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Loans And Write-Downs And Shares… Oh My!

My family and I recently went to see the musical Wicked . Having already been with my wife when it first opened in 2003, I was thrilled to relive the awesome and spine-tingling performance with my kids. The creative genius of Wicked is its backstory – the plot that no one hears throughout the Wonderful Wizard of Oz . Turns out, the wizard isn’t really all that wonderful, and the witch isn’t so wicked after all. This got me thinking about parallels to the world of finance and how things aren’t always as they seem. We all know that the S&P/TSX Composite Index is heavily skewed toward the financials (37%), energy (20%) and materials (12%) sectors, but attitudes towards these industries have become rather split lately. In the past few years, financials have been all aglow thanks to consistently improving quarterly results, whereas the resource sectors have been a source of pain amid lower earnings, dividend cuts and write-downs. While faith in the financial sector may be justified, investors might not realize just how dependent the Canadian stock market has become on its earnings and dividends. According to data compiled by Bloomberg, while financials make up more than a third of the market cap, the sector accounts for more than 50% of the earnings and slightly less than half of the dividends paid on the S&P/TSX Composite Index. Click to enlarge Something wicked this way comes? Outsized dependencies are rarely a good thing in investment portfolios. For example, in the late 1990’s investors became overly dependent on technology companies trading at ever higher multiples, and then found themselves in a post-financial-crisis love affair with emerging markets. In both of these cases, investors paid too little attention to the backstory: technology had become more than a third of the S&P 500 and paid no earnings, and emerging markets had become reliant on leverage and an ever-expanding China. Investors also became overly dependent on U.S. financials a decade ago when the sector contributed more than 50% of the S&P 500’s earnings and dividends in 2006 only to fall off a cliff when the financial crisis hit two years later. The financial sector also grew to almost a quarter of the listed market in 2006, well above today’s level of 17% (still high but just not as high). Does this mean Canadian financials are due for some sort of rude awakening? Not necessarily. It depends on whether Canadian banks will report more bad loans and will have to incur larger write-downs than are currently reflected in loan loss provisioning or the share price. Intuitively, the nearly 70% decline in oil prices over the past two years and the broadening difficulties in the Canadian energy patch would imply a greater risk of loan defaults. Moreover, banks could see declining revenue growth and weaker revenues as the indirect consequences of low oil prices work through the extensive supply chain. But for now, these worries are the backstory. Canadian share prices are following the lead story: The banks’ exposures are manageable, the banks are prepared, and they continue to stress-test their loan book. Importantly, investors should know what their exposures are. Right now, investors in Canadian stocks are highly dependent on earnings and dividends from the big banks. If Canadian financials were to dip, investors could be in for a rude awakening. With any luck, the energy and materials stocks won’t seem as wicked if the rise in commodity prices in recent weeks supports upward earnings revisions in the next few quarters. The best outcome for reducing dependency on the financials is growing earnings from other sectors, not falling earnings from the banks. What can Canadian investors do to help reduce dependencies and limit outsized domestic exposures to the financial, energy and materials sectors? I would recommend considering allocations to two sectors that are underrepresented in the Canadian equity markets, such as global healthcare and technology, where there has been better dividend growth and stronger secular growth trends. Source: Bloomberg. This post originally appeared on the BlackRock Blog

NGE: Invest In Nigeria’s Economic Revival

I am going to be a bit provocative and suggest that low oil prices is good for the world especially for the oil producers. When we look across the board at the largest global oil producers from Russia to Saudi Arabia, Iran, Venezuela, Nigeria and Brazil. It becomes clear that abundant oil or high oil prices is neither a blessing nor a benefit to the populace of these nations. These nations have been characterised by mismanagement and corrupt usage of funds and it is only now that we have had an extended season of low oil prices that we are now hearing and seeing serious structural, economic and constitutional reforms to wean these nations from almost complete reliance on oil revenues. Nigeria’s Reforms Out of all these nations, the one that excites me the most is Nigeria for a number of reasons. Firstly, nations like Saudi Arabia, Russia and the South Americans have a number of regional and internal political challenges that I believe will act as a drag on their ability to take decisive measures to reorient their economy. On the other hand, despite the matter of Boko Haram, Nigeria is as a whole politically stable and united under one democratically elected leader and administration. This is important because the oil markets are extremely volatile and wild moves there can wreak havoc on a nation’s balance sheet within a short time and the ability to make fast and decisive decisions are very critical to success in the endeavour to shield and wean a nation from dependence on oil or commodities revenues. This is what the Nigerian President Mr. Buhari has begun to do with the banning of large amounts of