Impact of Political Risks on MENA Equity Markets

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Investing in the equity markets of Middle East and North Africa (MENA) involves high political risks since most of the countries are not democratic(with the exception of Israel) and are run by monarchies, dictators, etc.  As a result, economic growth is stagnant and social ills such as corruption, high unemployment, lack of transparency, nepotism, etc.others are the norm and not the exception. So investing in these markets involves higher risks than other frontier markets. Though many countries in the region have abundant natural resources such as oil and natural gas, equity markets are not mature and public participation in the markets are very low relative to developed countries.

From December, 2010 thru the end of 2012 the MENA region was rocked by the Arab Spring revolution. In country after country regimes fell amid widespread opposition from the general public against the status quo. For example, in Egypt the Western-backed longtime dictator Hosni Mubarak’s regime collapsed and was replaced by Egypt’s President Mohamed Morsi who himself is under fire from the public for his heavy-handed actions against protesters.

During the Arab Spring, Egypt, Lebanon, Tunisia and Morocco – the four biggest markets based on market capitalization in the region fell heavily. Egypt suffered the heaviest losses due to many months of uncertainty and violence as Mubarak tried in van to crush the revolution.  The Egyptian stock market was closed for eight weeks in early 2011 and the index by about 50%. The other markets in the region recovered from their lows but they remain very volatile. The following chart shows the performance of the performance of the four markets mentioned above:

Click to enlarge

Sample-MENA-Equity-Market-Returns
Source: Two years of Arab Spring: Where are we now? What’s next?, Deutsche Bank Research

However CASE3o, the benchmark index of the Cairo Stock Exchange, was the world’s third-best performing index in 2012 when it rose 50.8%. The dramatic plunge and the incredible rise of the Egyptian market underlines the risks and volatility involved in the MENA markets.

Most of the structural problems in the countries that experience the Arab Spring have not been resolved though regimes have been replaced. Hence further protests and anemic economic growth are likely to continue for years. From an investment standpoint, it is a wise idea to stay away from the equity markets of the region or invest only a very small portion of one’s portfolio via an ETF.

Related ETFs:

Market Vectors Gulf States (MES)
PowerShares MENA Frontier Countries ETF (PMNA)

Disclosure: No Positions

Three Auto Dealership Chain Stocks To Consider

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cAR-1899 JacksonThousands of auto dealers operate in the country but most of them are private companies run by local families for generations. However a few of them are large with hundreds of dealerships and are publicly-listed. In this post, let  us a take a quick at three of them.

Before we dive into the details, there are plenty of reasons to invest in auto dealership stocks some of which include this is a cyclical business and as the economy recovers consumers tend to switch cars, autos are primary mode of transport for the majority of the population, auto dealerships tend to make substantial profits not only from selling cars but also from lucrative commissions that banks  and other lenders pay them when buyers take out loans thru the dealership, high-end cars tend to have high margins, auto repair and services offered such as oil change, tire replacement and others also add to higher profits, etc.

Three of the large listed auto retailer stocks are:

1.Company: Group 1 Automotive Inc. (GPI)
Current Dividend Yield: 1.01%

2.Company: AutoNation Inc. (AN)
Current Dividend Yield: No Regular Dividends

3.Company: Penske Automotive Group, Inc. (PAG)
Current Dividend Yield: 1.84%

Note: Dividend yields noted are as of Feb 22, 2013

Of these three firms, AutoNation has the highest market cap at over $5.0 billion and is also the largest dealership chain. The company runs 258 franchises in 15 southern and western states and sells cars under three operating segments: Domestic, Import, and Premium Luxury.Its stores sell 32 brands of new cars. Last year the total revenue exceeded $15.0 billion.

Penske operates 171 franchises in the U.S. and internationally about the same number in UK, Ireland, Germany, Peurto Rico and and Italy.

Group 1 runs 131 franchises representing 31 brands of automobiles in the U.S. and has a few dealerships in the UK. Last week the company plans to acquire 18 new car dealerships in Brazil to expand its presence there. The seller is UAB Motors Participacoes SA of Sao Paulo. Group 1 will pay $47.4 million in cash, 1.45 million of its common shares and assume about $62 million of debt. This is an excellent deal at this time for Group 1 since autos sales are booming in Brazil due to the growing middle class and rising income levels. In fact, Brazil is now the fourth largest market for auto sales after the US, China and Japan.

From an investment perspective, all three auto retailers are good choices but Group 1 offers a better potential for growth due to the acquisition in Brazil.

Source: Car Dealer Hits the Road, Betting on Global Growth, The Wall Street Journal

Disclosure: No Positions

Is It Time To Invest In Russia?

