, and is due for a quick drop? You may still be able to profit with ProShares UltraShort FTSE/Xinhua China 25 (FXP). This is a 2x leveraged inverse ETF. For instance, on a day when the underlying index goes down 2 percent, FXP is calibrated to move twice as much in the other direction — up 4 percent in this example.

On the other hand, if you’re bullish on the Chinese market, there’s the ProShares Ultra FTSE/Xinhua China 25 (XPP). This 2x leveraged “bullish” fund aims to give twice the daily move in the same direction.

The leverage factor for ETFs like these is reset daily, so the 2x math doesn’t always work for periods longer than a day. In other words, FXP and XPP are best used as tools by short-term traders, but if your timing is right you can make big profits from them.

Chinese Currency ETFs

If you want to bet on China’s currency, the renminbi (also called the yuan), you can do it with these two instruments:

• Market Vectors Chinese Renminbi/USD ETN (CNY)

• WisdomTree Dreyfus Chinese Yuan Fund (CYB)

There’s one key difference between the CNY and the CYB: CNY is actually an exchange traded note (ETN), not an ETF. Practically speaking, ETNs work much the same way as ETFs, but they’re actually a form of debt instrument. I wrote about the unique risks of ETNs earlier this year in my Money and Markets column.

Chinese law prevents the funds from directly investing in the renminbi, so they hold currency derivatives known as nondeliverable forwards. These are similar to futures contracts, which reflect a market’s expectations. As a result, these funds might not perfectly track the yuan.

As you can tell, there are plenty of ways to invest in China’s stunning growth story. I’ve only covered a few of them here, and ETF sponsors are planning many more. Do your research first, but don’t overlook China. The opportunity is too big to pass up!

Best wishes,

Ron

This Country’s Market Could Jump +33%, One 25% Yielding Fund Could Do Even Better

Published: October 6, 2009

The Chinese Civil War ended Oct. 1, 1949. The (winning) communists controlled Mainland China and the (losing) Chinese Nationalist Party was relegated to Taiwan.

The relations between the two governments since have generally been hostile. Each side hated the other and claimed they were the legitimate Chinese government. Now, after 60 stand-offish years, Taiwan’s leaders are trying a new — more conciliatory — approach.

In April, Taiwan began to allow Chinese investors to buy some Taiwanese stocks for the first time since the end of the civil war. In June, Taiwan expanded the areas where Chinese investors could put their money.

Taiwan’s market has soared +33% since April. The Shanghai index has managed about half that in the same period.

Now, many observers are saying that Taiwan still has plenty of room to run. Bloomberg reported that Lu Zheng-Ying, manager of the SinoPac Small & Medium Capital Fund, said that the rally would continue for the next two years. Lu predicted the rally will push the index to a record: Above 12,682, or about +70% higher than it is today.

I decided to ask Mike Turner, editor of Street Authority’s Trade of the Week, what he thought about Taiwan. Turner said his proprietary software was giving a Taiwan-focused ETF a “Strong Buy.” He thinks the iShares MSCI Taiwan Index Fund (NYSE: EWT) could gain another +33%.

Another Play
Another fund in a great position to continue to benefit from Taiwan’s growth is the China Fund (NYSE: CHN). This fund focuses on small and medium-sized companies in China, Taiwan and Hong Kong. These lesser-followed stocks have an average market cap of about $1.5 billion.

As of the end of July, the fund’s top holdings included investment firm Citic Securities, supermarket retailer Wumart Stores and the health-care company Shandong Weigao Group. Management visits more than 1,000 companies each year. The fund also can invest up to 25% of its assets in unlisted, over-the-counter companies, securities that tend to be overlooked by other managers.

So far this year, CHN is up more than +42%. Although it has lagged the Shanghai Index, the fund hasn’t experienced the pullback Shanghai has, either. Management says the fund is taking a conservative approach by investing in steadier consumer growth companies and staying clear of commodity and property stocks. As the Taiwan, China and Hong Kong gain value, CHN has an attractive strategy.

CHN has achieved tremendous long-term returns, averaging +20% a year during the past 10 years. Morningstar ranks the fund in the top 1% of funds in the Pacific/Asia ex-Japan category for the 10-year period. Despite stellar long-term returns, CHN sells at a -6% discount to its holdings’ net asset value.

