financial pacific: emerging market credit (third party), december 14.2010
DESCRIPTION
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M O R G A N S T A N L E Y R E S E A R C H
Global
November 30, 2010
EM Credit Portfolio
Sovereign & Corporate
EM Credit View We believe that sovereign risk concerns in the EU will sustain volatility in the near term, but eventually give way to a path of EM spread compression in 1Q11. Global and EM macro momentum has turned more favourable, which should support the market – along with what we believe will be robust fund inflows and ongoing support of QE by the Fed. Technical positioning is overall benign, with EM-dedicated investors remaining overweight investment grade credits. Although the primary market is likely to remain active, new supply should be easily absorbed by strong inflows.
Exhibit 1
EM Spread* 3-Month Forecast (bp)
240
303
200
220
240
260
280
300
320
340
360
380
Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Oct-10 Nov -10 Jan-11 Feb-11
90% 70% 30% confidence interv al
Source: Bloomberg, Morgan Stanley Research; *EMBI Global spread
EM Model Portfolio Positioning We remain overweight high-beta credits and favour the CEEMEA region. We increase our exposure to Venezuela, Kazakhstan and Poland, which become the most overweight credits along with Argentina and Hungary.
We reduce further our exposure to low-beta countries, Chile, Panama and Malaysia remaining our most underweight credits. We also decrease our exposure on Turkey and South Africa.
We add duration exposure as we see curves bull-flattening in the coming months.
We continue to see value in the Oil & Gas sector.
Exhibit 2
EM Portfolio: Risk Exposure Beta Exposure Spread Exposure
1.03
0.95
1.00
1.05 10bp
-15
-5
5
15
Source: Morgan Stanley Research
Exhibit 3
EM Model Portfolio: Top Changes Monthly Changes in Country Allocation
0.6%
0.6%
0.6%
-0.4%
-0.4%
-0.4%
-0.4%
-0.4%
-0.4%
-0.9%
Poland
Kazakhstan
Venezuela
Chile
Malay sia
Panama
Brazil
Bulgaria
Turkey
South Africa
Ex posure
Increase
Decrease
Ex posure
Source: Morgan Stanley Research
Morgan Stanley & Co. International plc+
Regis Chatellier [email protected] +44 (0)20 7677 6982
EM Strategy AXJ Strategy EM Economics
M O R G A N S T A N L E Y R E S E A R C H
2
November 30, 2010 EM Credit Portfolio
Table of Contents
Outlook, Technicals and Valuations _______________________________________________________
EM Market Outlook 4
Credit Portfolio 6
Curve Monitor 7
EM Return versus Risk 8
CDS SovRank Model 9
Fund Flows 11
Cross-Market Monitor 12
EM Technicals 13
Primary Market 14
Bond Payments 15
CDS Market 16
Credit Views 17 _______________________________________________________
Sector Views _______________________________________________________
Quasi-Sovereign Model 40
Oil & Gas Sector 41
Appendix 43
M O R G A N S T A N L E Y R E S E A R C H
3
November 30, 2010 EM Credit Portfolio
Market Assessment
Fundamentals Technicals Valuations Market View
Market
Country Assessment – Sub-Investment Grade
Single B Credits Fundamentals Technicals Valuations Credit View
Argentina (B)
Venezuela (B+)
BB Credits Fundamentals Technicals Valuations Credit View
Colombia (BB+)
Indonesia (BB)
Philippines (BB)
Romania (BB+)
Turkey (BB)
Legend:
FundamentalsPositive Negative Neutral
Technicals
Positive Negative Neutral
ValuationsCheap Rich Fair
Credit View
Outpeform ++ Outperform + Neutral Underpeform - Underpeform - -
Country Assessment – Investment Grade
BBB Credits Fundamentals Technicals Valuations Credit View
Brazil (BBB-)
Bulgaria (BBB-)
Hungary (BBB)
Kazakhstan (BBB-)
Lithuania (BBB)
Mexico (BBB)
Panama (BBB-)
Peru (BBB-)
Russia (BBB)
South Africa (BBB+)
Single A Credits Fundamentals Technicals Valuations Credit View
Chile (A+)
Korea (A+)
Malaysia (A-)
Poland (A-)
M O R G A N S T A N L E Y R E S E A R C H
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November 30, 2010 EM Credit Portfolio
EM Credit Market Outlook
We believe that sovereign risk concerns in peripheral Europe will sustain volatility in the near term but eventually give way to a path of EM spread compression in 1Q11.
Global macro momentum has turned more favourable, which should support the market along with robust fund flows and QE measures.
Technical positioning is still benign overall, though notably exposure levels have increased; EM dedicated investors maintain their overweight position in investment grade credits.
The primary market is likely to remain very active but strong fund flows and large coupon payments should largely contribute to absorb new supply.
We continue to overweight high-beta credits and the CEEMEA region based on more attractive valuations and a medium-term constructive view of the market.
We extend duration exposure and we see the market rallying into early next year.
The Oil & Gas sector brings substantial alpha versus sovereigns and should better capture EM value.
Tail risks in the EU should take time to affect core Europe and credit markets in general. The recent turbulence surrounding the bailout of Ireland has triggered a sell-off, in line with our prior month’s forecast (see EM Credit Portfolio, October 29, 2010). Given the size of the Irish and Portuguese economies, however, we believe that the problem is still manageable (at least at this point) should policy-makers respond in kind, and the impact on the credit market should in that case eventually subside. In fact, this structural risk is likely to take time to permeate core Europe, the market going through different phases of optimism and pessimism in that respect. As the bailout of peripheral Europe (in this case Ireland and potentially Portugal) is implemented, investors’ confidence should resurface – if only for a time.
Macro momentum and QE measures by the Fed should support the market. After consistently moderating for about a year due to a weak global growth impulse, momentum in macro fundamentals is finally reversing to positive (see Exhibit 4). Moreover, we reiterate that EM fundamentals – growth, fiscal and debt dynamics – remain more favourable than for the majority of DM countries.
The pressure for upgrades remains in place for the majority of EM countries (see our SCRM model, Exhibit 14 on page 9). Indeed, Fitch’s revision of Turkey’s outlook to positive on its BB+ rating is in line with our SCRM rating of BBB- for the credit.
Exhibit 4
Macro Fundamentals Turning Positive MDTI Index*
0
10
20
30
40
50
60
70
80
90
100
Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10
Global AXJ CEEMEA Latin America
Source: Morgan Stanley Research; *See Appendix
So why the recent sell-off? As we highlighted, positioning deteriorated in the run-up to the November FOMC meeting in anticipation of the announcement of additional QE. So, we have endured a technical correction. This reassessment was also integral to our rationale for a short-term correction, with the EMBI spread widening to the 300bp area (see again EM Credit Portfolio). Although the long-term impact on the US real economy of additional QE is unclear, the vast amount of liquidity should help to anchor long-term US yields and in the process help to benefit risky assets.
That said, the EU sovereign risk saga could continue to weigh on investors’ sentiment in the very short term; we see EM spread trading in a wide range around 300bp in the next few weeks. As the situation stabilises in Europe, however, the market should rebound and rally more consistently until early next year; our 3-month spread forecast is 240bp for the EMBI Global (see Exhibit 1).
During most of the year, the performance in EM credit was largely driven by US Treasuries. Going forward, they should play a relatively modest role in EM performance; as US rates remain relatively low due to QE measures, the bulk of the EM performance should come from spread compression (fuelled by both QE and fund flows) and carry.
M O R G A N S T A N L E Y R E S E A R C H
5
November 30, 2010 EM Credit Portfolio
Still-benign overall market technicals. Although hard currency funds registered outflows in the last couple of weeks, and as a result exposure has increased, overall risk exposure remains benign (see Exhibit 5). Despite being overweight some high-beta credits (notably Argentina), EM funds are still largely overweight investment grade credits (around 7% overweight versus benchmark), making the aggregate exposure close to neutral.