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Many global investors avoid investing in Russian equities. Despite the country holding democratic elections and the legalization of private property rights since the fall of communism in 1991, Russia remains a pariah for most investors for good reason. Some of the factors that work against Russia include the widely-held beliefs that it violates human rights, jails opponents questioning the state, arbitrarily takes over private enterprises, suppresses the media, arbitrarily prosecutes company executes and throws in prison without due process, etc. The list of factors that one can document seem to be endless. Hence Russia is unable to attract high foreign investment in Russian equity markets like other emerging markets are able to.

Russia will host the 22nd Winter Olympics from February 7th to the 23rd of next year in the city of Sochi. By hosting this high-profile event, Russia hopes to present a positive image to the global investment community. Already investors are warming up to Russian stocks with the benchmark index up 5% YTD.

From a recent article titled Russia’s image problem in the US in FT beyondbrics blog:

Chris Osborne, Head of Sberbank CIB USA, would be the first to admit that Russia has an image problem among American investors.

“Selling Russia can be a challenge,” he told beyondbrics. “For people who are not already investors in Russia, the image of the country is very negative.”

Indeed, despite being the world’s ninth largest economy with a rising middle class that’s driving a boom in everything from car sales to malls to e-commerce and holidays in Spain, Russia hasn’t been getting much love from investors.

Last year Russian equity and fixed income funds attracted a combined $8.8bn of inflows according to EPFR, which tracks fund flows. While this is a leg up from 2011 – when Russia suffered an outflow of $2bn – the amount is still far less than the $12.9bn that investors pumped into Brazilian assets and the $16.5bn attracted by Chinese assets in 2012, according to EPFR.

Composition of Russia’s MICEX Index:


 Russian-Micex-Composition-Chart

 

Source: Russia’s image problem in the US, FT beyondbrics blog

As shown above, the Russian equity market is heavily dominated by the energy industry. This is not surprising since the country is blessed with all types of natural resources including crude oil and natural gas. As a result, the movement of Russian stocks is highly correlated to the price of oil.

Russia-Stock-Oil-Price-Correlation1

 

Source: Diversifying Russia, Harnessing regional diversity, European Bank for Reconstruction and Development

The Russian stock market appears to be dirt cheap as per an article in Canadian Business magazine. From the article:

For years, money has shunned the country, mostly because of uncertainty. There’s always a threat of nationalization, a sudden tax hike, arbitrary executive prosecutions and weird policies such as forbidding Americans from adopting Russian orphans.

Those fears, paradoxically, have made the country incredibly attractive from a value perspective. The Russian stock market is currently trading at around 5.5 times earnings, barely half the price-to-earnings ratio of other emerging markets. “It seems logical that a market trading that cheaply doesn’t have a lot of downside,” says Michael O’Flynn, the Massachusetts-based managing director and global head of business development for UFG Asset Management. A decade ago, Russia was trading at a 50% premium to its Brazil, one of its BRIC peers; today it trades at a 50% discount.

That discount could easily diminish. For starters, the events that most spooked investors are fading from memory. The state takeover of Yukos, a massively successful oil company, happened a decade ago. Former CEO Mikhail Khodorkovsky may be out of prison by Olympic time.

Russia’s middle class is growing too—and the country’s GDP per capita is about US$18,000, much higher than that of other emerging markets. There’s also been talk of privatizing government assets, which “foreign investors should be applauding,” Elena Shaftan, manager of the Jupiter Emerging European Opportunities Fund, wrote in a recent report.

Russian-Market-chart

 

Source: The Russian bear turns bullish, Canadian Business

Investors looking to add exposure to Russia can consider adding stocks in the consumer and manufacturing sector due to the rising middle class and growing consumption. The energy sector is highly volatile and can be avoided. However Chris Osborne, Head of Sberbank CIB USA quoted in the FT beyondbrics article that not many companies in the consumer and industrial sector are listed and hence investing in those sectors is a challenge.

The best way to invest in Russian equities is via the Market Vectors Russia ETF (RSX). This fund has about 42% of the assets in the energy sector.However investors can access the consumer staples, consumer discretionary industrials and other sectors with this ETF. The two consumer sectors and the industrials account for about 7% and 1.3% respectively  The asset base of the fund is $1.6 billion which is low relative to the assets held by other emerging market country-specific ETFs such as iShares’ Brazil ETF (EWZ) with assets of over $9.0 billion.

Investors who prefer to buy individual Russian stocks in any sector can consider the following five companies. These firms trade on the OTC market and were the largest traded depository receipts in 2012 according to a report by BNY Mellon:

1.Company: Gazprom (OGZPY)
Current Dividend Yield: 6.28%
Sector: Natural Gas Producers

2.Company: Lukoil (LUKOY)
Current Dividend Yield: 5.60%
Sector: Oil & Gas – Integrated

3.Company: Rosneft(OJSCY)
Current Dividend Yield: No regular dividends paid
Sector: Oil & Gas – Integrated

4.Company: Norilsk Nickel(NILSY)
Current Dividend Yield: 6.84%
Sector: Metal Mining

5.Company: Sberbank(SBRCY)
Current Dividend Yield: 1.78%
Sector: Banking

Note: Dividend yields noted are as of Feb 22, 2013

Disclosure: No Positions

Comparing U.S. Tax Revenues To Other G-7 Countries

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For the Fiscal Year 2012, the total U.S. Federal Spending was about $3.8 Trillion and the Tax Revenue was about $2.5 Trillion resulting in a deficit of about $1.3 Trillion. For many years now, the U.S. has been running deficits as revenues were lower than expenditures. In fact, expenditures have been soaring due to rising medicare costs and other programs but revenues have barely moved up in pace.

