How Sensitive in Growth in Emerging Markets to a US Slowdown

First seen on 'The Big Picture'

How Sensitive is Growth in Emerging Markets to a US Slowdown? - .PDF file (Deutsche Bank Global Economic Perspectives)

"...increasing exchange rate flexibility will tend to increase the sensitivity of EM economies to foreign developments. And financial market linkages, particularly co-movements across equity markets are becoming increasingly important.

Equity market capitalization relative to GDP in many EMs now rivals and in several cases exceeds that in industrial countries. Hence, the vulnerability of EMs to a US slowdown may be intensified via financial linkages, including both increasing flexibility of exchange rates (a possible appreciation of EM currencies against the dollar) and perhaps even more so via stock market linkages should the US market turn down significantly."

In other words if the US goes down, EM markets go down because of the transmission of shock through the stock exchange markets and forex markets.

hot blog alert: stockinsight.blogspot.com

I was googling for articles written up concerning PetroChina's 1trillion dollar market valuation (Can you say, "Bubble"?) when I came across this blog. Its pretty interesting.

The perspective is relatively free from financial jargon. Blogger was in China and wrote about his experiences in the Red Hot Economy of the Century. So you get an idea of the kind of consumer experience one can expect in that country.

Real Option Valuation Spreadsheet

URL: http://pages.stern.nyu.edu/~adamodar/

For all you MBAs, MScs, CFAs, finance undergrads/postgrads, whatever, I bring to you, the sourcebook, the panacea for all your valuation pains - Damodaran Online!

Checks its outs, yo, all your excel spreadsheets preconfigured with the formula so that all you've gotta do now is plug accounting numbers to relevant cells, do a bit of messing about with the numbers and voila! numbers for you to plug into that term report.

Damodaran is the man!

(Apologies for the slang; I don't quite know what came over me.)

Expectations Investing - (Sorta like Trading on Fundamentals, except with a fancier name)

URL - http://www.expectationsinvesting.com

Kinda excited about reading this book actually.

From the site:

1. A revolutionary yet common-sense investment approach that reads the market's current expectations and provides the tools to anticipate future expectations.
2. A clearly written book on expectations investing written by valuation experts Alfred Rappaport—author of Creating Shareholder Value—and Michael J. Mauboussin—Chief Investment Strategist at Legg Mason Capital Management-and published by Harvard Business School Press.
3. A web site that serves as a resource for those wishing to learn more about Expectations Investing—and how to apply its powerful analytical tools.

Alright, I'm sold.

Everything 'Subprime Crisis'

Got a term paper to write on an international financial crisis? Need a quick background on CDOs and the US Subprime Crisis but don't have time to read? Curious as to the spillover effects of a crisis in other markets?

Over the past 10 years or so, banks have been securitizing their debt obligations. What that means is that they've reduced their on-balance obligations and moved it off-balance sheet. These obligations are contingent liabilities. Basically, the banks lend only their reputations and names but the ultimate lender isn't them since they're just the middleman who brokered the deal. The bulk of all that risk is the person who bought that unit of securitized asset. The problem is that some banks have been writing cheques or using these debt assets as capital. In times of crisis, these kinds of securities are largely insolvent. To make things worse, we're not entirely sure who bought what and used what type of asset to back up those purchases.

In an earlier interview dated 31 July 2007, Satyajit Das replies to Stephen Long's comment:

STEPHEN LONG: The counter-argument is that that means that the risk is diversified, the risk has been spread so far and wide that the fallout won't be so bad.

SATYAJIT DAS: That ironically is what the central bankers have believed. It should be said that investment bankers and many pundits have been telling central banks that's the case. In fact, my view is exactly the opposite.

What has happened is that banks have essentially sold the risk out of one part of the bank to these investors, but there's other parts of the bank which have then used the securities which reference these underlying risks, and what they've done is lent money against that.

And the irony is the risk is now concentrated among very, very few banks, 'cause the people who do this, it's an activity called prime broking, are very, very few banks, less than ten.

Read the interview transcript.

URL: http://www.abc.net.au/worldtoday/content/2007/s1992847.htm

Also, Australian Broadcasting Corporation's 'Four Corners' program has good coverage as well as insight on this topic.

Watch the interview with Satyajit Das. Its a good exposure on an important finance topic about the transfer of risk exposure off the balance sheet - to be bought piece meal by investors who want exposure to this kind of risk.

URL: http://abc.net.au/4corners/content/2007/20070917_subprime/interviews.htm

Here's the teaser -

Video On Demand: "Mortgage Meltdown"

Last month an unfamiliar expression appeared in the Australia media. A "subprime mortgage crisis" was unfolding in the United States. Homeowners across America were defaulting on loan payments and economists warned of major financial fallout occurring anywhere from Paris to Beijing to Melbourne. But why should a foreclosure in Cleveland affect a hedge fund in Sydney?

As Four Corners reports, Australia, along with the rest of the world is at risk of a virulent economic virus thanks to financial globalisation where everything is interconnected through a sophisticated form of pass the parcel. And even more alarmingly, no-one knows just how bad it might get.

In "Mortgage Meltdown" Paul Barry reports on the fallout from the US subprime mortgage crisis and asks what impact it will have on Australia.

Calculating Cost of Equity for EM countries

Again from Adrian Buckley's Multinational Finance pp 481.

Cost of Equity = Comparable Domestic Return + Country Risk Premium

Country Risk Premium = Default Spread for EM Country X (Std Dev. for EM equity market/ Std Dev. for EM government bonds.)

Default Spread = EM government bonds yields - Comparable Domestic government bonds.

This is the spread between the emerging market government bond yields and a comparable domestic bond i.e. US Treasury Bond.

Cost of Equity for Emerging Markets

The following was sourced from Adrian Buckley's Multinational Finance, ch 24, pp 481 "International Investment: what discount rate?"

24.10 - Emerging Markets

[preceding this section was a discussion on the choice between an arbitrary extra risk premium when calculating discount rates for projects in EM countries and the International CAPM.]

Hooke(1998), for example, reckons that the cost of equity capital for emerging markets can be conceptualized as being equal to a comparable domestic return plus a foreign risk premium ranging between 5 percent and 15 percent.

Thus he recommends target returns for low-risk emerging markets, for example, Poland, the Czech Republic and Chile, at 18-20 per cent.

For medium-risk markets, such as Brazil, India, Indonesia and Mexico, Thailand and Turkey, he reports a recommended return of 20-25 per cent.

And for high risk countries, his cost of equity is between 25 and 30 per cent. Into this group, he categorizes China, Peru and Russia.

25 - 30 per cent Cost of Equity is a very large number to plug into your bog-standard Weighted Average Cost of Capital calculations. Unless you've got lots of debt in your capital structure, a 25 - 30% cost of equity, will discount your future cash flows by a lot. For investors, this means that Chinese and Russian stocks should trade at lower prices, given the risk they bear.