Exhibit 5
Relatively Modest Risk Exposure EMEI* Beta Exposure Index
0
10
20
30
40
50
60
70
80
90
100
01-Jan 01-Mar 01-May 01-Jul 01-Sep 01-Nov
EMEI EMEI-HC EMEI-LC
Source: Morgan Stanley Research; *See Appendix
Besides, the market should benefit from a strong seasonality factor which typically sees strategic allocations into the asset class taking place in 4Q/early 1Q. Arguably, the last two weeks have seen outflows for hard currency (credit) funds, but the fact that local currency funds are still posting positive numbers is a gauge that the risk appetite for EM is still there.
We continue to see the primary market as particularly active during 1Q10 as US Treasury yields trade near to historical lows. Amortisations for the next three months reach US$13.7 billion, which should fuel further bond issuance. However, this new supply should be easily absorbed by the market as investors are expected to receive US$21 billion of coupon payments, i.e., 50% more than the amortisations coming due.
Compelling valuations in high-beta names and CEEMEA sovereigns. Given its proximity with the euro-zone, the CEEMEA region has largely underperformed this year. Arguably, fundamentals are a bit weaker than for Latin America and Asia. However, as suggested by our SovRank model (see Exhibit 6), such a discount versus other regions is disproportionate. As tensions become subdued in the EU in the coming weeks, the CEEMEA region should largely outperform.
On average, CEEMEA countries are overweight by 0.4% in our portfolio, compared to an average underweight of 2.7% for Latin America and 1.2% for Asia. Note that two countries of the CEEMA region are substantially underweight in our portfolio: Turkey and South Africa, which brings down the average overweight for the CEEMEA region.
Exhibit 6
SovRank* Model: CEEMEA Cheap to Other Regions
Rom
Bra
Bul
COL
CRO.
HUN
IndiaINDO
Kaz
LITH
Mal
Mex
PAN
PerPHI
POL Rus
Soaf
Thai
Turk
BB-BBBB+BBB-BBBBBB+A-A
0
50
100
150
200
250
300
350
400
Average Rating (Moody's, S&P, Fitch)
5-y
ea
r C
DS
(b
p)
Source: Morgan Stanley Research; *See Appendix
We extend duration to be overweight the 20/30-year sector. Curves have largely steepened in the last few weeks. As the rally materialises, however, curve should largely bull-flatten. Given the steepness of the US Treasury curve, the 20/30-year sector is also where most of the carry remains.
We continue to like the Oil & Gas sector, the latter offering substantial pick-up versus sovereigns, a strong argument for investors trying to capture extra yield. Our view is that Oil & Gas companies are particularly well poised to capture the value of EM (see page 41).
On the month, the MS model portfolio outperformed the EMBI Global benchmark by 52bp (see page 7).
M O R G A N S T A N L E Y R E S E A R C H
6
November 30, 2010 EM Credit Portfolio
EM Credit Portfolio
The recommended sovereign portfolio allocation reflects our relatively benign view on EM credit until early next year.
We believe that the situation in Europe should stabilise, and we take this opportunity to increase exposure on high-beta credit and extend duration.
The beta of the portfolio versus EMBIG index is 1.03 for a weighted average spread of 314bp (11bp higher than the current EMBIG level).
The proposed allocation continues to favour CEEMEA, which trades largely cheap to other regions (see our SovRank model on page 9).
Apart from Argentina and Hungary, which were the two biggest overweight credits in our previous allocation, we increase our exposure to Venezuela as the recent sell-off offers a good opportunity to gain high-beta exposure at cheap levels – note in this respect that our increase in exposure to Venezuela is purely tactical as we remain cautious on the long-term perspective of the credit).
We also increase our exposure to Kazakhstan and Poland. These two credits have consistently underperformed the index in the last few months and risk/reward on these two countries has become very compelling, in our view.
We maintain a large overweight on Hungary. The latest measures from the government regarding the pension system could bring some concerns in the longer term. In the short term, however, these measures should bring considerable savings for the government.
We increase our underweight exposure to low-beta credits, in particular Chile, Malaysia and Panama. These three credits should largely underperform the index as spreads on higher-beta names tighten in the coming months.
We also reduce our exposure to South Africa and Turkey. These two low-beta countries have largely outperformed the market in the recent months and valuations have become unattractive, in our view.
Exhibit 7
Morgan Stanley Portfolio Risk Exposure
Beta Exposure Spread Exposure
1.03
0.95
1.00
1.05 10bp
-15
-5
5
15
Source: Morgan Stanley Research
Exhibit 8
Morgan Stanley Portfolio Allocation (Overweight/Underweight versus EMBIG)
1.3%
1.3%
1.3%
1.3%
0.8%
0.8%
0.8%
0.8%
0.8%
0.3%
0.0%
-0.2%
-0.2%
-0.2%
-0.7%
-0.7%
-1.2%
-1.2%
-1.7%
-1.7%
-1.7%
Argentina (B)
Hungary (BBB)
Kazakhstan (BBB-)
Venezuela (B+)
Romania* (BB+)
Indonesia (BB)
Lithuania (BBB)
Poland (A-)
Russia (BBB)
Bulgaria (BBB-)
Korea* (A+)
Mexico (BBB)
Peru (BBB-)
Philippines (BB)
Brazil (BBB-)
Colombia (BB+)
South Africa (BBB+)
Turkey (BB)
Chile (A+)
Malaysia (A-)
Panama (BBB-)
Underweight Overweight
Overweight
Underweight
Source: Morgan Stanley Research *Off-index
M O R G A N S T A N L E Y R E S E A R C H
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November 30, 2010 EM Credit Portfolio
On the curve-positioning side, we extend duration to become overweight the 30-year sector.
Curves have dramatically steepened (especially in yield terms), making the long end more attractive. Moreover, long-dated bonds should outperform in cash terms in a rally scenario.
We largely overweight the long end of Indonesia. We believe that the curve should normalise as the 10y30y slope flattens very substantially.
Broadly speaking, the 20y-30y maturity bucket is overweight in our portfolio, including Argentina, Brazil, Colombia, Mexico, Peru, the Philippines, Russia, Turkey and Venezuela.
However, we believe that there is still substantial value in the short end for high-beta credits, in particular Argentina, Hungary and Lithuania. The spread curves of these countries should disinvert in the coming months, at least partially.
The belly is quite attractive for two particular countries: Russia and Poland. The 5y10y slope has massively steepened in the recent weeks (both in yield and spread terms), making the 10Y quite attractive at current levels. Note the particular case of the Russia 2030 benchmark, which should perform particularly well.
MS Portfolio Performance versus EMBI Global
Based on our previous portfolio allocation (see EM Credit Portfolio, October 29, 2010), we outperformed the EMBI Global benchmark by 52bp on the month, 3bp due to country allocation and 49bp due to curve allocation – see below.
