GLOBAL EMERGING MARKETS QUARTERLY
Brazil: a consumer, not commodity
driven economy
Pictet Asset Management
July 2010
The vibrancy of emerging market growth owes much to the
confluence of financial market reform and demographic factors.The
emergence of aspirant middle class consumers, as an expected 3 billion
people move out of poverty over the next two decades, is fuelling
demand for a huge range of goods and services across emerging
markets. China and India remain key elements of this story, but
within the LATAM region, Brazil’s growing consumer power stands
out as a significant factor behind the country’s dynamic growth.
Brazil’s domestic consumption set to boom
The population of Brazil is approaching some 200 million people
and, according to Goldman Sachs estimates, an additional 10
per cent of the populace have moved into the middle-class income
cohort over the last five years. This group (officially starting at a
household income level of around USD7,500 p.a.) now accounts
for close to 52 per cent of the nation as a whole. Although often
perceived as being a predominantly export oriented economy,
direct commodity exports account for only 8 per cent of Brazil’s
GDP. Of increasingly greater significance, and in common with
many other emerging countries, is the role of the consumer in
driving demand for goods and services. As the consumer sector
expands, it accounts for a greater proportion of labour demand
and therefore of income growth, contributing to self-sustaining
economic development. In much of the emerging world, credit
penetration is still in its early stages and consequently, household
credit levels are low compared to developed markets. With banks
in a generally strong position to facilitate credit expansion, debt
is increasingly being used to promote the consumption of larger
ticket items, including housing and autos within emerging markets.
Moreover, there remains substantial capacity to fund credit-based
consumption; interest rates still relatively low and growth is strong.
The country’s middle class is expanding rapidly, leading
to a change in consumption patterns
The rapid expansion of Brazil’s middle class is perhaps something
of a surprise given its history of a sharply skewed distribution of
income. The narrowing of income differentials has been helped
by the Lula administration significantly increasing the minimum
wage. His government is also credited with turning the Bolsa
Familia, a programme which provides financial assistance for the
poorest section of Brazil’s population, into one of the world’s
largest cash-transfer systems.  Pictet Asset Management portfolios remain overweight in Brazil
The wider availability of credit, along with longer duration
loans (implying lower monthly repayment requirements) and
tax cuts in response to the global downturn, have both spurred
and sustained consumer demand. Better financial management
has been reflected in the strength of the real, which has appreciated
by nearly 10 per cent against the USD over the last twelve months.
This has helped lower the costs of imported goods and effectively
raised real disposable incomes. According to a recent study
1 | GEM QUARTERLY | Q2 | JULY 2010
conducted by the Brazilian Institute of Geography & Statistics
(IBGE), the average income of Brazilian households expanded
by 10.3 per cent in real terms in the five years to 2009. However,
taking account of the decline in the average family size that has
occurred over the period, average income per head has increased
at twice this rate. The survey also provides a breakdown of how
rising income is being reflected in changing consumption patterns.
Food consumption as a share of total income has declined over
the 5 years since the previous survey was completed. Typically
during such periods, expenditures on branded foodstuffs rise at
the expense of more generic food staples. Notably, expenditures
on telecom, personal care (including health care) and durables
have risen. 
Our valuation database helps us to pick out the most
attractive stocks in this theme
The case for investing in Brazil’s consumer power is compelling
—but inevitably valuations are not cheap, as investors apply high
multiples to many sectors with exposure to the underlying trend
in growth. Typically, as the incidence of poverty recedes and
budding middle-class spending patterns emerge, much of the
initial increase in real disposable incomes is directed towards
small-ticket items. In Brazil around 34 per cent of household
spending is in the supermarket. There remain opportunities to buy
stocks in this sector on reasonable valuations according to our
valuation database. Hypermarcas has a revenue mix encompassing
processed food, personal care products and pharmaceuticals and
has a management team with a record of making value-enhancing
acquisitions. Ambev, with a 70 per cent market share in Brazil,
remains one of the most profitable brewers in the world, and
operates throughout LATAM in both the beer and soft drinks
markets.  Genomma in  Mexico  is  a  play  similar  to  Brazil’s
Hypermarcas, selling personal care products and over-the-counter
medicines. Its principal strengths include a strong branding
position backed by a powerful distribution strategy, and a high 
return on invested capital. Sustainable strong revenue growth
suggests that the stock has long-term dynamics which are not
yet fully discounted in the market.
We are overweight in the Brazilian financials, telecom-
munications, and home-building sectors
where, although many consumer related stocks are not particularly
cheap according to our valuation metrics, the attractions of
structural growth do much to underpin their ratings. Exposure to
the dynamics of the sector can also be gained through the financials,
telcos and home-building sectors. These areas are overweight in
our portfolios. The current period of increasing investor risk
aversion will, we believe, present opportunities to acquire further
positions at reasonable valuation multiples.
COUNTRY REVIEW

