The Curious Case Of Brazil And Turkey

I do not spend all that much time talking about economics, monetary policy, and the like, but I am making an exception to talk about an interesting “compare and contrast” situation in the emerging markets. Specifically, I find it very interesting to see the unusual monetary policy being pursued by Turkey vis a vis other large emerging economies like Brazil.

High Growth, Lower Rates

Turkey is currently enjoying some of the best growth in Europe, coming in at about 8% for 2010. In most cases, that sort of growth would have policymakers nervous about inflation and looking to hike rates to cool things off. After all, that's what's going on in countries like Poland, Hungary, China, and Brazil right now.

Turkey is handling things quite a bit differently though, and lowering rates. Last week, Turkey's central bank cut rates by 25bp (to 6.25%) after cutting them 50bp back in December. At the same time, the country is raising banks' reserve requirements.

The idea here, then, is to deter yield-shoppers and limit the inflow of speculative/investment capital. Unfortunately, world markets do not usually react well to the unorthodox or the unexpected, and Turkey's actions are both – Turkey's central bank has been pretty cagey and this last rate move took the market by surprise. Moreover, a lot of economists and commentators believe that Turkey will botch this delicate balancing act and that the tougher reserve requirements won't offset the stimulation of lower rates and that this will this ramp up credit growth and stoke inflation.

What might be helping embolden Turkey's officials is the fact that inflation is very low by Turkish standards – about 6.4% in December. On the flip side, the ballooning current account deficit is a real concern, standing as it does at over 7.5% for the last period I could find data. Given that higher rates do not always produce their desired consequences, it is a credible (if very unorthodox) approach for Turkey to try.

That said, this unorthodox policy is certainly not helping Turkey's financial sector and major banks like Garanti (Nasdaq: TKGBY), Akbank (Nasdaq: AKBTY), and Yapi. All of those stocks have taken a smacking lately, as has the stock of Turkcell (NYSE: TKC). If Turkey's central bank is ultimately proven right, this could be a great buying opportunity in one of my favorite markets. If this “low rate in the face of high growth” policy backfires, though, it could take years to sort out the damage.

Brazil Going The Conventional Route

While Turkey is trying something new, Brazil is sticking to the old pattern. Brazil recently bumped its interest rate up 50bp to 11.25%, due in no small part to concerns about inflation. While Turkey has had bouts of high inflation before, it doesn't have the same history of some truly rampant hyper-inflation periods like Brazil does. Consequently, it is hard for me to imagine Brazil's central bank ever being cavalier about the risks of inflation. Unlike Turkey, Brazil also has much less to worry about in terms of its current account balance and the impact of capital inflows.

Not surprisingly, though, this round of tightening hasn't been great news for Brazilian bank stocks like Itau (Nasdaq: ITAU) or Banco Bradesco (NYSE: BBD). On the other hand, it has made virtually no difference for major exporters like Embraer (NYSE: ERJ) and Vale (Nasdaq: VALE). And then you have the broader market ETFs like the iShares Brazil Index (NYSE: EWZ) and Market Vectors Brazil Small-Cap ETF (NYSE: BRF) – with a mix of exporters and more domestically-oriented stocks, these have traded lower, but not to the same extent as the financials.

It will be interesting to see how these two countries' policies play out. Clearly there are very different circumstances for each economy – Brazil is highly leveraged to China's development and appetite for raw materials, while Turkey is keenly exposed to Europe's health and demand for lower-cost manufactured imports. Nevertheless, Brazil runs the risk of choking off growth at time when it really needs to be using the windfall of commodity exports to develop a more balanced and sustainable economy. On the other hand, Turkey is not endangering its growth, but may well be risking its future stability.

The Bottom Line

I do not want to sound too cavalier about things, but on some level I dismiss monetary movements as “rates go up, rates go down … and the markets march on”. It's not wise to ignore a country's economic conditions or present fiscal/monetary policies, but you also cannot lose the forest for the trees. Should investors buy Brazilian financial stocks in the face of higher rates or Turkey financials in the face of market disapproval and uncertainty? Maybe not. By the same token, long-term value investors know that stocks often turn before the news changes and these stocks will probably stabilize and start rebounding ahead of any official “all clear” in interest rates.

More to the point, Turkey and Brazil are two places I really want to be for the long haul.