Exhibit 9
MS Portfolio Month-to-Date Performance Breakdown Credit Allocation vs. Duration Allocation
52bp
3bp
49bp
0 10 20 30 40 50 60
Duration
Country
Total
Source: Morgan Stanley Research
Exhibit 10
Curve Attractiveness by Maturity Bucket (See legend at the bottom of the chart)
Argentina
Brazil
Bulgaria
Chile
Colombia
Hungary USD
Hungary EUR
Indonesia
Kazakhstan*
Korea
Lithuania USD
Lithuania EUR
Malaysia
Mexico
Panama
Peru
Philippines
Poland USD
Poland EUR
Romania EUR
Russia
South Africa
Turkey
Venezuela
Short End Belly Long End
Very High Medium Very LowCurve
Attractiveness
High Low N/A
Source: Morgan Stanley Research; *5Y CDS for Kazakhstan assessment
M O R G A N S T A N L E Y R E S E A R C H
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November 30, 2010 EM Credit Portfolio
EM Return versus Risk
Exhibit 11
Month-to-Date Index Return (Percentage)
+0.7%
-0.0%
-0.6%
-0.7%
-1.1%
-1.1%
-1.3%
-1.5%
-1.7%
-1.9%
-1.9%
-2.3%
-2.3%
-2.9%
-3.0%
-3.1%
-3.1%
-4.2%
-4.4%
-1.9%
-6% -4% -2% 0% 2%
Composite
Bulgaria (BBB-)
Malay sia (A-)
Chile (A+)
Philippines (BB)
Lithuania (BBB)
Turkey (BB)
Kazakhstan (BBB-)
Indonesia (BB)
Russia (BBB)
South Africa (BBB+)
Poland (A-)
Brazil (BBB-)
Argentina (B)
Hungary (BBB)
Venezuela (B+)
Colombia (BB+)
Mex ico (BBB)
Panama (BBB-)
Peru (BBB-)
Source: Bloomberg, Morgan Stanley Research
Exhibit 12
Month-to-Date Return vs. Risk (MTD Return, beta-adjusted, %)
+2.8%
-0.0%
-0.9%
-1.0%
-1.1%
-1.2%
-1.2%
-1.3%
-1.7%
-1.9%
-2.0%
-2.4%
-2.7%
-2.7%
-3.0%
-3.1%
-3.3%
-3.5%
-3.6%
-1.9%
-5% -3% -1% 1% 3% 5%
Composite
Bulgaria (BBB-)
Malay sia (A-)
Argentina (B)
Turkey (BB)
Philippines (BB)
Lithuania (BBB)
Chile (A+)
Venezuela (B+)
Indonesia (BB)
South Africa (BBB+)
Russia (BBB)
Brazil (BBB-)
Mex ico (BBB)
Poland (A-)
Colombia (BB+)
Hungary (BBB)
Kazakhstan (BBB-)
Panama (BBB-)
Peru (BBB-)
Source: Morgan Stanley Research
Exhibit 13
MS Portfolio Excess Return* (Month-to-date, bp)
5.3
2.4
1.3
1.0
1.0
0.9
0.8
0.7
0.3
0.3
0.0
-0.4
-3.3
-2.0
-1.3
-1.3
-1.2
-1.2
-0.9
2.5
-6 -4 -2 0 2 4 6
Total Portfolio
Panama
Colombia
Peru
Turkey
Mex ico
Chile
Brazil
South Africa
Philippines
Bulgaria
Malay sia
Poland
Kazakhstan
Russia
Indonesia
Lithuania
Argentina
Venezuela
Hungary
Source: Morgan Stanley Research *Excluding duration impact
M O R G A N S T A N L E Y R E S E A R C H
9
November 30, 2010 EM Credit Portfolio
SovRank Credit Model
Exhibit 14
Sovereign Credit Rating Model (SCRM*)
-2 -1 0 1 2
Turkey
Hungary
Israel
Lithuania
Poland
Mexico
Venezuela
China
Source: Morgan Stanley Research; *See Appendix
Exhibit 15
5Y CDS Z-Scores versus Global Credit Curve*
-2 -1 0 1 2 3
Poland
Hungary
Croatia
Chile
Indonesia
Argentina
Israel
Malaysia
Source: Morgan Stanley Research; *CC-MR Model. *See Appendix
Exhibit 16
SovRank* Credit Model
Ger
Rom
Bra
Bul
CHILEChina
COL
Cro
Czh
.
HUN
India
INDO
ISR
Kaz
Kor
LITH
Mal
Mex
PAN
PerPHI
Pol
QAT
Rus
Soaf
Thai
Turk
UkFraAut
Swd
JapAus
Ita
AAA B+BB-BBBB+BBB-BBBBBB+A-AA+AA-AAAA+
0
50
100
150
200
250
300
350
400
Average Rating (Moody's, S&P, Fitch)
5-y
ea
r C
DS
(b
p)
Legend:
CHEAP +
RICH +
Cheap -
Rich -
Source: Morgan Stanley Research; *See Appendix
M O R G A N S T A N L E Y R E S E A R C H
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November 30, 2010 EM Credit Portfolio
EM Curve Monitor
Exhibit 17
10-Year EM Yield and Z-Spread Composites
200
250
300
350
400
9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-Nov
4.6
5.1
5.6
6.1
6.610Y Bond Z-spread Comp.
10Y Bond Yield Comp. (RHS)
Source: Morgan Stanley Research
Exhibit 18
Yield 10s30s and 5s10s Bond Slopes (bp)
90
100
110
120
130
140
150
9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-Nov
180
190
200
210
220
230
24010s30s Yield Slope
5s10s Yield Slope (RHS)
Source: Morgan Stanley Research
Exhibit 19
10s30s Bond Slopes (Z-Spread Differential, bp)
PHI INDO BRA
PAN MEXCOL PER
TURK RUS
0
10
20
30
40
50
60
701 month ago
10Y-30Y Slope
Source: Morgan Stanley Research
Exhibit 20
10-Year Bond Z-Spread Level per Country (bp)
RUS
POL
TURK
COL SOAF
INDO MEX PER PAN PHI
BRA
100
120
140
160
180
200
220
2401 month ago
10Y Z-spread
Source: Morgan Stanley Research
Exhibit 21
Z-Spread 10s30s and 5s10s Bond Slopes (bp)
15
20
25
30
35
40
45
50
9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-Nov
-5
0
5
10
15
20
25
3010s30s Z-Spread Slope
5s10s Z-Spread Slope (RHS)
Source: Morgan Stanley Research
Exhibit 22
5s10s Bond Slopes (Z-Spread Differential, bp)
MEXPHI
SOAFBRA
COL RUSTURK
HUN PER
INDO
PAN
POL
-30
-20
-10
0
10
20
30
40
501 month ago
5Y-10Y Slope
Source: Morgan Stanley Research
M O R G A N S T A N L E Y R E S E A R C H
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November 30, 2010 EM Credit Portfolio
Fund Flows
Hard currency funds saw consecutive outflows, while inflows into local currency funds continue. EM credit funds (dedicated hard currency debt funds) had moderated inflows early this month and saw back-to-back outflows in the last two weeks, as returns have started to diminish lately. Local currency funds, however, have continued to receive inflows and the weekly average inflow is now close to US$400 million. Year to date, cumulative hard currency flows are positive for 22.2% of assets under management (AUM), compared to a whopping 98.2% for local currency. Hard and local currency combined, EM debt funds’ YTD fund flows have reached 48.1% of asset under management (source: EPFR).
EM hard currency fund flows are moving in tandem with high yield. The strong correlation between EM hard currency and high yield fund flows remains in place even in weaker periods, as both have registered outflows lately. Flows into EM equity funds have also shown signs of moderation, but outflows remain yet to be seen. In fact, they have recorded positive flows for 26 consecutive weeks, which is the longest streak on record.
Investors seem to be more wary of risky assets. Moderate outflows followed by inflows into money market funds suggest a shift from riskier assets in EM and high yield funds towards safer instruments. These movements are likely to reflect an overall more cautious stance by investors (see Exhibit 23). We think that this is related to a market pullback and hence will be temporary in nature, and expect further inflows into year-end and early 2011.
Exhibit 23
Hard, Local and Mixed Currency Fund Flows (Weekly data, % of assets under management)
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Feb-10 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov -10
EM Debt Blend CCY
EM Debt Local CCY
EM Debt Hard CCY
Source: EPFR
Exhibit 24
EM Debt Fund Flows versus EM Equities (Weekly data, % of assets under management)
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Feb-10 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov -10
EM Debt-dedicated
EM Equities
Source: EPFR
Exhibit 25
EM Debt Fund Flows versus High Yield Funds (Weekly data, % of assets under management)
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
Feb-10 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov -10
EM Debt-dedicated
High Yield
Source: EPFR
Exhibit 26
EM Debt Fund Flows versus Money Market Funds (Weekly data, % of assets under management)
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
Feb-10 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov -10
EM Debt-dedicated
Money Market
Source: EPFR
M O R G A N S T A N L E Y R E S E A R C H
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November 30, 2010 EM Credit Portfolio
Cross-Market Monitor
Eroding EM credit returns first due to the widening in US Treasury yields… EM credit returns have dropped by almost 2% on the month after a stunning performance earlier this year. Interestingly, as the higher returns were mainly driven by the unprecedented tightening in US Treasury yields, the turning point has also been triggered by Treasuries. Post-FOMC Treasury yields have climbed higher and returns have dropped by 1.6% over the past few weeks. Nevertheless, EM credit has underperformed Treasuries by roughly 40bp.