Even better, CHN pays out one distribution each year in January. The last distribution was $5.82. That’s about a 25% yield.

– Anthony Haddad
Staff Writer
StreetAuthority.com

Colombia and Peru Top Emerging Markets

By Jason Mitchell
The Banker Thursday, September 24, 2009

While the Western world has been struggling through the global financial crisis, Latin America has shown a remarkable resilience to the upheaval. Two countries in particular – Colombia and Peru – are showing particularly impressive growth, and look set to become important emerging economies.

With the prudent macroeconomic policies pursued in Colombia and Peru over the past five years starting to bear fruit, the two countries are set to become much more important emerging markets in Latin America over the course of the next decade.

One of the most important aspects of the international financial tsunami that has battered the world for the past year has been Latin America’s ability to act as a shock absorber, rather than as a shock amplifier as has been the case in previous financial crises. Brazil and Chile are probably the best examples of Latam economies that have weathered the storm well; however, Peru and Colombia have also shown remarkable resilience, especially given the countries’ turbulent economic histories.

Even countries such as Venezuela and Argentina – which have followed much more heterodox macroeconomic policies – have not suffered from a meltdown, although they are now suffering from stagflation (Colombia and Peru have only seen declines in gross domestic product [GDP]).

“One of the most notable things about Colombia and Peru is that they have not taken the hit from the financial crisis that many people expected,” says Joydeep Mukherji, head of the sovereign ratings group at Standard & Poor’s. “They have remained fundamentally strong. Furthermore, there are only a few countries in Latin America that have been able to run proper countercyclical fiscal policies during this crisis: Chile, Brazil, Peru and, to a lesser extent, Colombia.”

Commodity demand

Colombia and Peru were among the region’s fastest growing emerging markets between 2003 and last year, expanding at an average of 5.4% and 7% a year, respectively. The economic expansion in both countries was fuelled by rocketing international demand for commodities – mostly oil, coal and gold in Colombia’s case, and copper, gold and zinc in Peru. Although Venezuela and Argentina grew at faster rates (averaging 10.4% and 8.4% a year respectively), Colombia and Peru did not experience the kind of inflation witnessed in those two countries. Goldman Sachs forecasts economic growth for Peru of 2% this year with inflation at 1.6%, and an economic decline in Colombia of -0.1% with inflation of 3.9%. Venezuela is forecast to have economic growth of 1% combined with inflation of 24.7%, while Argentina is expected to decline by -0.9%, with local analysts estimating inflation of 15% to 20%. According to the IMF, Peru’s GDP was $128bn last year (with a total population of 28 million people), while Colombia’s stood at $240bn (with 44.7 million inhabitants). The two countries have much smaller economies than Brazil and Mexico (at $1570bn and $1080bn, respectively), but are middle-ranking in size, comparable with Argentina and Chile (at $326bn and $169bn, respectively). “Colombia is a market economy, open to the international trade of goods, services and capital,” says José Dario Uribe, president of Banco de la República, Colombia’s central bank. “Property rights are respected and the rules of play are clear and stable. There exist guarantees for foreign and national investors. “Macroeconomic stability is valued and an independent central bank is in charge of monetary policy, maintaining low and stable inflation and a sustainable exchange rate regime.” Dr Julio Velarde, president of Peru’s central bank, says: “I am sure Peru will become one of the most important emerging markets in Latin America and have a modern economy within the next few years. “During the past five years the role of the free market has been pushed heavily in the country. Companies that were privatised were privatised well. State intervention has become a lot lower and tariffs have been reduced close to zero.” Fundamentals in place During the past five years, Colombia and Peru have become much more attractive destinations for foreign direct investment (FDI) and for portfolio investment; have seen their private pension fund industries expand massively in size; witnessed the development of private equity markets; seen the evolution of long-term yield curves; and experienced the rise of an acquisitive middle class.

Colombia has free-trade agreements with Chile, El Salvador, Venezuela and Mexico (the one with the US is quagmired in the US Congress), while Peru has agreements with Chile, China, the US and Thailand.

“Colombia and Peru have performed very well in terms of macroeconomic policy-making,” says Jerome Booth, head of research at private equity group Ashmore Investment Management. “They are both very close to Brazil in that sense. Both countries are now better credits than Argentina, and in fact are snapping at the heels of Mexico.”

