Emerging Mkt Assets Seen Poised To Climb In Months Ahead

Thursday April 3, 11:05 PM (This article was originally published Wednesday) By Charles Roth Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)--Notwithstanding the way the war in Iraq has been whipsawing global financial markets recently, emerging market assets appear well positioned to ultimately ride the volatility higher in the months ahead.

Emerging market fund managers and strategists say cheap stocks and high-yielding bonds, coupled with solid economic growth prospects, all bolster the case for the asset class.

"If we get some form of (Iraq) resolution over the next couple months, then we will see a huge rally in all markets," said Allan Conway, head of global emerging markets fixed-income and equities at WestAM in London.

After a great run last year and so far this year, emerging market bonds still remain attractive. But the asset class's equities look set to offer the wildest ride, with the war and its aftermath driving the swings.

Once U.S. forces take Baghdad, from which they are now within 30 miles, according to the Pentagon, stocks are expected to soar.

"Then the question will be how sustainable is the rally? For that we'll have to look at the global economy," Conway said, adding that indicators point to weakness in the U.S., the European Union and Japan.

While emerging market stocks aren't likely to fly as high as developed market equities, they won't give as much back, he said, explaining that "valuations are extremely attractive" compared to the fair value or still-rich levels at which much of Wall Street still trades.

Tim Love, emerging market strategist at Deutsche Bank in London, agreed. "We're very bullish on a relative basis as they (emerging market stocks) enter their fifth year outperforming" the Morgan Stanley Capital International's All Country World Index, he said.

In addition to lower volatility, emerging market stocks "still have extreme support from valuations...indicative of the positive upside yet to go in the asset class," he added.

Brad Durham, a managing director at Massachusetts-based Emergingportfolio.com Fund Research, which tracks fund flows, pointed to data indicating that the forecast average emerging markets 2003 price-to-earnings ratio is 8.3. That's markedly cheaper than the double digit ratios at which most of Wall Street's stocks trade.

Even if U.S. economic growth accelerates in the second half, as anticipated, faster growth in emerging markets should provide a more solid foundation for appreciation in their asset prices.

WestAm's Conway, whose fund manages $750 million in fixed-income and equity investments across emerging markets, said most emerging market economies will expand between 3.5% to 6% this year. The World Bank expects developing countries to grow 4% in 2003, up from 3.1% in 2002. The range clearly outstrips the consensus 2.6% U.S. growth forecast, as well as the World Bank's 2.3% global growth projection for 2003.

A Wall Street-based trader of American Depositary Receipts from Asia said a number of Asian stocks are poised to rise on the back of several factors: robust growth in places such as China, India and Thailand; budget surpluses; improved corporate governance; hefty international reserves; falling dollar-denominated debt levels; and a willingness of Asian monetary and fiscal authorities to employ counter-cyclical measures to ramp up economic growth. At the same time, inflationary pressures remain benign.

One possible damper on growth, particularly in Hong Kong, Vietnam, Singapore and ultimately perhaps even China may be the recent outbreak of severe acute respiratory syndrome, or SARS, a highly contagious, little understood and potentially fatal illness.

Overall, Love said Deutsche Bank finds the Asia story compelling, and recommends adding weight in Asian equities.

WestAm's Conway, though, is less bullish on Asia, with an overweight only in Thailand, which is so far this year the only Asian equity market to post a gain in dollar terms - rising 5.5% on the MSCI index.

Outside Asia, Conway's overweight equity positions include Brazil, Chile and Russia.

Brazil has indeed turned into a popular play thanks to dirt-cheap valuations, its large market and the view that leftist President Luiz Inacio Lula da Silva, who took the helm at the beginning of the year, is sticking to orthodox economic policies.

"There's lots of positive news out of Brazil," said Tim Ramsey, an emerging market strategist at Bear Stearns in New York. "It should outperform in a resolution of the war in line with U.S. objectives."

Ramsey is recommending the South American giant's industrial exporters and sectors in which the government has a "lighter regulatory touch" such as the wireless telecommunications sector.

Views are more mixed, though, on Mexico and Russia, two other emerging market giants.

Conway is underweight Mexico, while Love likes the outlook for the country.

Love points out that despite its recent strengthening, Mexico's currency is still undervalued, which should help its exporters and producers for the domestic market. And market capitalization is less than 20% of gross domestic product, compared to 70% at its peak, he said.

Others, such as Bear Stearns' Ramsey, note that while Mexican stocks may be cheap historically, they don't have many drivers for growth, with structural reform initiatives stalled by divided legislative and executive branches, and likely continued political infighting even after July mid-term elections.

And without faster growth in the U.S., which absorbs more than 80% of Mexican exports, the country's stocks, which trade at a 2003 forward-looking P/E of 11.2, or more than double Brazil's forecast P/E this year, may not see as much upside as other emerging market stocks.

Russian equities, despite giant gains last year, are still attractively valued. But like the country's bonds, performance hinges predominantly on the price of oil. Love is neutral Russian stocks, while Bear Stearns' Ramsey is "very wary" in a "climate in which oil prices are falling."

As U.S. forces advance on Baghdad and oil fields in Iraq are increasingly secured, oil prices have tumbled to nearly $28 a barrel for May delivery from a high of almost $40 a barrel in the prelude to the war.

Falling oil prices could also spell trouble for sovereign credits such as Venezuela, Colombia, Ecuador and Nigeria, and don't much help Mexico, which sources about a third of its public income from oil and related taxes.

But lower energy costs, in addition to facilitating growth in the U.S. and Europe, will also help oil importers such as Brazil, Chile, Turkey and Northeast Asia. For these countries, cheaper oil may ease inflationary pressures, and could even prompt monetary authorities to lower interest rates, which would make corporate borrowing and debt servicing easier. That, in turn, should help stocks.

If it appears that emerging market stocks are on the whole poised to gain near term, the asset class's bonds will likely still garner plenty of investor attention.

After gaining 14% last year, and 8.4% so far this year, the spread on the J.P. Morgan EMBI Plus, at about 650 basis points over U.S. Treasurys, may not contract much more near term. But, WestAm's Conway said, with yields running around 10% compared to U.S. Treasurys, "they're pretty attractive."

And spread contraction is still probable in Brazil, Ecuador, Nigeria and Argentina, he added.

-By Charles Roth, Dow Jones Newswires; 201 938 2226; charles.roth@dowjones.com