Winners And Losers In Emerging Markets

My bearishness on the Brazilian Real in 2012 was vindicated by its 10 per cent fall against the US dollar, while the Mexican peso appreciated sharply since July against the greenback. Brazil, taunted by General de Gaulle as “a country of tomorrow that will remain a country of tomorrow” was a spectacular investment theme during the Lula decade.

Yet Brazil’s GDP growth has now plummeted from 7.5 per cent to barely one per cent under President Dilma Rousieff. Political interference in gasoline prices, bank credit card charges and utilities prices makes it unattractive to invest in the state-owned colossi that dominate the Bovespa index, mainly Petrobras, Vale and Banco Itau Unibanco.

The fall in steel, iron ore, aluminum, sugar and coffee markets have hit Brazil corporate profits, for obvious reasons. Finance Minister Guido Mantega has also done his best to depreciate the Brazilian Real, with his punitive taxes on offshore capital and preemptive central bank intervention. 2013 is not the year to own Brazil.

I am already a fan of incoming Chinese Paramount Leader Xi Jinping, the princeling technocrat anointed as the new general secretary of the Communist Party and the holder of Mao/Deng’s mandate of heaven in the People’s Republic for the next decade.

After all, he made several capital markets bullish statements in the inaugural Politburo meeting he chaired in Beijing.

It was no coincidence that the Shanghai Composite Index and Hong Kong Chinese H shares both rallied 10 per cent after the political transition. This reinforces my bullishness on the FTSE Xinhua China index fund (symbol FXI) at 37.

I believe the China FXI index fund is headed to 45 in the next six months. Why? Chinese shares are highly correlated with reform initiatives from Beijing, which is high on the agenda of the incoming Politburo as it consolidates power at a time when retail sales/industrial production/ bank loan growth is set to accelerate.

The Bo Xilai scandal, corruption scandals and ethnic revolts in Sinkiang have hit the legitimacy of the Communist Party and the new Politburo has stressed the need for a code of conduct to govern the actions of Party mandarins.

This is the first time in the history of the People’s Republic that the Politburo has addressed the governance deficit in the party elite. Mark my words. Xi Jinping could well go down in history as the greatest economic reformer in modern China since Deng Xiaoping.

If so, we could be in the embryonic stages of a historic bull market in China, since the market prices minimal reform expectations.

Of course, with 145,000 state-owned companies acting as the world’s biggest patronage network for the Communist Party’s top apparatchiks, economic reform momentum will not be linear. No past Chinese Politburo was ever under the critical digital microscope of 500 million internet user and bloggers. MSCI China now trades at 9.5 times earnings at a time when EPS growth could be as high as 17 per cent next year.

Chinese shares (MSCI China) trades at a price/book value of a mere 1.4 so it would take only modest reform momentum, PBOC monetary easing (inevitable now that Chinese inflation rates have plummeted) and cyclical data all converge to trigger a valuation rerating. I see the Shanghai Composite at 2500 – 2600 sometime before June. The Year of the Snake could also be the Year of the Bull in the Chinese stock market.