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Conclusion: While  we certainly don't intend to make light of a serious global issue (food inflation), we'll use today's media focus as a platform to cook up some emerging market “food for thought” for you to digest over the weekend.

It has taken riots in Egypt, Tunisia, India, Bolivia and other countries worldwide for consensus to notice the price action in many emerging markets equities and bonds since the announcement of Quantitative Guessing Part II. Since November 3rd, the MSCI Emerging Market Index, a collection of over 2,600 EM equities spanning 21 countries, has dropped (-3.8%) on the product of a very simple equation which we introduced back in early November:

QG2 = accelerating inflation globally = policy tightening globally = slower growth globally

Needless to say, we’ve been bearish on emerging market equities and bonds ever since.

Putting aside “smaller” countries like Egypt and Tunisia and focusing on the major “engines” of developing nation growth, emerging markets have largely fallen victim to the Starvation Trade since 11/3: 

  • Brazil’s Bovespa down (-8.6%)
  • China’s Shanghai Composite down (-6.7%)
  • India’s SENSEX down (-13.4%)
  • Hong Kong’s Heng Seng down (-5.4%)
  • Turkey’ ISE National 100 Index down (-5.6%)
  • Indonesia’s Jakarta Composite down (-5.9%)
  • Singapore’s FTSE Straits Times down (-4.6%) 

Meanwhile (since QG2’s official announcement): 

  • Corn up +19.3%
  • Oats up +11.8%
  • Rice up +7.2%
  • Wheat up +18.8%
  • Lean Hogs up +20.1%
  • CRB  Foodstuff Index up +18.9%
  • UN Food and Agriculture Organization World Food Price Index reached an all-time high in each of the following two months; closed out January up +28.4% YoY. 

For reference, the Starvation Trade is going long foodstuffs and agricultural commodities and shorting the large populations that need to tighten monetary policy in order to eat and maintain price stability in basic goods. As tactless as it may be to make light of something that’s actually not funny at all, we too have been guilty of gambling in The Ber-nank’s Casino. On January 14th, we offered up a few ideas in a collection of our best inflation plays in a note titled “Ten Ways to Play the Spike in Global Inflation” (email us if you need a copy): 

  • COMMODITIES: FOOD – As we last saw in summer of ’08, deadly riots are breaking out globally in protest of rising food prices, currently at all-time highs. Perpetuated by global supply shortages, we anticipate a meaningful increase in import demand for many food products throughout the course of the year as developing nations look to rebuild domestic stockpiles. Long Sugar; Long Corn.
  • COMMODITIES: OTHER – Severe weather is adversely affecting many key agricultural-producing regions globally (flooding in Australia, mudslides in Brazil, etc.). Getting ahead of growing supply/demand imbalances is key, as agencies like the USDA tend to be rather hopeful with their production estimates, leading to downward revisions to their forecasts in subsequent reporting. Long Cotton.
  • CURRENCIES – As monetary policy tightens globally, several countries will see their currencies move as a result of: a) slowing global growth; b) the direction of global interest rates and rate differentials; and c) key moves in their basket of counterparts. Long Chinese Yuan.
  • EQUITIES – As we have seen many times in financial market history, inflation can erode returns on equities by reducing company earnings via margin squeezes or by investors discounting slowdowns in growth as central banks tighten monetary policy. Despite this, there are ways to play this on the long and short side depending on the type of tightening measures implemented. Short Indian Equities. 

Now that consensus’ best idea is the “short EVERYTHING emerging markets and get long the Dow,” we’ll use their sentiment and combine it with price action to form more actionable investment ideas. The “flows” don’t produce alpha; last week’s $7B outflow from emerging market equity funds was the largest since January 2008 – NOT a bullish data point for global growth right; we don’t buy the “US decoupling from the rest of the world” argument.

Given, we’ve assembled a collection of seven emerging markets we’ve done some work on recently that we think you need to consider as it relates to your exposure to growth and inflation trends – both domestically and globally. We’ll keep these updates short; email us if you’d like to see copies of the relevant reports and/or if you have any follow up questions:

China – The news flow regarding China eerily quiet of late; it seems perma-bulls only mention the world’s second-largest economy when they need to engage in storytelling around accelerating global growth. With the S&P at the top of a +96.5 rally from the March ’09 lows, it appears the bulls no longer need what they dubbed: “the engine of the world’s growth”. Chinese growth is slowing. How much Chinese growth overshoots the bottom of consensus estimates over the next two quarters remains to be seen.

The Starvation Trade Is Consuming Emerging Markets - 1

India – India has been far and away our favorite short idea since early November. Nothing has changed but price (down -15.3% since we turned bearish on November 9th). Even to a value investor (which we are far from), India still looks iffy: SENSEX shares trade at 16.8x NTM P/E vs. 13.2x in China, 10.4x in Brazil, and 7.2x in Russia. Broken on all of our core durations (TRADE, TREND, and TAIL), we see more downside here.

The Starvation Trade Is Consuming Emerging Markets - 2

Korea – Korea has certainly gotten the benefit of the US growth story. An inflated Q4 US GDP number has certainly given this export economy a nice boost until today’s (-1.6%) decline – yes, the GDP deflator is being understated and downward revisions to NTM S&P 500 earnings will create a massive divergence between the US government’s reported growth numbers and corporate profits in the coming quarters. If the commentary provided on CSCO’s earning call is any indicator, it’s decidedly bearish for Korea (and Japan) in the coming quarters. That’s on top of slowing growth and accelerating inflation at home on the peninsula. The market didn’t like the Bank of Korea’s decision to keep rates on hold today (down -1.6%).