A generally weak quarter for emerging market equities

Sovereign debt fears and austerity measures take their toll

Chindia outperforms once again Interest rate hikes in emerging markets may still have some way to go
China [-4.5 per cent] outperformed as 
2008 peak to 30/06/10
the oil major CNOOC [+4.7 per cent] 
1400
Official interest rate Change since 2008 peak
and telecoms giant China Mobile [+4.6 1200
per cent] benefited at the expense of do- 1000
800
mestic cyclical stocks such as China Na- 600
tional Building Materials [-16.6 per cent]. 400
200
Industrial production growth slowed in 0
May for the third consecutive month  (200)
(400)
and loan growth weakened, suggesting (600)
that credit restrictions are having an im- (800)
(1000)
pact. Although overall property prices 
Turkey

Chile

Hungary

Peru

South Africa

Russia

Brazil

Philippines

India

Mexico

Egypt

Korea

Indonesia

Israel

Poland

Czech Republic

Thailand

Taiwan

China

Argentina

increased in May, the picture was more
mixed with some cities showing price
falls. Inflation, now above 3 per cent, will
continue to rise in the short term but we
estimate it peaking in July below 4 per
cent. Ahead of the G20 meeting, China’s
central bank announced that it would
gradually loosen the renminbi peg to the
US dollar, which should allow a degree of
currency realignment.  sales exposure to Europe also suffered,
India [-2.2 per cent] outperformed.
The large fiscal deficit overhang has been
improved by a strong 3G telecom auction
and by a substantial cut in fuel subsidies.
The market was unnerved by a third
25bp interest rate rise, a move much in
line with the central bank’s incremental
approach to policy tightening.  Indonesia [+4.5 per cent] continued to
Stocks tumble in Korea and Taiwan,
despite strong growth
In North East Asia, currency weakness in
Korea [-7.6 per cent] depressed returns.
The weaker currency helped first quarter
earnings of exporters such as Hyundai
Motor [+25.1 per cent]. Domestic stocks
such as the utility KEPCO [-13.5 per
cent] and KB Financial [-13 per cent]
Malaysia
Sources: Pictet, Bloomberg
[-9.3 per cent] was again the worst rupiah against the US dollar. The market
performing Asian market. Index heavy- has benefited as a play on Asian domestic
weights in the technology sector such as consumption growth. Consumer related
Hon Hai Precision [-17.1 per cent] were companies including the scooter manufac-
notably weak. IT companies with high turer Astra [+15.2 per cent] performed
well, as did infrastructure related stocks
and the PC manufacturer Acer [-19.9 per  such as cement producer Semen Gresik
cent] was hit particularly hard. Taiwan’s [+19.2 per cent]. The Philippines [+3.1
economy grew by 13.7 per cent in the per cent] was supported by strength in
first quarter of 2010, the fastest pace in bank and telecom stocks. The major 
over 30 years. development over the quarter was the
election of Benigno Aquino who pledged
South-east Asia leads the pack to reduce the budget deficit from last
years level of 3.6 per cent of GDP. 
outperform and now leads the emerging Malaysia [+0.2 per cent] was helped
market return table with a gain of 66  by its defensive characteristics—some 
per cent over the last twelve months,  40 per cent of the index is composed of
supported by a 12.8 per cent rise in the  telecoms, consumer staples and utility
Emerging consumer demand underpinned by secular credit growth
Household credit as a % of GDP
%
120
100

underperformed. Korea’s improving 80
economic conditions is largely a result 
60
of its relatively high export exposure to
China. First quarter GDP growth of  40

2.1 per cent (yoy) was well ahead of 20
expectations, while exports in May were
0
40.5 per cent higher than a year ago.
Argentina

Mexico

Brazil

Chile

Turkey

Russia

Poland

Czech Republic

Hungary

Israel

South Africa

Indonesia

Philippines

India

Thailand

China

Germany

Japan

UK

USA

Despite improving domestic economic
activity, interest rates were held at 2 per
cent as the central bank noted risks
emerging from the eurozone. Taiwan Sources: IMF, Morgan Stanley, Pictet estimates