Last year, one of Peru’s biggest achievements – and Brazil’s – was to secure investment grade from Fitch and Standard & Poor’s (Chile and Mexico have had the coveted status for a long time). Those agencies rate Colombia investment grade on local currency but not yet on the sovereign’s foreign currency ratings. Moody’s ranks Colombia and Peru (and Brazil) one notch below investment grade.

Two of the main reasons why the agencies rank Peru better than Colombia are the level of public debt against GDP and the fiscal accounts. In Peru, public debt against GDP was 27% last year against 40% in Colombia. Peru has strong fiscal constraints enshrined in law, while Colombia has had problems trying to ease the flow of central government transfers to the provinces.

Goldman Sachs forecasts an overall public sector deficit of -1.7% in Peru this year and -3% in Colombia, and forecasts an overall surplus of 0.2% in Peru next year and a deficit of -3.7% in Colombia.

Analysts also see Peru as a more politically and socially stable country than Colombia, which still has problems. Colombia is the world’s number one producer of cocaine (430 metric tonnes produced last year, according to the UN), followed by Peru (302 metric tonnes). Peru has had terrorist problem in the past, in the form of Maoist guerrilla organisation Shining Path, but now the Peruvian state is in charge of the whole national territory. In Colombia’s case, the number of guerrillas has dropped to 8000 from 30,000 but revolutionary group FARC has not yet been totally wiped out.

“Both Peru and Colombia have witnessed significant economic transformation during the past six years but they are quite different countries,” says Francisco Aristeguieta, Citi’s country officer for Colombia and regional head for the Andean region. “Colombia has a much bigger population than Peru; it has five important cities, while Peru is heavily concentrated in Lima.”

International trade

Peter Hakim, president of the Inter-American Dialogue, a Washington, DC-based think tank focusing on Latin America, says: “Peru is clearly the country among the two that has progressed the most. President Alan Garcia’s first term between 1985 and 1990 really was an economic shambles. President Alberto Fujimori’s government [between 1990 and 2000] did some pretty noxious stuff but, when he took over, the country was on its economic knees and it moved forward economically in many ways.

“Peru has really opened itself up to foreign investment and foreign trade. Colombia has come a long way but it still follows a social democratic model and has a fairly active state.”

Mr Hakim adds that the government of president Alvaro Uribe of Colombia – who was first elected in 2002 and re-elected in 2006 – has followed orthodox macroeconomic policies but it is not yet clear that the country’s political elite shares this philosophy. During President Garcia’s second term – which started in July 2006 and ends in July 2011 – Peru has become a nation of born-again capitalists and the free-market approach is shared by most members of the political establishment.

José Dario Uribe, president of Banco de la República, Columbia’s central bankJosé Dario Uribe, president of Banco de la República, Columbia’s central bank

Growth of pensions

One of the most important developments in both countries has been the growth in pension funds. According to Barclays Capital, Peru has 12 private pension funds today and the industry’s assets under management (AUM) has risen to $20.2bn today against $2.8bn in 2000. In Colombia’s case, the country has 25 pension funds today and total AUM has increased to $40bn now from $5.1bn in 2000.

The Latin American Venture Capital Association (Lavca) ranks Colombia in joint sixth best place among 13 countries in the region on its scorecard – which takes into account all the key factors affecting private equity and venture capital investment – while Peru is ranked in 11th place. Lavca says both Andean nations have liberal policies towards foreign portfolio investment by the countries’ pension funds, but Colombia scores better on its laws on fund formation and operations.

“I think Colombia is better than Peru from a private equity standpoint,” says Cate Ambrose, president of Lavca. “Colombia has a highly diversified economy: it exports flowers, coffee and high-valued added manufactures. Peru is more focused on natural resources. It could be a better investment for hedge fund managers.”

Furthermore, Colombia has outperformed Peru in terms of the amount of net inflows of FDI that it has secured: it attracted an average of $9.1bn a year between 2005 and last year, compared with an average of $3.9bn a year for Peru. During the same period, Argentina averaged $6.25bn a year, Venezuela $1.09bn, Chile $11.46bn, and Brazil $28bn.

Traditionally, Colombia has had better developed capital markets than Peru; the country had investment grade until 1999 but lost it following a severe economic meltdown in the wake of the 1997 Asian crisis. Today, total credit against GDP in Peru is 24%, compared with 30.5% in Colombia (and 60% in Chile).

