Emerging markets

In his recently released Equity Comments for Q2, Sturm notes that emerging markets are leading the global recovery. Usually, the U.S. leads the way but its financial system took a serious knock; banking systems in the emerging world, on the other hand, got their shock a decade ago “and their subsequent conservatism has proved useful during this crisis.”

The growth potential of the emerging countries “remains the thematic opportunity for investors, yet global investors so far have only repurchased 20% of what they sold out of emerging markets in the downturn.” In particular, Sturm thinks consumer stocks in the emerging world can grow faster than consumer stocks in developed countries over the next ten years based just on population dynamics. One could also add that U.S. consumers are still highly indebted whereas emerging market consumers are less so.

Stimulus vs. deflation

He observes that central banks so far have been successful at stabilizing financial markets and stemming the deflation spiral. And given the usual policy and implementation lags, there is more stimulation working its way through the financial system into the real economy. As a result, Sturm’s analysis suggests continued improvement in corporate earnings into 2010, which will support higher share prices. 

Yet, in Q3, the tension between stimulative policies and debt-deflation pressures could stalemate markets. The economy is working through a number bankruptcy restructurings, employment trends are still dismal, shaken consumers will be more inclined to build up savings than spend, and the financing needs of the U.S. government could ratchet up interest rates to concerning levels.

Still, any market corrections, Sturm feels, will be buying opportunities. For one thing, near record-levels of cash are on the sidelines. A lot of it is just waiting for a dip to get back into the market now that market psychology has been uplifted by the rally since the March lows.

Weak U.S. dollar and commodity prices

China has been an “opportunistic buyer of resources, becoming more aggressive in its efforts to spend dollars (on commodities).” Sturm thinks diversifying out of the U.S. dollar makes sense for investors too. And a weak U.S. dollar should “be supportive of resource prices before more robust demand resumes.” He singles out precious metals in this context as a commodity group good to have exposure to.

Natural gas prices

The “ugly, low pricing” for natural gas this summer presents an opportunity to raise exposure to gas producers. Supply has ballooned as a result of past investments and new horizontal technology, but “a more than 50% cut in active drilling rigs will translate into lower supplies next year with a commensurate improvement in prices.”

But it won’t be bad news across the board for emerging countries. “The emerging market universe will split into the haves and have not’s,” claims Bushell, with the dividing line being current account positions. Those countries with good surpluses and foreign-currency reserves, like China, will continue to enjoy access to access to capital while those with deficits, such as India, Indonesia, Vietnam and Eastern Europe, will face more difficult adjustments.

Bushell thinks the impending global growth scare will “quell the inflationary storm.” But if governments in emerging countries find inflation fighting unpalatable, growth may maintain momentum longer “and deliver a boomerang back to the U.S.” in the form of greater inflationary pressures. The implication from Bushnell’s commentary in Perspective Online would seem to be that the world could face an unpleasant choice between hyperinflation and a 1982-1983 style deep recession to bring inflation under control.

So while Canadian banks may seize opportunities in the U.S. market, there is also a risk they could be blindsided by a cooling off of the insatiable demand for metals, minerals, and foodstuffs. Whether or not the commodity boom goes into remission depends upon the extent of the economic downturn now said to be in progress. If it’s severe and spreads to emerging countries, then Canadian bank stocks will find it tough going regardless of the potential for making inroads into the U.S.