…and due to intensifying risk-aversion lately. With European peripheral issues getting back into the spotlight, risky assets in general have been hit by the latest bout of risk-aversion. This has sparked a decline not only in EM credit but also in EM equities (see Exhibit 28). However, EM equities have closed the month with a moderate decline, MSCI EM dropping by 0.61%. The outperformance of the equity market can be explained by the muted impact of US Treasury yield widening in the first half of the month, while bonds have suffered more.
The correlation between high yield and EM credit spreads remains strong. The strong relationship between EM credit and high yield remains firm, not only with regards to fund flows (see page 11), but also in terms of price action. Correlation between spreads in the two asset classes is 83% in the last six months, somewhat lower than last month as volatility has picked up in the past few weeks (see Exhibit 29). On the month, CDX EM underperformed CDX HY as spreads widened by 19bp and 14bp, respectively.
Exhibit 27
EMBIG Return vs. US Treasury Return* (Based 100)
R²=92%
95
100
105
110
115
4-Jun 2-Jul 2-Aug 30-Aug 28-Sep 27-Oct 29-Nov
UST Return
EMBIG Return
Source: Bloomberg; *IBoxx 7-10Y total return index
Exhibit 28
EM CDX Spread (bp) versus MSCI EM
R²=73%
850
900
950
1000
1050
1100
1150
1200
07-Jun 05-Jul 02-Aug 30-Aug 30-Sep 28-Oct 25-Nov
0
50
100
150
200
250
300
350
MSCI EM
CDX EM Spread (RHS, rev ersed)
Source: Bloomberg
Exhibit 29
EM CDX Spread versus CDX High Yield (bp)
R²=81%
420
470
520
570
620
670
720
7-Jun 5-Jul 2-Aug 30-Aug 1-Oct 29-Oct 29-Nov
150
200
250
300
350
400
450CDX HY Spread
CDX EM Spread (RHS)
Source: Bloomberg
Exhibit 30
EM Spread versus 10Y US Treasury Yield
R²=38%
2.3
2.5
2.7
2.9
3.1
3.3
3.5
3.7
4-Jun 2-Jul 2-Aug 30-Aug 28-Sep 27-Oct 29-Nov
240
260
280
300
320
340
360
380
UST 10Y Yield
EM Spread (RHS)
Source: Bloomberg
M O R G A N S T A N L E Y R E S E A R C H
13
November 30, 2010 EM Credit Portfolio
EM Technicals
Gross nominal exposure of EM hard currency debt funds has risen by 18.6% on a compounded basis over the last four months (versus 24.6% for local currency funds; source: EPFR). Hard currency fund exposure versus benchmark has also risen, climbing back towards neutral from underweight (see Exhibit 31). This shows that investors’ risk appetite for the asset class is still there.
On an aggregate basis, however, cash balances have risen to 5.1% of assets under management (0.3% below the long-term average), due to the accumulation of inflows.
Exposure to EM IG credits has increased to 7.2% overweight from 7.0% – on aggregate, investment grade credits (excluding cash balances) represent nearly 62% of the market value of EM fund’s portfolios.
Argentina remains the biggest overweight credit (both in cash and risk exposure terms). Exposure to this country has risen back to levels last seen two years ago. By contrast, Turkey and the Philippines remain the biggest underweight.
Over the last three months, Turkey is by far the country showing the biggest rise in exposure (+1.1%). The largest decreases in exposure over the period are Indonesia (-0.71%), Mexico (-0.58%) and Hungary (-0.54%).
Year to date, EM hard currency funds have returned over 13%, outperforming their index by 50bp on aggregate.
See Market Technical Watch: Volatility Driving Exposure Lower, November 25, 2010, for the full report.
Exhibit 31
EMEI Beta Risk Exposure Index vs. Benchmark*
0
10
20
30
40
50
60
70
80
90
100
01-Jan 01-Mar 01-May 01-Jul 01-Sep 01-Nov
EMEI EMEI-HC EMEI-LC
Source: Morgan Stanley Research *See Appendix
Exhibit 32
Exposure by Rating Category (% AUM)
7.2%
-5.4%
-1.8%
-10.0%
-7.5%
-5.0%
-2.5%
0.0%
+2.5%
+5.0%
+7.5%
+10.0%
Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
BBBBBB
Source: EPFR, Morgan Stanley Research
Exhibit 33
EM Funds YTD Excess Return (Alpha) vs. Benchmark
-50
0
50
100
150
200
250
300
350
400
450
01-Jan 01-Mar 01-May 01-Jul 01-Sep 01-Nov
EM Alpha Hard Ccy Alpha Local Ccy Alpha Source: Morgan Stanley Research
Exhibit 34
EM Funds’ Cash Balances (% AUM)
3%
4%
5%
6%
7%
8%
9%
Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10
Source: EPFR, Morgan Stanley Research
M O R G A N S T A N L E Y R E S E A R C H
14
November 30, 2010 EM Credit Portfolio
Primary Market
As of November 29, total YTD EM bond issuance reached US$288 billion, US$70 billion higher than the total amount issued for the whole of 2009.
So far this year, net supply has amounted to US$200 billion, nearly 40% higher than the peak of 2007.
The primary market should continue to be particularly active; however, this should be easily absorbed by coupon payments and strong fund flows.
After US$39 billion issued in October 2010, November saw another US$28 billion of EM bonds issued in the market, putting YTD total issuance at US$288 billion, US$70 billion higher than the total amount issued for the whole of 2009. YTD net supply (gross issuance, less amortisations) has reached US$200 billion, US$56 billion higher than thr 2007 record of US$144 billion.
Corporates (including banks and quasi-sovereign names) have issued US$202 billion over the period, compared to US$87 billion for sovereigns. This represents net supply of US$147 billion and US$54 billion, respectively.
Per region (sovereigns and corporates combined), CEEMEA has once again largely dominated the EM primary market this year (US$128 billion), followed by Latin America (US$86 billion) and Asia (US$74 billion). The traditional big issuers, including Brazil (US$37 billion), Russia (US$29.4 billion), Mexico (US$25.3 billion), Korea (US$17.0 billion) and Poland (US$11.9 billion), led the pack.
The primary market is likely to continue to be very active, at least until the beginning of next year. In fact, bond amortisations for the next three months reach US$13.7 billion (47% coming from corporate and 53% from sovereign issuers), which should fuel further supply. However, this new supply should be easily absorbed by the market as investors are expected to receive US$21 billion of coupon payments over the period, i.e., 50% more than the amortisations coming due (see page 15). Moreover, fund flows continue to be very strong and provide ample liquidity to the market to absorb further supply.