From January 1, 2013 thirteen tax increases went into effect as part of the deal struck between the Obama administration and Congress according to The Heritage Foundation. These include the social security tax component of payroll taxes rising to 6.2% from 4.2% for all Americans, top marginal tax rate jumping to 39.6% from 35.0%, taxes on capital gains and dividends rising from 15 to 20% for taxable incomes over $450,000 for joint filers,  a 3.8% surcharge on investment income for taxpayers with taxable income of over $250,000 for married filers, etc.

Though all these tax increases seem high and thousands of hours were wasted by politicians debating the issues as part of the Fiscal Cliff negotiations late last year, they are actually lower compared to taxes paid by citizens of other G-7 countries.

The following chart shows the U.S. government taxes by revenue source as a measure of GDP in 2010 relative to other G-7 countries:

Click to enlarge

US-Tax-Revenues-vs-G-7-Countries

Source: US in Debtors’ Prison: A Life Sentence? by Emanuella Enenajor and Andrew Grantham, Economic Insights, January 29, 2013, CIBC World Markets

The total U.S. tax revenue was at at least 10% lower than the average of other G-7 countries. Except corporate taxes, the U.S. collected lower taxes in the other sources noted above compared to other G-7 countries.

According to the CIBC research report, Japan plans to implement a new sales tax in the years ahead to increase tax revenues. However in the U.S. sales taxes on goods and services are controlled and collected by the individual states and no national sales tax such as Value Added Tax(VAT) exists in the country. In  fact, the U.S. is the only developed country which does not have a national-level sales tax. As a result of this archaic tax system, each state behaves like a separate country constantly manipulating the tax rates mostly to finance all types of local boondoggles such as tax subsidies for casinos, stadiums, construction of parking garages, park renovations, etc.

Equity Investing for the Very Long Term Will Yield Spectacular Returns

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I wrote an article last week discussing about the strategy of investing in stocks during a crisis for great returns. This post is a follow up to that article but takes on the benefits of investing in equities for the very long-term. Very long-term can be defined as   a time period measured in decades.

From Reasons to Avoid Buying Stocks, and Why You Should Ignore Them in The New York Times:

THERE are always reasons not to buy stocks. Investors may think the Dow Jones industrial average is too high, as was the case in 1954 when the index topped 360. In 1941, there was Pearl Harbor. In 1962, the Cuban missile crisis. In 1997, the Asian financial crisis.

The list, adding up to 78 for each of the years from 1934 to 2012, was compiled by Bel Air Investment Advisors.

But the punch line to this list was that stocks went up by an annual compounded rate of 10.59 percent over those 78 years, with occasional plateaus, and that $1 million invested in 1934 was worth $2.4 billion in 2012.

Click to Enlarge

Growth-of-1-Million-in-Stocks-from-1934-to-2011

78-Years-of-Equity-Crises

Source: Reasons to Avoid Buying Stocks, and Why You Should Ignore Them, The New York Times

Data Source: Bel Air Investment advisors

The return calculated in this study based on the S&P 500 is indeed astonishing. Similar studies in the past have shown great returns as well. Here is one chart from the fourth edition of famous book Stocks for the Long Run by Professor Jeremy Siegel of The Wharton School.

Stocks-vs-Bond-Very-Long-Term

A $1 invested in 1801 would have been worth $12.7 million according to his analysis.  So investing in equities for the very long-term will yield spectacular returns.

However for most investors this strategy will not work for many reasons. For example, most investors do not hold stocks for many decades. Since very few of us live past the age 100, the idea of investing for centuries is ruled out. Despite these flaws, reviews of the benefits of long-term investing are interesting to follow. While investing for the very long-term is not feasible for most investors, it is a wise idea to hold equity investments for at least five years. One way to do this would be to build a diversified portfolio of  dividend-paying well-established companies and reinvesting dividends and other earnings to take advantage of compounding.

Related ETFs:

iShares MSCI Emerging Markets Index (EEM) 
Vanguard Emerging Markets ETF (VWO)
SPDR S&P 500 ETF (SPY)
SPDR STOXX Europe 50 ETF (FEU)
SPDR DJ Euro STOXX 50 ETF (FEZ)

Disclosure: No Positions