Three Reasons To Underweight South Africa (ILF, EZA, SZR, AFK, GAF)

Russ Koesterich:  In my opinion, investors should consider minimizing their exposure to emerging markets in Europe, the Middle East and Africa, otherwise known as EMEA.

The big reason: emerging markets in EMEA generally have close economic ties to the euro zone, which as we all know is going through a rough spot and is likely to experience at least a mild recession this year.

Drilling down to the stocks of specific emerging market countries within EMEA, I’m particularly focused on South Africa as it’s the largest country in the MSCI Emerging Markets EMEA index. In fact, while I’m not making an official call on emerging EMEA overall, I’m now initiating an underweight view of South African stocks for three reasons.

Relatively Expensive: First, as the chart below shows, South African equities are relatively expensive compared to other emerging markets. They are currently trading at 2.5x book value vs. an emerging market average of 2.2x.

Click here for definitions: Price to Book and Credit Default Swap

Relatively Risky: Second, as the chart above also shows, while credit default swap spreads for South Africa are down since late last fall, they are still above those of all Latin American and Asian emerging market countries, making South Africa a riskier trade. This is partly because South Africa, along with the rest of EMEA, is more exposed to the continuing economic drag from the euro zone than other parts of the emerging market world.

Economic Conditions: Finally, certain economic conditions in South Africa aren’t all that great. South African inflation is a bit high and up from six months ago at 6.1%. In addition, the country has a persistent current account deficit and a very high unemployment rate.

To be sure, South African stocks do have some things going for them and a lot of smaller EMEA countries look worse. South Africa’s growth prospects actually seem pretty robust with the IMF predicting 2012 real GDP growth for the country of 3.6%. South   Africa also has relatively high corporate sector profitability.

Still, in my opinion, the negatives outweigh the positives and I believe there are better emerging market plays out there than South Africa such as countries in Latin America [potential iShares solution: iShares S&P Latin American 40 Index Fund (NYSEArca:ILF)].

Source: Bloomberg, Worldscope

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.  Securities focusing on a single country may be subject to higher volatility.

Written By Russ Koesterich From The iShares Blog 

Russ  Koesterich, CFA, is the iShares Global Chief Investment  Strategist as  well as the Global Head of Investment Strategy for  BlackRock Scientific  Active Equities. Russ initially joined the firm  (originally Barclays  Global Investors) in 2005 as a Senior Portfolio  Manager in the US  Market Neutral Group. Prior to joining BGI, Russ  managed several  research groups focused on quantitative and top down  strategy. Russ  began his career at Instinet in New York, where he  occupied several  positions in research, including Director of Investment  Strategy for  both US and European research. In addition, Russ served as  Chief North  American Strategist for State Street Bank in Boston.

Russ holds a JD from Boston College Law School, an MBA from Columbia  Business School, and is a holder of the CFA designation. He is also a  frequent  contributor to the Wall Street Journal, New York Times,  Associated  Press, as well as CNBC and Bloomberg Television. In 2008,  Russ published  “The ETF Strategist”(Portfolio Books) focusing on using exchange traded funds to manage risk and return within a portfolio.

Leave a Reply

Your email address will not be published. Required fields are marked *