Exhibit 35
EM Gross Bond Issuance (US$ billion)
55
108132
165 171189
94
218
288
2002 2003 2004 2005 2006 2007 2008 2009 2010
YTD
Source: Bond Radar
Exhibit 36
Net Supply by Sector (US$ billion)
9.4 9.4
46.453.5
134.7
25.6
89.8
147.0
2007 2008 2009 2010 YTD
Sovereigns
Corporates
Source: Bond Radar, Morgan Stanley Research
Exhibit 37
Monthly Net Supply (US$ billion)
-5
-
5
10
15
20
25
30
35
40
45
Nov -09 Jan-10 Mar-10 May -10 Jul-10 Sep-10 Nov -10
Gross Issuance Amortizations Net Issuance
Source: Bond Radar, Morgan Stanley Research
M O R G A N S T A N L E Y R E S E A R C H
15
November 30, 2010 EM Credit Portfolio
Bond Payments
Exhibit 38
Amortisation and Coupon Payments* (US$ billion)
0.1
4.1 3.1 4.1
1.33.5
0.3 2.6
4.1
4.41.4
5.1 3.0
4.3
3.13.5
4.7
3.2
3.6
5.1
13.9
16.1
11.9
14.2
8.5
Dec-10 Jan-11 Feb-11 Mar-11 Apr-11
Amortisation Sov ereign Amortisation Corporate
Interest Sov ereign Interest Corporate
* Sovereign & Corporate Source: Morgan Stanley Research
Exhibit 39
Bond Amortisations per Country (US$ million) Type Country Dec-10 Jan-11 Feb-11 TotalSovereign Brazil 1,582 1,582
Mexico 1,540 1,540Panama 333 333Philippines 1,270 1,270Poland 1,378 1,378Turkey 1,034 1,034Uruguay 92 92
Sovereign Total 0 4,156 3,074 7,230Corporate Argentina 179 179
Brazil 545 545Colombia 250 250Croatia 414 414Czech Rep. 138 138Hong Kong 76 76Hungary 414 414India 100 284 384Kazakhstan 253 253Korea 714 19 615 1,347Malaysia 260 260Other Latam 79 79Panama 150 150Russia 93 93Trinidad & Tob. 100 100U.A.E. 1,600 1,600Ukraine 175 175
Corporate Total 3,496 326 2,634 6,456Total 3,496 4,482 5,708 13,685 Source: Morgan Stanley Research
Exhibit 40
Main Corporate Bond Amortisations of the Month
Date Country Issuer Cpn Ccy Amount $ Equiv. ISIN
01-Dec-10 Panama Banco Continental 6.625 USD 150 150 USP09097AA71
06-Dec-10 U.A.E. Nat'L Bank Of Dubai L+35 USD 750 750 XS0237182513
06-Dec-10 Korea Kookmin Bank L+29 USD 300 300 XS0237030688
06-Dec-10 Other Latam Corp Andina De Fomento 7.625 GBP 49 79 XS0159072668
07-Dec-10 Malaysia Telmal 8 USD 260 260 XS0121434350
08-Dec-10 Korea Woori Bank 35 EUR 300 414 XS0237371678
14-Dec-10 U.A.E. Nat'L Bk Of Abu Dhabi L+30 USD 850 850 XS0238236243
20-Dec-10 Hungary Otp Bank E+15 EUR 300 414 XS0238379514
22-Dec-10 Argentina Telecom Personal 9.25 USD 174 174 USP9030AAA36
23-Dec-10 India State Bank India L+60 USD 100 100 XS0239218471 Source: Morgan Stanley Research
M O R G A N S T A N L E Y R E S E A R C H
16
November 30, 2010 EM Credit Portfolio
CDS Market
Volatility has picked up amid declining liquidity… As concerns around European periphery resurfaced, hedging activity picked up in the CDS space, mainly led by hedge funds. However, liquidity in the CDS market has been fairly poor, implying larger spread movements on lighter volumes.
CDS spreads have widened across EM, with high-beta names suffering the most. The proximity of Central European countries to the epicentre of the European woes has been reflected in the price action as CEE has underperformed Latin America or even South Africa and Turkey, offering more attractive valuations in the region (see our SovRank model on page 9). Low-beta Latin American names have not been intact, either, with spreads back above the 110bp levels.
…as the bond-CDS basis climbed to neutral territory from negative levels. The CDS market underperformed the bond market in the first half of the month as most of the widening took place in the CDS market, pushing the bond-CDS basis into positive territory, after a long period in negative territory. With prolonged uncertainty in Europe and rising yields in US Treasuries, real money investors have started selling bonds in the second half of the month. Consequently, the bond-CDS basis has dropped back to neutral levels.
Exhibit 41
CDS Slope versus Bond Slope (5s10s, bp)
-5
0
5
10
15
20
25
9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-Nov
15
20
25
30
35
40
45Bond Slope Comp.CDS Slope Comp. (RHS)
Source: Morgan Stanley Research
Exhibit 42
5Y CDS and Basis Spreads (Market Composite, bp)
-50
-40
-30
-20
-10
0
10
20
30
9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-Nov
120
130
140
150
160
170
180
190Basis Spread Comp.
5Y CDS Comp. (RHS)
Source: Morgan Stanley Research
Exhibit 43
5s10s CDS Slopes (bp)
INDO PHI
BRA COL PER SOAF TURK MEX PAN RUS
POL
HUN
0
5
10
15
20
25
30
35
40
451 month ago
10Y-5Y
Source: Morgan Stanley Research
Exhibit 44
CDS Basis Spreads (5-Year Sector, bp)
UKR
PHI
BRA MEXHUN SOAF
INDO PERTURK
COLPAN
RUS
POL-60
-40
-20
0
20
40
60
80
100 1 month ago
5Y Basis
Source: Morgan Stanley Research
M O R G A N S T A N L E Y R E S E A R C H
17
November 30, 2010 EM Credit Portfolio
Credit Views
M O R G A N S T A N L E Y R E S E A R C H
18
November 30, 2010 EM Credit Portfolio
Argentina (B)
Fundamentals
By Daniel Volberg: Strong growth, a comfortable fiscal position and the
election calendar underpin our positive outlook for Argentina. The
strength of the economic expansion in Argentina continues to surprise;
in fact, we expect GDP growth to remain robust in 2011 at 5.9% after
nearly breaking into double-digit growth this year. The key seems to be
a combination of robust external conditions: elevated soft commodity
prices and robust growth in Brazil as well as a consumption boom,
driven by real wage growth. With robust growth comes strong tax
revenue and a comfortable fiscal position. In fact, we expect the
authorities to cover next year’s financing needs out of a combination of
a primary surplus and US$7.5 billion in international reserve inflow.
In addition to the comfortable macro fundamentals, especially on the
growth and fiscal fronts, Argentina may see positive momentum on the
policy front. Presidential and congressional elections in October next
year have opened up the potential for a change in policy regime once a
new administration takes office.
Strategy – Outperform ++
After the market correction, we believe Argentina is now well poised to
outperform. Indeed, valuations remain very attractive as the credit
trades wide to fair value, especially considering the latest macro
numbers. Positioning has increased over the last couple of months,
which could limit the upside, but only to a certain extent ,in our view. We
see the Argentina spread curve partially disinverting in the coming
months with the new 2017 global bond benefiting the most from this
move. We also see compelling value in the GDP warrant at current
levels (see Global EM Investor – Update, November 24, 2010).
Argentina Rich & Cheap Model*
B '17
B '13
B '15
$ Disc $ Par
'17 New
€ Disc
€' Par
10Y5Y
2Y
3Y
300bp
350bp
400bp
450bp
500bp
550bp
600bp
650bp
700bp
750bp
800bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Argentina Macro Fundamentals, 2011 Forecasts*
SCRM Rating: B-GDP Growth
5.9%
Inflation
10.7%
Fiscal Bal./GDP
0.8%
Govt Debt/GDP
45%
Current Acc./GDP
2.6%
Av g. B
Argentina
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
Argentina Credit View
Buy GDP WarrantBuy Glo 2017
Credit View
Bea
rish
Bu
llish
Asset Preference
BullSteepening
Argentina Valuations: Spread to Fair Value* (bp)
378
0200400
600800
1000
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Argentina Technicals: Exposure versus Average
-2.5%-2.0%-1.5%-1.0%-0.5%0.0%0.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Argentina Av g. Single B
Source: EPFR, Morgan Stanley Research
M O R G A N S T A N L E Y R E S E A R C H
19
November 30, 2010 EM Credit Portfolio
Brazil (BBB-)
Fundamentals
By Gray Newman: After a robust rebound during much of 2009 which
quickened its pace during 1H10, we are starting to see signs of
softening. Despite still strong domestic demand, the experience of
2008/09 (and even more recently during 2Q10) serves as a reminder
that Brazil’s fortunes remain closely linked to global economic factors.
As the Brazilian economy settles back to a much more moderate pace,
the gap with global fundamentals is likely to be reduced.
The Brazilian economy may be at a turning point, a fact that we think is
still underestimated by the market due to deceptive year-on-year
comparisons. Based on industrial production, and despite record
releases on the demand side, 3Q10 is likely to be more sluggish than
during the infamous ‘red hot’ first quarter. Absent a sharp rebound, this
would likely stall Brazil’s potential growth, in our view. If global
fundamentals end up relatively benign, then Brazil should do just fine in
2011. Based on these assumptions, we foresee 4% growth for 2011
(versus around 7.9% in 2010) and expect a strengthening of the Real
(1.65E by year-end 2011). But until then, questions are likely to arise
ahead of January 2011, when a new administration takes office.
Strategy – Underperform
Despite the underperformance of Brazil until early November,
valuations are still not very compelling; we therefore remain neutral on
the credit. In fact, the credit trades expensive to fair value, and the
technical position has been deteriorating. At this point we see the value
mostly in the long end as the curve has steepened a lot in the last few
weeks. We expect investors to be inclined to extend duration in a rally
scenario (our base case for the coming months).