imports and restriction of the use of dollars in Nigeria thus making it increasingly expensive to do dollar transactions abroad. While these actions in the short term has caused significant disruptions and distortions like the extortionate prices that dollars is currently being sold on the black market, in the medium and long term, many will agree that these actions are the best for the economy. These actions will benefit the economy for three reasons, it will discourage the importation of substandard and dangerous products that are endangering the health and safety of the local population, it will help to stimulate local production which over time will be instrumental for the diversification of the local economy. Finally, it will help to counteract and counter balance the low prices of oil because as oil is traded in dollars, the fall in oil prices means less dollars to import products and also as the level of imports falls and local production increases, it softens the blow of low oil prices. All of these actions will have the combined effect of increasing the price of the naira itself, stabilize the CBN’s dollar reserve accounts, reduce inflation over time and also interest rates can then be reduced to manageable rates. Further, the net effects of this will also make local naira denominated bonds more attractive over the medium to long term. Secondly, they are very much focused on the matter of corruption and have taken several measures to streamline government accounts and increase transparency into how governmental funds are used. As far as I am aware, these are unprecedented steps even for developed economies. Despite this, the administration has come under significant pressure to change their focus back to Nigeria’s other economic challenges without understanding that by simply curtailing and cutting out corruption, the Nigerian economy will begin to experience more stability and success. Local Equity Markets Growth In light of all of the foregoing, in going back to my original thesis, what really excites me about all of these measures is the effect it will have on the local equity markets. Click to enlarge The chart above compares the Brent Crude Benchmark with the Nigerian Stock Market Index and it is self-evident that the correlation between the price of crude oil and the returns from the NSE were much linked. I am gradually coming around to the realization that oil prices will remain depressed for at least another year for various reasons. Firstly, it is clear that the depressed price of global crude oil is a supply problem and not a demand problem especially in the short and medium term. We know this because crude oil demand increased by 1.5 to 1.8 million barrels per day which is a 5 years high yet the price remained depressed. No one can really price or adequately measure when oil prices will increase or supply will reduce based on two factors, one factor is the ongoing saga of shale oil production in North America where it seems that industry consolidation is taking place. It will take about a year for the dust to settle and only then can we know with any certainty where short and medium term prices will be heading. The second major factor is Iran. They continue to be unpredictable and the market is correctly pricing in significant outputs of crude oil from Iran into the price per barrel. What this means is that things will get worse than better but this will be a positive for a nation like Nigeria particularly considering its current reform trajectory. It is my belief that over the next 12 months, we will see a gradual delinking in the chart above whereby oil prices continue to fall perhaps to 20-25 but at the same time, the NSE begins to gain ground as the constituent companies begin to do better under new economic conditions. This is true because if one looks at the listed companies of the NSE, it becomes clear that most of these companies are well placed to do well as this drive to increase local production, consumption and demand consolidates. The chart above is indicative of this divergence within the markets and we can see Dangote Cement, Flour Mills of Nigeria and Oando which is a leading indigenous oil company. As one can see that while they were all nearly at the same place in May 2015, Oando continues to weaken while the other two are gradually strengthening. These two represent construction, agriculture and food production, three sectors that we should see significant growth within the next 12 months as the national policies begin to take root. This final chart is the Global X Nigeria Index ETF NGE which invests at least 80% of its total assets in the securities of the Underlying Index which is designed to reflect broad based equity market performance in Nigeria. This is an ETF that has hit the bottom and has significant upside potential over the next 12 months. Here we can also see that the growth is tentative but increasingly established. This trend of divergence is one that we are seeing across the board whereby as commodities markets weaken, stock prices appreciate especially when the local economy is supported by government policies. To highlight this point, I have added two South American favorites of mine. In the first one, I compared the Brazilian stock market index to the crude oil prices and in the second, I compared the Argentinean stock market to the feeder cattle prices. Click to enlarge Click to enlarge In conclusion, it is my belief that rather than being a negative, low commodities prices can be a stimulant to help commodities dependent nations diversify their economy and thus creating profitable investment opportunities for investors in local production, manufacturing and services companies. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The BRICs To Consider Now