The Starvation Trade Is Consuming Emerging Markets - 3

Thailand – Thailand has been an interesting story in and of itself. While we recently covered our short position in the THD for a +5.28% realized return, we still remain bearish on the economy that is setup to slow from growth perspective and heat up from an inflation perspective. Serious compression (both margin and multiples) a’cometh for Thai equities. Mean reversion alone should keep this trade working over the intermediate term (up +36.5% in the past year).

The Starvation Trade Is Consuming Emerging Markets - 4

Brazil – Today’s +1.8% move in the Bovespa reminds us all that there are pockets of value out there. The consumer and infrastructure stories in Brazil are the kind of long term bull theses that keep a smile on Mark Mobius’ face. Unfortunately, pockets of value can easily turn into Value Traps, as investors get sucked into buying good IDEAS not good INVESTMENTS. If you’re bullish on Brazil, patience will allow you to buy exposure at a discount to today’s price. The fight with inflation is far from over for the rookie president and central bank president duo. Growth will continue its deceleration in 1H11 as well.

The Starvation Trade Is Consuming Emerging Markets - 5

Mexico – Much like Korea, Mexico is getting the benefit of the doubt from the US growth story (in addition to positive exposure to crude oil prices). Even if US growth was, in fact, robust in 4Q10, that’s in the rear view. Of the leading indicators we track, none are signaling an acceleration of growth for this US’s 70% household consumption-based economy. WTI’s lackluster performance over the past few weeks of heightened geopolitical risk is an explicitly negative US demand signal.

We need to see much better employment data than the last two payrolls misses to get us constructive on US growth. And one can make a very compelling argument that the COGS inflation being felt by companies like KO, PEP, SYY, CSCO, NKE, F, and GT is definitely NOT bullish for CFO’s increasing their labor expense in 2011. Add in the impact of rising interest rates on the bottom line and companies will be forced to take up price on a weak US consumer. Margin compression will come from slower traffic or sitting on rising input costs. Either way, Mexico loses from a lack of pricing power here (80% of its exports go to the US).

The Starvation Trade Is Consuming Emerging Markets - 6

Argentina – Alongside Zimbabwe, Argentina wrote the book on modern-day emerging market inflation. Just over 20 years later, President Fernandez and company have taken the liberty to sue private economists who report inflation – many of which are 250% of the government’s official reading of +10.9% YoY. No country in the world has a more suspect CPI calculation – not even the US. The Merval Index is up +7.7% since QG2 was announced on the strength of the parabolic moves in soybeans, corn and wheat prices (Argentina’s main exports). Apparently Argentineans themselves don’t have to eat. Social stability or stock market performance – something’s going to give here.

The Starvation Trade Is Consuming Emerging Markets - 7

Don’t be swindled by the statements of our Fed Chairman Ben Bernanke:

"Indeed, prices of many commodities have risen lately, largely as a result of the very strong demand from fast-growing emerging market economies..."

- The Ber-Nank, Feb. 3, 2011

From our purview, the slope of demand growth in emerging markets is falling like a “BRIC”.

Keep your head on a swivel and have a great weekend.

Darius Dale


Recent Hedgeye Macro research notes on CHINA (email us for copies):

  • 10/21: China Sets the World up for a CRASH
  • 11/11: Chinese Inflation Data Confirms What We Should Already Know: QE2 Will Slow Global Growth
  • 11/24: Tales of the Global Inflation Tape: China, Brazil & India
  • 12/14: China by the Numbers
  • 1/6: Pondering Chinese Growth
  • 1/6: Tales of the Global Inflation Tape Part II: China, Brazil & India
  • 1/11: Extrapolating Asia… The Warning Signs Continue To Mount
  • 1/21: Is Consensus Getting Chinese (or Global) Growth Right? 

Recent Hedgeye Macro research notes on INDIA (email us for copies):

  • 11/9: India’s Two Big Problems
  • 11/24: Tales of the Global Inflation Tape: China, Brazil & India
  • 1/6: India’s Two-Factor Squeeze
  • 1/6: Tales of the Global Inflation Tape Part II: China, Brazil & India
  • 1/11: Extrapolating Asia… The Warning Signs Continue to Mount
  • 1/26: Top Emerging Market Short Ideas: Indian Equities
  • 2/3: Falling Like a BRICk: Is India the Next Egypt? 

Recent Hedgeye Macro research notes on KOREA (email us for copies):

  • 11/17: Trouble Brewing in Korea (trouble for Korean growth; not regarding geopolitical risk) 

Recent Hedgeye Macro research notes on THAILAND (email us for copies):

  • 11/22: Slowdown in SE Asia : A Leading Indicator for Global Growth
  • 1/21: Asian Trade Data Exposes Façade of US Growth
  • 1/27: Shorting Thai? 

Recent Hedgeye Macro research notes on BRAZIL (email us for copies):

  • 11/9: Outlook for Brazilian Interest Rates: Read the Fine Print
  • 11/24: Tales of the Global Inflation Tape: China, Brazil & India
  • 12/17: Brazil: A Leading Indicator for the Global Economy
  • 1/6: Tales of the Global Inflation Tape Part II: China, Brazil & India
  • 1/21: Navigating the Brazilian Terrain
  • 1/26: Bullish on Brazil (and Other Emerging Markets)?
  • 1/31: Time to Buy Brazil? 

Recent Hedgeye Macro research notes on MEXICO (email us for copies):

  • 7/15: Shorting Mexico… Aye Carumba!
  • 7/30: Mexican Headwinds
  • 8/13: Latin America CDS… Risk is Always On

Recent Hedgeye Macro research notes on ARGENTINA (email us for copies):

  • 8/13: Latin America CDS… Risk is Always On
  • 10/6: Eye On Latin America: Callouts from Brazil and Argentina
  • 11/4: Is Argentina Signaling a Cyclical Peak in Emerging Market Asset Values?