Brazil Rich & Cheap Model*
'30
'40
'20 '21
'41'37'34
'13
'14
'15
'17
'19
'25
'24
'27
10Y
7Y5Y
2Y
3Y
0bp
20bp
40bp
60bp
80bp
100bp
120bp
140bp
160bp
180bp
200bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Brazil Valuations: Spread to Fair Value* (bp)
-43
-80
-60
-40
-20
0
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Brazil Credit View
Buy Glo 2037Buy Glo 2034Buy Glo 2041Sell Glo 2040Sell Glo 2014
Credit View
Bea
rish
Bu
llish
Asset Preference
BullFlattening
Brazil Technicals: Exposure versus Average
-1.5%-1.0%-0.5%0.0%0.5%1.0%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Brazil Av g. BBB
Source: EPFR, Morgan Stanley Research
Brazil Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB-GDP Growth
4.0%
Inflation
5.1%
Fiscal Bal./GDP
-2.8%
Govt Debt/GDP
60%
Current Acc./GDP
-2.6%
Av g. BBB
Brazil
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
20
November 30, 2010 EM Credit Portfolio
Bulgaria (BBB-)
Fundamentals
By Pasquale Diana: Bulgaria was one of the countries which
accumulated the largest external imbalances during the credit boom.
The current account deficit widened to over 25% of GDP in the course
of 2008, on the back of credit flows and solid FDI inflows (largely in real
estate). The subsequent drought in inflows has turned the C/A position
around dramatically (-1.2% latest, and moving fast into surplus) in a
pattern we also saw in the Baltics. The last data show an economy
which is still contracting, albeit at a slower pace (-1.5%Y in 2Q), and is
driven by net exports. Domestic demand components continue to suffer
from low credit creation and high unemployment (around 9% compared
to sub-6% pre-crisis).
We note with concern that Eurostat revised the 2009 ESA-95 deficit to
4.7% of GDP (up from the previous estimate of 3.5%), a deterioration
worth 6.4% of GDP from 2008, and much worse than the government’s
cash data showing a cash deficit of just 0.8% for the year. The deviation
is likely explained by the social security deficit as well as the inclusion of
the losses made at the state-owned railway company. For this year, the
government targets a 4.6% of GDP cash deficit, which will fall to 2.5%
in 2011, based on somewhat optimistic GDP forecasts (+3.6%Y in
2011). True, Bulgaria’s debt stock is very low in a regional perspective,
at 14.7% of GDP in 2009 according to Eurostat. Note, however, that the
recent fiscal trends are not encouraging, and the government has had
to deplete its fiscal reserve in order to fund the budget deficit: the
reserve is down to around 8% of GDP, roughly half what it was at the
peak in 2008. This fiscal buffer, built over many years thanks to fiscal
discipline, can be used as a source of liquidity for the banking system in
case of a reserve drop and is one of the pillars of the current monetary
policy set-up. That is why its depletion is a concern.
Strategy – Outperform +
Investors have started reducing their underweight in CEE, trying to
rebalance their positioning. They have favoured Bulgaria over Hungary
and Romania, but we disagree on that. Although the public debt is
lower than Hungary, the total external debt hovers at similar level
(external debt versus exports is 182% in Hungary and 220% in
Bulgaria; external debt versus GDP is 142% and 110%, respectively),
particularly so for the short-end component (short-term external debt
versus GDP is 24% in Hungary and 40% in Bulgaria). Bulgaria does not
look attractive at the current level in the CEE space and we prefer either
improving stories (i.e., Hungary) or more generous credits (i.e.,
Romania). However, we rate Bulgaria as Outperform + in the short term
as we see a year-end rally materialising.
Bulgaria Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB-GDP Growth
2.0%
Inflation
2.9%
Fiscal Bal./GDP
-2.2%
Govt Debt/GDP
19%
Current Acc./GDP
-5.8%
Av g. BBB
Bulgaria
Source: IMF *The wider the web, the better the fundamentals
Bulgaria Credit View
Sell 5Y CDSBuy Glo 2015
Credit View
Bea
rish
Bu
llish
Asset PreferenceSpread
Tightening
Bulgaria Valuations: Spread to Fair Value* (bp)
100
050
100
150200250
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Bulgaria Technicals: Exposure versus Average
-0.5%
0.0%
0.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Bulgaria Av g. BBB
Source: EPFR, Morgan Stanley Research
M O R G A N S T A N L E Y R E S E A R C H
21
November 30, 2010 EM Credit Portfolio
Chile (A+)
Fundamentals
By Luis Arcentales: The fundamental picture for Chile remains strong.
On the real economy front, activity has rebounded sharply from the
tragic earthquake of late February, with substantial strength in domestic
demand (up 18.2% in 3Q compared to a year ago). The rebound
seems to rest on solid ground: consumers are enjoying rising
employment, positive real wage growth and ample credit availability
while confidence among Chile’s captains of industry is riding high,
translating into a surge in investment (+18.5% in 3Q). Even if the global
backdrop deteriorates ahead – an important headwind for a small, open
economy like Chile’s – the post-earthquake rebuilding efforts should
provide a significant boost to growth, particularly in 2011. Indeed, GDP
growth expectations have been progressively upgraded and we
currently forecast 5.6% for 2011. Despite the breakneck pace of growth
so far this year, inflation has remained muted.
Given the enviable position of Chile’s public sector – with gross debt to
GDP at just 7.0% and assets nearing 10% of GDP at mid-year –
funding is unlikely to be an issue for the rebuilding efforts. Importantly,
despite having ample resources at its disposal, the rebuilding plan
includes a balanced approach that mixes temporary tax hikes, sales of
non-strategic assets as well as partial use of the stabilisation funds,
reflecting the administration’s commitment to fiscal discipline.
Strategy – Underperform - -
Despite very solid fundamentals, Chile has been underperforming since
this summer only to briefly outperform during the latest sell-off. The
technical position has improved and valuations are now more in line
with fair value. Given its low-beta status, the credit should continue to
underperform the index, however. We favour the 2020 global bond.
Chile Z-Spread Curve
'12'12'12
'13
'20
'12'12
58bp
59bp
60bp
61bp
62bp
63bp
64bp
65bp
66bp
67bp
68bp
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0
Mod. Duration
Z-sp
read
Source: Morgan Stanley Research
Chile Credit View
Buy 2020
Buy 5Y CDS
Credit View
Bea
rish
Bu
llish
Asset PreferenceUnchanged
Chile Valuations: Spread to Fair Value* (bp)
-3
-40-30-20-10
01020
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Chile Technicals: Exposure versus Average
-0.5%
0.0%
0.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Chile Av g. Single A
Source: EPFR, Morgan Stanley Research
Chile Macro Fundamentals, 2011 Forecasts*
SCRM Rating: A+GDP Growth
5.6%
Inflation
3.1%
Fiscal Bal./GDP
-0.8%
Govt Debt/GDP
5%
Current Acc./GDP
-2.4%
Av g. A
Chile
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
22
November 30, 2010 EM Credit Portfolio
Colombia (BB+)
Fundamentals
By Daniel Volberg: There are three key stories in Colombia: the cyclical
backdrop, the structural reform outlook, and the oil boom. On the
cyclical front, the economy is on solid footing: GDP growth is in the
4-4.5% range (around 5.1% expected for next year), inflation is below
the 3% target and unemployment is falling. This benign macro backdrop
has allowed the authorities to focus on fighting currency appreciation,
although this goal may be difficult to achieve, given the strong FDI.
The new administration has surprised by announcing a commitment to
structural reforms. One of the key reforms is the proposed fiscal rule,
which was submitted to Congress at the end of September and is now
expected to be approved by mid-2011. This reform should add
transparency, accountability and discipline to the fiscal accounts. In our
view, the implementation of the fiscal rule raises the likelihood of a
rating upgrade for Colombia.
Lastly, Colombia is also enjoying inflows from the early stages of an oil
boom. The government is projecting that technology improvement will
boost oil output to around 1.5 million barrels per day by 2015, nearly
twice the current level. This prospect has brought significant FDI inflows
(nearly half of FDI this year has been directed to the oil sector.