Once considered the darlings of the emerging market world, the BRICs have faced economic and political challenges lately. However, certain BRICs still offer opportunities for investors. BlackRock’s Terry Simpson explains. artpixelgraphy_studio / Shutterstock Many BlackRock fund managers have raised their emerging market (EM) allocations lately, and we’ve warmed up in general to the asset class after a long underweight . EM valuations overall, as measured by the MSCI Emerging Markets Index, look cheap, and we see value for long-term investors. A Fed on hold and a weaker dollar are good news for the asset class (see the chart below), and there are signs of progress on structural reforms in certain EM countries. Click to enlarge Which BRIC country do you like best? Join in. You may be wondering, however, what we think of the so-called BRIC countries in particular – otherwise known as Brazil, Russia, India, and China – especially given the recent political scandal and slowing growth headlines surrounding some of these countries. Despite the economic and political challenges facing these one-time darlings of the EM world, we still see long-term opportunities within the BRIC universe. We like Brazil The words impeachment, corruption, bribery, and recession are all too synonymous with Brazil these days. And perhaps with justification, Brazilian gross domestic product (( GDP )), on the decline since 2010, finally entered negative territory in 2015 at -3.0 percent. Economists expect to again see negative economic activity in Brazil this year, with growth at -3.4 percent, according to Bloomberg data. Local inflation remains high, forcing the Brazilian central bank to leave its policy rate unchanged since July 2015. With so much bad news emanating from Brazil, one might ask what’s there to like about this BRIC? We believe Brazil offers value, as there’s potential for a significant turnaround story. Much of the bad news about Brazil appears already priced into the market. Brazilian equities, as measured by the MSCI Brazil Index, are 20 percent cheaper than their 2014 highs on a price to book basis. This means we could see Brazilian stocks move higher if confidence in the market is restored. We think sentiment toward Brazil has just begun to turn, as many long-term investors remain on the sidelines. In addition, lower real wages and declining labor costs are making the country more attractive for foreign business when measured against regional Latin American peers. However, an investor confidence recovery ultimately will rest on whether we’ll see real political change and reforms. We’re neutral toward Russia Undoubtedly, Russia is the BRIC member with the most to gain from recovering oil prices. Russia reaped the benefits of the oil price boom starting in the early 2000s, averaging 7.1 percent GDP for the six years ending in 2008. Last year, oil revenue accounted for 45 percent of Russian government revenue, according to an analysis of data accessible via Bloomberg. But Russia’s economy has suffered more recently, following declining oil prices and economic sanctions imposed by the U.S. and Eurozone. The country entered a recession in 2015 and is expected to produce negative growth again in 2016, based on consensus forecasts available via Bloomberg. A flexible currency has allowed Russia to quickly adjust to economic difficulties, and Russian markets are receiving inflows following rebounding oil prices. However, we need to see sustained economic momentum and a more sustainable long-term economic growth model not so dependent on oil. Thus, in the context of an EM portfolio, we advocate remaining neutral this BRIC. We favor India India is a bright spot within the BRICs and stands out in a world where economic growth is sparse. In 2014 and 2015, the country expanded at 6.9 percent and 7.3 percent, respectively. According to the IMF, India’s 2016 GDP is forecasted to grow at 7.5 percent. Yet even with this rosy economic picture, India’s market performance has waned since reaching a post-crisis peak in January 2015, weighed down by a rising U.S. dollar and slow progress on fiscal reforms. Looking forward, we are encouraged that the Indian government has committed to keeping the fiscal deficit in check. Furthermore, the government is expected to spend 0.3 percent of GDP on public infrastructure that should support growth. As such, we’re likely to see fiscal and monetary policy makers working in unison to spur growth. This, combined with a reasonable valuation for the S&P BSE Sensex Index, bodes well for Indian stocks into 2017. We like China Sentiment toward China began deteriorating in August of 2015, with the domestic stock market crash and less transparent currency management . Long-term issues remain, and the country’s reforms have slowed due to cyclical pressures. However, the reforms that have been implemented are ones that are supportive to growth. In addition, the Fed’s delay has eased pressure on China, and we’re encouraged by the slowing of capital outflows from the country. Finally, Chinese stocks (measured by the Shanghai Stock Exchange Composite Index) have trailed their Brazilian counterparts (measured by the Ibovespa Index) and moved in lock step with Russian equities (represented by the MICEX Index) since late January, based on Bloomberg data, and their low valuations are poised to potentially rise in a risk-on environment. Looking forward, we could see Chinese multiples increase as investors regain confidence in the country’s outlook. Within China, we prefer the offshore market vs. the domestic market, as well as domestic sectors and companies that could benefit from expected Chinese structural reform. The main takeaway from all of this: Investors should be cognizant that EM is no longer a homogenous asset class, and each market faces its own challenges. Even within the BRICs, there is growing heterogeneity across countries. This post , originally appeared on the BlackRock Blog