So, how cute should an investor be? After all, banks like Itau, Garanti, and Yapi are now trading at pretty attractive valuations. Sure, there is the risk that the stocks could go down another 10-20% with investor worries about monetary policies. But tell me when, exactly, there isn't *some* risk that could push down the price of an emerging market stock by a similar amount.

All things considered, I'd probably rather own exporters, but that's not always so easily done. The most liquid stocks (and those most likely to trade as ADRs) are usually domestic-focused companies like banks, utilities, and telecoms. It's a little easier with Brazil, with stocks like Embraer, Brazil Foods (Nasdaq: BRFS), and Vale, but there are fewer options with Turkey beyond ETFs, index funds, mutual funds, and a few stocks like Anadolu Efes.

The bottom line, then, is that I'd be looking to start buying. Maybe world markets are at a near-term top and maybe we're all due for a pullback. That's just part of the risk of investing. Given the turbulence and concerns over monetary policy, though, I'd probably take a multi-stage approach – looking to buy maybe one-third of my position in the next few weeks, another third a few weeks later, and the final third in a few months.

What should investors buy? I would take a very serious look at the three banks – Akbank, Garanti, and Yapi (the first two are reasonably liquid ADRs). I would also dig deeper and look into names like Anadolu, Tofas, Koc Holdings and so on. In fact, I hope to be back in a week or so with some additional Turkish names, hopefully with available ADRs. For Brazil, I'm talking my book, but I'd seriously consider Brazil Foods, as well perhaps as Cosan (NYSE: CZZ), Vale, Itau, Petrobras (NYSE: PBR), and Hypermarcas.

Disclosure: I own shares of Turkcell and Brazil Foods

2010 - A Year Of Banking Dangerously

From recovery in Asia to hot growth in Latin America to seemingly near-collapse in Europe, it is a yeoman's task to try to sum up the 2010 world of international banking in under 800 words. Perhaps, though, that is the summation; Asia came back, Latin America never left and Europe struggled to hang on through the latest crisis. Suffice it to say, it sets the table for an interesting 2011. 

Asia - Been There, Done That, Learned the Lesson
To some extent, it is probably fair to say that between Japan's property bubble-fueled bank bubble and collapse (and a 20-year zombie economy), Hong Kong's boom-bust real estate markets and Southeast Asia's debt-fueled over-expansion of past decades, Asian bankers had already seen this movie before. Consequently, while the decline of global trade during the Great Recession did no favors for these economies, the underlying models were in better shape and 2010 saw good rebounds in many markets. (For more, see 7 Ways To Position Yourself For Recovery.)

Publicly-traded Korean banks like KB Financial (NYSE:KB) and Woori (NYSE:WF) lagged the U.S. S&P 500 (Shinhan (NYSE:SHG) outperformed), but were still up for the year and did quite a bit better than American banks on the whole. Japanese banks like Mitsubishi UFJ (NYSE:MTU) and Mizuho (NYSE:MFG) were likewise "yeah, but" performers - yeah, they did better than most American banks, but still not all that well.

Elsewhere in Asia, there was substantially better performance. Indian wonder twins ICICI (NYSE:IBN) and HDFC (NYSE:HDB) were strong stocks this year, as was Australia & New Zealand Banking Group (Nasdaq: ANZBY.PK). While China's efforts to cool inflation impacted the likes of China Construction Bank, Industrial & Commercial Bank, and Bank of China, the share price performance still holds up relative to many regional U.S. banks.


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Want A Strong Bank? Think ICICI

After spending a lot of 2009 and 2010 rebounding from freak-out lows, American banks like Citigroup (NYSE:C) and Bank of America (NYSE:BAC) are choking and sputtering. Not only are investors wrapped up in the negative headlines about potentially huge mortgage documentation risks, but loan growth is stagnant and the U.S. is still over-banked.

On the flip-side, the picture for banks outside of the U.S. and Western Europe is quite a bit brighter. In India, strong credit growth and surprisingly strong credit quality is providing a healthy environment, and ICICI Bank (NYSE:IBN) is making hay while the sun shines.

The Quarter That Was
ICICI reported earnings for its fiscal second quarter that handily surpassed the analysts' targets. Bottom-line earnings rose 19% in the quarter, fueled by 8% growth in net interest income and a 40% drop in provisions. Growth was helped by margin expansion of 10 basis points, loan growth of 2%, and deposit growth of 13%, while a significant rise in expenses (10%) was a dampener. (For more, see The Bottom Line On Margins.)