Strategy – Underperform
Colombia should be upgraded at some point, as suggested by our
SCRM model. The credit has been largely overpriced, however, and for
this reason it largely underperformed in the last three months. Technical
position continues to be favourable but the upside remains limited in our
view, the credit still trading expensive to fair value. The 5y10y slope has
substantially flattened recently and we favour the long end of the curve.
Colombia Rich & Cheap Model*
'20
'33
'12
'13
'14
'17'19
'37
'24
'41
10Y7Y
5Y
2Y3Y
0bp
50bp
100bp
150bp
200bp
250bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source. Morgan Stanley; *See appendix
Colombia Credit View
Buy 2041Buy 2037
Sell Glo 2024Buy 5Y CDS
Credit View
Bea
rish
Bu
llish
Asset Preference
BullFlattening
Colombia Valuations: Spread to Fair Value* (bp)
-43
-60
-40
-20
0
20
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Colombia Technicals: Exposure versus Average
-0.5%
0.0%
0.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Colombia Av g. BB
Source: EPFR, Morgan Stanley Research
Colombia Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB-GDP Growth
5.1%
Inflation
4.3%
Fiscal Bal./GDP
-2.8%
Govt Debt/GDP
35%
Current Acc./GDP
-0.6%
Av g. BB
Colombia
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
23
November 30, 2010 EM Credit Portfolio
Hungary (BBB)
Fundamentals
By Pasquale Diana: The economy has emerged from recession, but its
recovery remains tentative and vulnerable to a euro area slowdown, given
Hungary’s extreme openness (exports/GDP at around 80%). Risk and
inflation outlooks are inconsistent with rate cuts, we believe. If anything, it
is clear that a move towards weaker risk appetite or a deterioration in the
inflation outlook is likely to be met with rate increases.
Following some unfortunate communication by the government and the
suspension of the IMF talks, markets began to worry about the direction
that fiscal policy would take over the coming years. Hungary has one of
the best primary balance positions in the EU, yet it remains in the spotlight,
given its history of fiscal profligacy, its comparatively high stock of debt
(public and private) and its large FX mismatch on the household liabilities
side. The recent commitment to stick to a sub-3% of GDP deficit target for
2011 looks encouraging to us, although excessively relying on one-off
temporary windfall taxes (on energy, retail, telecom and banking sectors).
We note with concern the plans to effectively nationalise the funds held in
the second pension pillar, worth around 10% of GDP. While the impact on
the debt ratios will be positive in the short-term, this is not necessarily true
in the medium-longer term.
Strategy – Outperform ++
Increasing corporate taxes to re-balance the fiscal position and unwinding
the 1997 pension reform represent a potential problem for the future
commitment of foreign companies in Hungary. We acknowledge that these
decisions are not forward-looking, but in the short-term will have
considerable positive impact on both fiscal balance and debt over GDP
(possibly dropping by 7-8%). We like long positions in Hungary.
Hungary Rich & Cheap Model*
€ Jul-'14
€ '18
€ '13
€ Jan-'14
€ '16
€ '17
€ '20
$ '15
$ '20
Cds 5YCds 10Y
$ '20
$ '15
150bp
200bp
250bp
300bp
350bp
400bp
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Hungary Credit View
Buy $2015Buy $2020Buy €2018Sell €2020
Credit View
Bea
rish
Bu
llish
Asset Preference
BullSteepening
Hungary Valuations: Spread to Fair Value* (bp)
234
0
100
200
300
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Hungary Technicals: Exposure versus Average
-1.5%-1.0%-0.5%0.0%0.5%1.0%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Hungary Av g. BBB
Source: EPFR, Morgan Stanley Research
Hungary Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB+GDP Growth
2.8%
Inflation
3.5%
Fiscal Bal./GDP
-3.7%
Govt Debt/GDP
80%
Current Acc./GDP
0.5%
Av g. BBB
Hungary
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
24
November 30, 2010 EM Credit Portfolio
Indonesia (BB)
Fundamentals
By Deyi Tan: We remain positive on Indonesia’s growth prospects.
General consensus tends to be also bullish on the credit given elevated
commodity prices, smooth transition to democratic setup and benign
demographic trends. What differentiates our view is that we see a
structural decline in cost of capital driven by improved macro
fundamentals, which should eventually incentivise more investment.
While inflation is structurally declining, cyclical inflation pressures are on
the rise in the near term as growth momentum gathers pace amid
elevated commodity prices. Though core inflation remains at
manageable levels for now, commodity tradables inflation such as food
are elevated amid unusual weather conditions and the relatively high
commodity weights in the CPI basket spell risks of spilling over to core
inflation amid healthy domestic demand. For now, strong trailing
currency appreciation from capital inflows has helped to do the policy
lifting in the interim, keeping a lid on import-led pressures this year, but
incomplete liquidity sterilisation adds to that inflationary risk going
forward.
Strategy – Outperform +
Indonesia is an improving credit, and this should eventually lead to
substantial upgrades from rating agencies. The technical position has
been consistently improving for more than a year now and this should
support Indonesian bonds in a rally scenario. According to our Rich &
Cheap model, the 10y sector is trading expensive, however, and the
value is essentially in the long end of the curve. On a spread basis, the
5Y sector is attractive compared to the belly.
Indonesia Rich & Cheap Model*
'35
'19
'37
'18 '20
'17'16
'15May '14
Mar '14
'38
Cds 10Y
Cds 5Y
80bp
100bp
120bp
140bp
160bp
180bp
200bp
220bp
240bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Indonesia Credit View
Buy 2038Buy 2037Buy Mar & May '14Sell Glo 2018Sell Glo 2020
Credit View
Bea
rish
Bu
llish
Asset Preference
BullFlattening
Indonesia Valuations: Spread to Fair Value* (bp)
-35
-50-40-30
-20-10
0
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Indonesia Technicals: Exposure versus Average
-1.5%-1.0%-0.5%0.0%0.5%1.0%1.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Indonesia Av g. BB
Source: EPFR, Morgan Stanley Research
Indonesia Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BB+GDP Growth
6.5%
Inflation
6.2%
Fiscal Bal./GDP
-2.0%
Govt Debt/GDP
25%
Current Acc./GDP
1.2%
Av g. BB
Indonesia
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
25
November 30, 2010 EM Credit Portfolio
Kazakhstan (BBB-)
Fundamentals
By Alina Slyusarchuk: We expect Kazakhstan’s real GDP growth to
reach 5.8%Y in 2010 (higher than officials’ forecasts of around 5% and
consensus of 5.3%), supported by strong external demand which has
already translated into healthy output gains in 1H10. The monthly data
show fast recovery in industrial production (+10.4%Y, year-to-date in
October) and retail sales data point to improvement in domestic
demand (+12.5%Y, year-to-date in October). Our long-term GDP
growth outlook for Kazakhstan stands at 5%Y (around +4.5% for 2011),
higher than its CIS peers, as we are positive on external demand
(particularly Chinese) for Kazakh exports (oil and gas). The risk is an
extended stagnation of credit activity, which can put further pressure on
consumption and construction, in our view.
Inflation accelerated this year, with the October print at 7.3%Y, up from
6.5%Y in August 2010, fuelled by the food prices. The budget deficit
widened in 2010: expenditure growth accelerated due to increases in
public sector wages and student grants, leaving the budget deficit on
track for a 2% of GDP deficit this year, after a 1.5% deficit in 2009. We
anticipate fiscal improvement to take place in 2011 as the government
plans to double oil export duties, from US$20 to US$40 per ton.
Strategy – Outperform + +
Kazakhstan is one of our top picks in CEEMEA, as fundamentals
remain very strong and we like being exposed to oil. Investors look
slightly underweight and this should be beneficial for this credit.
Sovereign CDS has underperformed lately and look very attractive now.
However, we recommend investors gain exposure to this credit through
the banking and oil sectors to capture the upside.
Our top pick in the corporate space is KMG ’15, currently offered at
z+394bp (YTM 5.35%). This trade reflects our bullish view on the EM
O&G sector (see EM Profile: EM Oil & Gas – Go Long to Capture the
EM Growth, October 21, 2010) and in our view is the most attractive
route to benefit from the macro story in Kazakhstan.