GEM QUARTERLY | Q2 | JULY 2010 | 2

The emerging consumer
companies. Its central bank made an
early move to raise interest rates this  underlying growth in Russia
year and May saw a further increase of
25bps to 2.5 per cent. Thailand [-1.7
per cent] performed well considering  Russia [-15.4 per cent]. Steel stocks were
the protracted political protests against
the incumbent Prime Minister Abhisit
Vejjajica. GDP expanded by 12 per cent
(yoy) in the first quarter as exports rose
strongly. Interest rates however remain at
1.25 per cent, as the authorities attempt
to counter lower tourist arrivals and
weak local consumption caused by the
political unrest.
Hungary’s blunder blurt felt in
Poland and Czech Republic markets
In EMEA, Hungary [-30.2 per cent]
suffered a particularly sharp reversal as
sovereign debt default issues triggered risk
aversion across Europe. Comments by the
Prime Minister’s official spokesman that
talk of default was ‘not an exaggeration’
fuelled the selling pressure. The forint fell
by 15.5 per cent against the US dollar,
and by 6.7 per cent against the euro over
the quarter. Banking major OTP lost a
third of its market value over the quarter.
Returns from Poland [-21.6 per cent]
and the Czech Republic [-13 per cent]
suffered from similar deteriorating
sentiment and the Polish zloty and Czech
koruna fell sharply against both the US
dollar and the euro. At a corporate level,
the IPO of PZU, Poland’s biggest insurer,
was the biggest public offering in Europe
for over two years.  commodity prices and better than
3 | GEM QUARTERLY | Q2 | JULY 2010
Syria | April 2010 | SDB
Commodity price falls mask strong expected economic data. GDP rose 
11.7 per cent (yoy) in Q1, the strongest
The decline in commodity prices, performance in the EMEA region.
particularly oil, reduced returns from
Brazil weak as rates hiked on
particularly hard hit with both Mechel and inflation fears
Severstal falling by over a third. Russian Weakness in the energy and materials
GDP advanced 2.9 per cent (yoy) in the sectors reduced returns from Brazil
first quarter, after shrinking by 7.9 per [-15.2 per cent]. Petrobras [-24.1 per cent]
cent last year. The recovery has been was hit by both the lower oil price and
accompanied by a fall in unemployment stock overhang effect after an expected
to 8.2 per cent, and a pick up in retail USD25billion share sale was delayed.
spending. Interest rates dropped to 7.75 Domestic consumption stocks fared much
per cent, continuing the trend lower from better including Hypermarcas [+6.5 per
the 2009 peak of 14 per cent.  cent] and Ambev [+10.3 per cent]. The
central bank began to tighten monetary
Football fever should aid South Africa policy, raising interest rates to 10.25 per
South Africa [-9.5 per cent] saw the cent as growth accelerated and inflation
rand slip by 5.1 versus the US dollar  exceeded its 4.5 per cent target rate. GDP
but gain 4.8 per cent against the euro. growth of 7.3 per cent is expected this
The major oil and material companies year, the highest since 1986. Mexico
struggled, including Sasol [-11.2 per [-9.0 per cent] underperformed in light 
cent] and Impala Platinum [-16 per cent]. of weaker US growth numbers - the US 
However strength was seen in gold stocks is Mexico’s main trading partner and the
such as Gold Fields [+12 per cent] and receiver of 80 per cent of Mexican exports. 
Anglogold [+19.4 per cent]. Consumer Chile [+2.9 per cent] reaffirmed its
spending rose at the fastest pace for over defensive characteristics given a near 
two years in the first quarter, fuelled by  50 per cent index weighting in consumer
a total 550bp cut in interest rates since staples and utility stocks. The central
December 2008. The government bank raised interest rates by 50bps to 
estimates the approximately 500,000 1 per cent, reversing its previous expan-
visitors to the World Cup will add 0.4 per sionary policy, which had seen rates fall
cent to South African GDP this year.  from an 8 per cent peak. Peru [+4.2 per
Turkey [-4 per cent] proved to be cent] was the best Latin American mar-
relatively immune to European ket over the quarter, as a strong rally in
problems, helped by the decline in gold miner Minas Buenaventura [+25.2
per cent] boosted the index.
OUTLOOK

Pictet Asset Management Limited

Strong consumer spending to buoy Moor House
emerging market stocks 120 London Wall
London EC2Y 5ET

www.pictet.com

year average and trading at a modest, but The real decoupling? (2)

