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Monday, October 09, 2006

Emerging Market & Commodities Effect and Global Opportunities In Canada & Vietnam

By Yaser Anwar, CSC of Equity Investment Ideas

The Emerging Markets & Commodities Effect

The overflow activity has not been unique to emerging markets funds. Commodity and energy funds have taken in an estimated $100 billion+ of investor money in the past couple of years.
This had generated speculative activity, some of which has recently been unwound, taking a couple of hedge funds down in the fray. Ex: Amaranth, MotherRock & huge losses at Vega & Fidelity funds.
Money flows into natural resource funds have climbed from almost nothing to roughly $3.0 billion, on a monthly basis, in early 2006. Not surprisingly, some metals prices have seen extraordinary moves.

Any trouble in the commodity markets could translate into problems for emerging markets and small & mid-caps. WSJ recently had an article on HFs taking positions in resource rich Afrian countries.
Investors should note that: there is a close relationship between emerging markets and commodity prices, and there is an even closer relationship between emerging markets and the Russell 2000.

Thus, a commodity boom’s correction is undeniably important for global investors. The correction effects can be felt in the weakening CAD/USD & AUD/USD currency values as well as stock markets, both of which are rich in commodities.
Thanks to my internship (Analyst, Oil & Gas at JPM) this summer, my valuation work tempts me to buy the Equipment & Service names, given their solid business trends and an earnings outlook due to current signed contracts. Other than E&S names, I particularly like Valero, the largest refinery. I've established some positions but don't want to fight the on going downtrend in the commodity section.

Investors need to understand that markets often discount peak earnings in advance & that cheap multiples in cyclical stocks are not necessarily a buy signal.

Prelude to a correction or another leg up?

Now that the Dow has topped the heights of January 00, investors are once again gaining confidence in stocks. Due to the 'wall-of worry' market status, there is a huge amount of cash on the sidelines and a boost in investor sentiment could fuel stocks higher (see image below). Not to forget the ever building short-interest, which remains at 5 year highs.

With the 3rd Q earnings season, I'm worried that a if a few major names disappoint, investors appetite for stocks would cease to exist & we could see a drastic drop in the Dow.
The recent outflow from US based mutual funds of about $650 million in the week ending October 4th didn't help either, reversing a $1.09 billion inflow during the prior week, TrimTabs Investment Research estimated on October 5th. Other than the AAII investor optimism being close to May highs, as indicated in image above, recently the UBS Gallup Index also surged to new highs. So much optimism has me worried.
Global Opportunities- For this week, I'm taking readers to Canada & Vietnam.

Canada: With dividend-rich sectors like utilities, financials and telecoms comprising 37% of market cap vs 29% of the S&P 500, the TSX stands to benefit even more than its US counterpart from falling long-term yields.
Investors should take a look at financials in TSX, which are also positively levered to falling bond yields.

Vietnam: As the government becomes more business friendly, Vietnam is fast becoming the new powerhouse of Southeast Asia. What I like about Vietnam is- A cut in trade barriers, and agricultural reforms have transformed Vietnam from a centrally planned to a more market-based economy and a continuation of successful economic reforms, favorable demographics, and a huge labor surplus in the countryside.

All of the above could enable Vietnam to maintain 8% growth annually over the next five years and the market capitalization of the fledgling Ho Chi Minh City stock exchange has risen ninefold from a year ago as the economy is on a roll.

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