Credit quality is getting better. As the 40% reduction in provisions might suggest, ICICI is feeling good about its balance sheet. Impaired loans were a bit more than 8% at the end of the quarter, continuing a multi-quarter sequential strength of improvement. As a percentage of loans, non-performing loans were 1.4% in the quarter on a net basis.

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A Little More on Unicredit

The more I look at this Unicredit situation, the less I like it.

It looks like the proximate cause of former CEO Profumo's departure (which very much reads like a "jump ... or we push" situation) was two Libyan entities taking a combined 7.4% stake in the bank. Nevermind the fact that Unicredit needed to raise capital and large stable investors are typically a good thing, apparently this rankled some on the board and caused problems.

Truth be told, I don't know exactly what the problem is. Libya is not exactly fully rehabilitated in the eyes of the West and its not as though European institutions are overjoyed to see Arab/African investors buying their assets. And maybe that's part of what lies underneath the controversy - Libya and Italy certainly have a "history" together, and it probably aggravates the hell out of some Italians to see Libya buying into Italian assets from a position of relative power. With rumors that certain Italian politicians were displeased with this arrangement and making that known to the board, who knows exactly what role this had.

Whatever the case may be, the fact still remains that Profumo guided Unicredit from being just another Italian bank to being a major player in Europe - the second-largest bank in Italy, the third-largest in Germany, and the largest in both Austria and CEE. Even granting that the stock performed better in the first half of his tenure than the second, Profumo should still be appreciated by long-term shareholders.

And now it's time to see where the bank goes from here. There is definitely some need for restructuring at Unicredit, and perhaps that was also part of the CEO's departure - whether he wanted to go slower than the board or faster. So if Unicredit is about to change itself in some pretty significant ways, maybe it is better to do so with new management at the helm.

The vacuum at the top is certainly a big risk factor, as nobody can really say what the near-term direction for the bank is going to be (at least not until the new CEO lays it out). Likewise, it is fair to wonder just how this board operates and what sort of "non-operating influences" get to be played out behind the closed doors of the boardroom.

Still ... this bank was a quality company before the crisis and even if Italy sometimes seems like a perpetual economic and political head-case, it seems likely to be a good candidate for a strong recovery. I have enough European banking exposure for now (though Santander (NYSE: STD, Danske, and a few Swedish banks are enticing...), and would rather add in places like South America (Itau), South Africa (Standard), and Asia (DBS Group), but Unicredit seems pretty dang cheap right now.  Assuming that the board isn't daft enough to screw up over a decade of progress, this could be a good opportunity to buy a dip and get a quality pan-European bank.

Bad Timing For UniCredit

This is not a good time for UniCredito to be seeing a change at the top, but word came out tonight that CEO Profumo quit. He had been in a pretty heated squabble with the board (obviously...), and it finally comes to a head with him leaving.

It's unfortunate - although UniCredit has clearly been badly hurt in the credit crunch, they are in vast company in that regard. And it should be remembered that during Profumo's tenure at the top, he did guide the company from a conglomeration of unspectacular Italian banks into a sizable pan-European bank with once-promising businesses in Central and Eastern Europe (that could still be worth quite a bit in the future).

Admittedly, I was wrong to be so keen on banks like Societe Generale, Danske Bank, and Unicredito going into the credit crisis; I would have been far better off with banks like Itau (Nasdaq: ITUB), DBS Group (Nasdaq: DBSDY) and Standard. Luckily, SocGen was the only one I actually bought, but still ... knowing your aim was off is not comforting even if you didn't pull the trigger.

I want to write more on this tomorrow ... but suffice it to say for now that this is another challenge for a bank that already has plenty of them.

Disclosure - I own shares of SocGen

Building A Portfolio Around Brazil's Building

The next six years are going to busy ones for Brazil. The World Cup is coming in 2014, with the Olympics following two years after. Suffice to say, like virtually every country that has hosted one of those events (let alone both in succession), Brazil has a great deal of infrastructure to build in the intervening years. Brazil is also a large country with a sizable population and a growing economy; all of which takes money to support in its own right.  


If You Build It, They Will ComeIn order to support the demands of these two major sporting events, Brazil is looking at wide-ranging projects including upgrading roads and power grids, building hotels, improving airports, and generally just adding "more" to country. Even granting that the sporting events will be concentrated in or near major cities, there will need to be infrastructure stretching into the hinterlands to bring in supplies. All told, the bill just for Rio's Olympics is looking like it will be at least $14 billion.  

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