However, the Peruvian banking system has been expanding rapidly. “Our bank has duplicated its client base to a total of 750,000 customers during the past two-and-a-half years,” says Eduardo Torres Llosa, country manager for Peru at BBVA Banco Continental, the country’s second biggest bank. “It’s true for other banks in the country, too. The middle class is expanding rapidly. Mortgage origination is increasing at 15% to 18% annually and the total stock of mortgages is now 150,000.”

Developing capital markets

Colombia and Peru enjoy much lower spreads than Venezuela and Argentina, and both Andean states have developed long-term yield curves unlike the other two countries. According to JPMorgan’s EMBI global index, on August 11, Colombia’s spread stood at 256 basis points and Peru’s was at 238bps, while Argentina’s was at 897bps and Venezuela’s was at 1019bps.

Mr Aristeguieta adds: “I think the biggest difference between, say, Ecuador and Venezuela on the one hand, and Peru and Colombia on the other hand, is that in the first two countries the state is the most important economic power, while in the second two the private sector is the main economic power.”

Peru’s central bank has $32.1bn in international reserves (the highest in Latin America, as a percentage of GDP), while Colombia’s reserves stand at about $20.8bn.

“Colombia’s capital markets have an intermediate level of development in the region,” says Mr Dario Uribe. “The debt market has seen significant advances, allowing the government and private companies to increase the amounts raised at a local level. In relation to derivatives, the forwards market has undergone a very important development in recent years. Exchange rate forwards are the most traded instrument.” H

e says the Colombian financial system is solid with high rates of capitalisation, profitability, liquidity and provisions. The solvency ratio is 14.5%, return on assets is at 2.4% and provisions as a percentage of overdue accounts are at 112.6%.

Recently, a futures market for fixed income and exchange rates was launched. The stock market is relatively small compared with other countries of the region in terms of the number of issuers, but from the perspective of stock market capitalisation as a proportion of GDP it is at an intermediate level in the region.

“To develop the capital markets, it is very important to maintain inflation at a stable and low level,” adds Mr Dario Uribe. “Furthermore, the design of appropriate regulatory frameworks must be advanced, including the implementation of codes of corporate governance, improvements in accounting practices and greater transparency.”

Colombia’s stock market has risen by 38% on the year to 10,437 points (even surpassing its peak of 10,178 points in May last year), while Peru’s market is up by 96% on the year to 13,831 (but remains way below its high of 18,094 in April last year). (These figures were taken on August 11, 2009.)

Eduardo Torres Llosa, country manager for Peru at BBVA Banco ContinentalEduardo Torres Llosa, country manager for Peru at BBVA Banco Continental

Four more years?

Colombia has presidential elections in May next year, and President Uribe has announced that he would like to run for a third term in office. However, a referendum would have to take place for this to happen and recently Congress has been proving reluctant to pass legislation for the referendum, despite President Uribe’s national popularity.

Peru will hold presidential elections in 2011, but the constitution does not allow presidents to run for two consecutive terms. In April, former president Alberto Fujimori was sentenced to 25 years in prison for human rights violations, but he remains popular with the country’s poor. Recently, his 34-year-old daughter, Keiko Fujimori, has started campaigning and could run as the presidential candidate for the right-wing party Alliance for the Future.

During the past few months, Peru has suffered from industrial action and social unrest. Many indigenous groups feel left out by the economic progress of the past five years and in June the country was rocked by clashes between the police and indigenous people in the coastal province of Bagua, which left 24 police and 10 civilians dead. Some analysts believe that President Garcia must pay more attention to the indigenous groups to stop a populist, left-wing candidate such as Ollanta Humala performing well in the next elections.

By pursuing orthodox macroeconomic policies, Colombia and Peru clearly have outperformed countries in the region with more populist governments, such as Argentina, Ecuador and Venezuela, in terms of attracting FDI inflows and portfolio investment. The two of them look set on becoming much more important emerging markets in the continent. Colombia has a bigger and much more diversified economy than Peru. However, Peru has some of Latin America’s most solid economic fundamentals and its government is aggressively attempting to insert the country deeper into the international community.

SOURCE: http://www.thebanker.com/news/fullstory.php/aid/6844/On_the_brink.html?current_page=NO_PAGE”>