EPSTEIN
page 8 / 451 . OCR, unverified
EM universe. The biggest risks are in those economies with weak hard budget
constraints, often as a result of a dysfunctional relationship between the state
and the corporate sector, as the absence of enforceable exit mechanisms
ultimately undermines returns on capital.
BRICs most et risk - beware short Exllong commodities across GEM
On this basis the BRIC markets with the possible exception of India are
eventually more liable to a 'classic' emerging type crisis compared to
Indonesia, South Africa or Turkey, though we accept that there is a risk with
Indonesia in particular, that predictions of a crisis, which lead to a rapid run-
down in FX reserves, could become self-fulfilling. China in particular has
become much more dependent on foreign funding to prop up 'acceptable'
rates of economic growth against a steady deterioration of the underlying
return on invested capital across much of the listed corporate sector. There is
also a risk across all emerging markets that any sustained rally in the dollar will
reveal 'hidden' short FX exposure, often linked to exposure to commodity
related assets, which were acquired at top of the market prices. Whilst some
EM currencies are now cheap, we would expect widespread further weakness
against the dollar in 2014 to include the Korean won and possibly the
Renminbi. Although Beijing's post-Plenum drive to attract foreign fund flows
depends on a stronger currency, it is difficult to think of many emerging
economies which have undergone a significant level of structural reforms
without the benefits of either an undervalued currency or a devaluation to
bring liquidity into the corporate sector - the renminbi is no longer undervalued
in our view and is becoming increasingly vulnerable.
Deutsche Bank AG/London
Page 5
CONFIDENTIAL — PURSUANT TO FED. R. CRIM. P. 6(e)
DB-SDNY-0 107081
CONFIDENTIAL
SDNY_GM_00253265
EFTA01451000
--- SOURCE: IMAGES__0076__EFTA01451001.txt ---
METADATA_SOURCE: IMAGES0076
METADATA_FILENAME: EFTA01451001.pdf
----------------------------------------
II December 2013
GEM Equity Strategy Outlook 2014
.
.
-
.
.
.
-
.
Figure 6: Total return of selected emerging market equity indices since 1 May
2013, USD
lotte,', //
OICaTertalatrirdmiclowen011somber2013
SmodirDouliemainkbeembeepArenoto
• since May I
• May 1 to trough
3. Potential for lower oil prices; Will 2014 finally be the year when oil
prices, ex-WTI, finally break down through their narrow range to
reflect the deterioration in the supply/demand fundamentals which
has been apparent for some time? The bearish factors seem to be
mounting up, namely continuing upwards revisions of US supply, less
unfavourable geopolitical factors including the partial rehabilitation of
Iran, less disruption to non-OPEC supply and lower EM demand - on
the latter point, senior DB Asian energy analyst David Hurd points out
the marked decrease in purchasing power brought about by currency
depreciation for Brazil, India and Indonesia, who have collectively
accounted for around 25% of the increase in oil demand over recent
years.
[Figure 7: 2013 VeISUI; 2007 - EVINCI (x) and CROCI (%) for main EM markers
4.00
16%
■
x
.
.
9)
•10%
I
14%
300 .1
12%
11111
2%
2.00 1
•
i t.
• 8%
110
0.00 •
d sr
45,
/,
9 t e t t
• EViNCI (2007) • LHS • E WHO (2013) • LHS •CROCI (2007) - RHS •CROCI (2013)- RI-IS
Socectaaannokx.4
Page 8
Deutsche Bank AG/London
CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e)
DB-SDNY-0 107084
CONFIDENTIAL
SDNY_GM_00253268
EFTA01451001
--- SOURCE: IMAGES__0076__EFTA01451002.txt ---
METADATA_SOURCE: IMAGES0076
METADATA_FILENAME: EFTA01451002.pdf
----------------------------------------
December 2013
GEM Equity Strategy Outlook 2014
4. Low GEM valuations give some option value; The relatively low level
of valuations for some GEM markets and sectors, especially in terms
of replacement cost (Figure 7 - EV/NCI is a reasonable proxy for
replacement cost), mean that any positive turn in sentiment is likely to
produce sharp rallies, albeit in an overall absolute and relative context
that remains bearish.
Investors should take longterm structural positions and live with volatility. or
else take shorter term disciplined contrarian approach
We prefer to base our recommendations on longer term strategic
considerations rather than the more flow-based tactical calls, which are
generally made on a post hoc basis to generate turnover. For those funds who
feel the urge to pursue more active strategies however, we have continued to
advocate a contrarian approach, which would have worked since early 2009
due largely to the increasing influence of momentum-based investors who
focus on anticipated fund flows, which is an ultimately self-defeating strategy
for most participants. The contrarian approach has continued to work well over
2013, both for GEM overall and for most individual markets, including all of the
BRICs with the partial exception of Brazil. The pattern appears set to continue