The return of global investor risk aversion rare, premium to developed markets. At
saw the MSCI EM index fall by 8.3 per Public debt as % of GDP
11.7x 2010 earnings, p/e ratios are slightly
%
cent over the second quarter. Sovereign debt below the long run average. Earnings 120
default risks in the Eurozone put fiscal growth of 34 per cent is expected in 2010, ADVANCED ECONOMIES
austerity firmly on the political agenda, just although some downgrades to forecasts  100
as governments have started to withdraw are possible in the third quarter. Looking
stimulus policies. Concerns over a renewed through the likely short-term volatility,  80
economic slowdown were intensified by signs our central view is for a normalization 
60
that growth in China was slowing in the of monetary conditions across emerging
face of further attempts to dampen property countries and for global growth to be  40
demand. Commodity prices, a traditional sustained, albeit at a sub-par pace. Any DEVELOPING ECONOMIES
bellwether for emerging equities, dropped as further significant market set back (i.e. 15 20
the pace of global recovery appeared to fade, per cent) would be regarded as a substan-
with the oil price falling by 9 per cent over tial buying opportunity in anticipation of
0
90 92 94 96 98 00 02 04 06 08 10 12 14
the quarter. Despite this, emerging markets better markets towards the end of the year.  Source: Pictet Asset Management
(EM) have continued to outperform
developed equities (fig. 1)—much the result We continue to favour the Financials Disclaimer
of their structural growth advantages and This document is for distribution to professional or
and Consumer sectors institutional clients only and is not intended for distribution
generally lower debt burdens (fig. 2). In sector terms, as many emerging coun- to or use by, retail customers or any person or entity who is
a citizen or resident of or located in any locality, state,
tries transition into consumer focused country or other jurisdiction where such distribution,
publication, availability or use would be contrary to law or
Our medium-term optimism for economies, we are overweight attractively regulation and does not constitute an offer or an invitation
emerging markets remains positioned consumer franchises, particu- to buy or sell any financial product. Any research or analysis
used in the preparation of this document is based upon
Many markets including China, Brazil, larly favouring those that can expand sources believed to be reliable, but no representation or
warranty is given as to the accuracy or completeness of those
Peru, Malaysia and India are now tighten- market share in their fragmented indus- sources. Any opinion, estimate or forecast may be changed
ing monetary policies in order to avoid  tries. The financials sector continues to at any time without prior warning. The information contained
herein does not set forth all of the terms, conditions and
inflating new asset bubbles. European be an attractive way of participating in risks related to these financial products. Past performance
sovereign debt issues have provided a jolt this trend, acting as a key facilitator of is not indicative of future results, the value of these financial
products may fall or rise, and it is possible that an investor
to confidence in the global economic  rising consumer spending and we remain may not recover the amount invested. Before making any
recovery and we suspect that slower overweight. As a result of our database investment decision to invest in a fund, investors should
read its prospectus or offering memorandum. For UK
growth in China will add to such fears. valuation scores by country, Our country investors, the Pictet Funds (LUX), Pictet Targeted Fund
(LUX) and Al Dar Islamic Fund umbrellas are recognised
These factors are likely to constrain the bets are currently relatively modest; collective investment schemes under section 264 of the
near-term performance of material,  Brazil, Indonesia and China are over- Financial Services and Markets Act 2000. Swiss Pictet
funds are only registered in Switzerland and thus are not
energy and information technology weight positions while Chile, Czech  registered for public distribution within the European Union,
stocks, which account for over 40 per cent Republic, Hungary, South Africa and and are categorised in the United Kingdom as unregulated
collective investment schemes. For Australian investors,
of the market index. An increase in equity Taiwan are underweight. Pictet Asset Management Limited (ARBN 121 228 957) is
exempt from the requirement to hold an Australian financial
issuance is likely to accompany any recov- services license, under the Corporations Act 2001, in
ery in risk appetite—Agriculture Bank of EM has far outperformed developed stocks (1) respect of the financial services. Pictet Asset Management
Limited is regulated by the Financial Services Authority
China, Petrobras and Coal India could 5 years to 05/07/10
under UK laws which differ from Australian laws. This
issue over USD50billion of shares by  July 2005 = 100 document has been issued in Switzerland by Pictet Asset
240 Management SA and in the rest of the world by Pictet Asset
September. In total, we estimate over MSCI EM USD Management Limited which is authorised and regulated by
220 the Financial Services Authority, and may not be reproduced
USD130billion of new equity could be  or distributed, either in part or in full, without their prior
200
issued in emerging markets over the next authorisation.
180
twelve months which would exceed  Pictet Asset Management (“PAM”) definition
160 In this document, Pictet Asset Management includes all the
the record fund inflows into emerging operating subsidiaries and divisions of the Pictet group that
markets in 2009.  140 carry on institutional asset management: Pictet Asset
120 Management SA, a Swiss corporation registered with the
Swiss Financial Market Supervisory Authority (FINMA),
Valuations remain supportive of 100 Pictet Asset Management Limited, an English company
authorised and regulated by the Financial Services Authority,
EM equities 80
MSCI WORLD USD and Pictet Asset Management (Japan) Limited, a Japanese
Current valuation levels are broadly neutral 60 company regulated by the Financial Services Agency
05 06 07 08 09 10 of Japan.
with a price-to-book ratio just below the 15 Source: Datastream

GEM QUARTERLY | Q2 | JULY 2010 | 4