We continue to see further stabilization in the Kazakh banking sector
with the level of bad loans stable at 26%. According to the latest data
from the regulator, depositor flow was 3.4% in October. Our top-pick in
the Kazakh banking sector is Halyk Bank 9.25% 2013, currently trading
at z+ 397bp (YTM 4.95%).
Kazakhstan Credit View
Buy KMG 2015Buy Halyk Oct '13
Credit View
Bea
rish
Bu
llish
Asset PreferenceSpread
Tightening
Kazakhstan Valuations: Spread to Fair Value* (bp)
47
02040
6080
100
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Kazakhstan Technicals: Exposure versus Average
-0.5%
0.0%
0.5%
1.0%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Kazakhstan Av g. BBB
Source: EPFR, Morgan Stanley Research
Kazakhstan Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB-GDP Growth
4.5%
Inflation
7.8%
Fiscal Bal./GDP
-1.0%
Govt Debt/GDP
17%
Current Acc./GDP
3.5%
Av g. BBB
Kazakhstan
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
26
November 30, 2010 EM Credit Portfolio
Korea (A+)
Fundamentals
By Sharon Lam: In the recovery cycle, Korea's growth has been driven
by strong exports, capex expansion and rising private consumption. In
2H10, growth looks certain to slow due to the diminishing low base
effect, less policy stimulus and lower exports following the slowdown of
the major economies. If global demand disappoints, we think Korea’s
exports could show more resilience compared to other countries due to
its high competitiveness, backed by a relatively weak currency, its
strength in technology and in branding. On the other hand, if the global
recovery moves ahead, we believe Korea could be a beneficiary, given
its export distributions towards more high-growth emerging markets.
The current spike in food prices could very easily trigger inflation
expectations among consumers. At this point, we expect Korea’s CPI
inflation to rise to above 3.0% in 4Q10 and 2011, but it is not likely to
get out of control, in our view, as the BoK would be likely to raise the
policy rates to anchor pre-emptive inflation pressures. Administrative
measures are also very likely if inflation rises too fast. Given its high
dependence on imported raw materials, Korea remains vulnerable to a
potential rise in commodity prices in the international market. With the
CRB index regaining momentum, this risk could become more tangible
if the pace of appreciation of the index were to accelerate.
Strategy – Underperform -
Fundamentals remain very solid, but at current levels Korean bonds
look fairly priced. At this point, we believe the current political tensions
with North Korea should not have a very significant impact on the credit.
Korea should still underperform the market in a rally scenario because
of its low-beta status. We see most of the value in the wings of the
curve (4Y and 15Y sectors).
Korea Rich & Cheap Model*
'16'16
'25
'19
Sep '14
Apr '14
'13
€'15€'15€'15€'15
60bp
70bp
80bp
90bp
100bp
110bp
120bp
130bp
140bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Korea Credit View
Buy Apr'14Buy 2025
Sell 2013Sell 2016
Credit View
Bea
rish
Bu
llish
Asset PreferenceUnchanged
Korea Valuations: Spread to Fair Value* (bp)
18
-20
0
20
40
60
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Korea Technicals: Exposure versus Average
-0.5%
0.0%
0.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Korea Av g. Single A
Source: EPFR, Morgan Stanley Research
Korea Macro Fundamentals, 2011 Forecasts*
SCRM Rating: A+GDP Growth
4.5%
Inflation
3.2%
Fiscal Bal./GDP
-0.2%
Govt Debt/GDP
38%
Current Acc./GDP
1.5%
Av g. A
Korea
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
27
November 30, 2010 EM Credit Portfolio
Lithuania (BBB)
Fundamentals
By Paolo Batori: Exports and inventories are expected to lead the
recovery in 2010 and GDP growth is set to move back to positive
territory (IMF forecast: 2.1% in 2010 and 3.2% in 2011). However, the
extent of the recovery is limited by weak domestic demand and lack of
credit. High unemployment reduced the demand for loans on the one
side, while deterioration in asset quality (NPLs from 5% in 2008 to 20%
in 2009) is likely to stem loan supply, on the other.
Debt has increased sharply, but sustainability still looks manageable to
us (government debt/GDP 29.3% in 2009, 38.6% in 2010E and 45.4%
in 2011E – European Commission forecast). Below-potential GDP and
deflationary pressures should keep upward pressure on the debt/GDP
ratio, and this will likely require a tight and orthodox fiscal policy and
reforms for years to come. Lithuania’s linkage to the Southern
European countries is limited, as mostly Nordic banks are involved in its
financial system.
Strategy – Outperform +
As per our SCRM model, Lithuania looks cheap in spread terms and
positioning remains quite light. We think investors are likely to reposition
from underweight to (at least) market-weight. Lithuania should largely
outperform in a year-end rally scenario, although we acknowledge the
country still faces fundamental challenges and we play this positioning
tactically. We like steeper USD bonds curve and favour Lithuania 2020
USD to the 2018 Euro, although we are aware of the different client
base. Buy 2015 and 2020 in USD and 2016 in Euro; sell 2018 in Euro.
Lithuania Rich & Cheap Model*
$ '15$ '15
€ '12€ '13
€ '14
€ '16
€ '18
$ '15 $ '17
$ '20$ '15$ '15$ '15
0bp
50bp
100bp
150bp
200bp
250bp
300bp
350bp
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Lithuania Credit View
Buy $2015Buy €'14
Credit View
Bea
rish
Bu
llish
Asset Preference
BullSteepening
Lithuania Valuations: Spread to Fair Value* (bp)
142
050
100
150200250
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Lithuania Technicals: Exposure versus Average
-0.5%
0.0%
0.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Lithuania Av g. BBB
Source: EPFR, Morgan Stanley Research
Lithuania Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB+GDP Growth
3.2%
Inflation
-1.1%
Fiscal Bal./GDP
-8.5%
Govt Debt/GDP
45%
Current Acc./GDP
2.6%
Av g. BBB
Lithuania
Source: Morgan Stanley, EU forecasts, IMF *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
28
November 30, 2010 EM Credit Portfolio
Malaysia (A-)
Fundamentals
By Deyi Tan: Malaysia should continue to get support from elevated
commodity prices, constructive global environment and still
expansionary fiscal policy, which should help sustaining growth at
around 5% in 2011 and 5.5% in 2012. In terms of growth outlook in the
region, we rank Malaysia on par with Thailand (below Indonesia and
Singapore). In the longer-term, however, structural issues such as soft
infrastructure gaps in labour force quality have implications on potential
growth prospects and are still in the midst of being addressed.
Compared to other Asian credits, Malaysia arguably falls in the camp of
the countries facing relatively low inflationary pressures. We forecast
inflation to remain fairly contained at 2.3% (2011) and 2.2% (2012). This
is because with commodity prices elevated, the first phase of inflation
pressures tend to come from the tradables front, but a subsidy system
on selected items (such as certain retail fuel and food items) helps defer
inflation to a certain extent until the next round of subsidy rationalisation.
The fact that the economy is not going into an overheated mode will
also keep demand-pull pressures and core inflation in check.
Strategy – Underperform - -
Malaysia benefits from strong fundamentals, but valuations remain tight
(Malaysia 5Y CDS now trades in line with DM countries like Austria and
France). Technical position has been deteriorating since the beginning
of the year; this factor should contribute to the country’s
underperformance in a market rally scenario.
Malaysia Credit View
Buy 5Y CDS
Credit View
Bea
rish
Bu
llish
Asset PreferenceUnchanged
Malaysia Valuations: Spread to Fair Value* (bp)
-33-40
-30
-20
-10
0
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Malaysia Technicals: Exposure versus Average
-0.5%
0.0%
0.5%
1.0%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Malay sia Av g. Single A
Source: EPFR, Morgan Stanley Research
Malaysia Macro Fundamentals, 2011 Forecasts*
SCRM Rating: A-GDP Growth
5.0%
Inflation
2.3%
Fiscal Bal./GDP
-3.5%
Govt Debt/GDP
51%
Current Acc./GDP
13.7%
Av g. A
Malay sia
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
29
November 30, 2010 EM Credit Portfolio
Mexico (BBB)
Fundamentals
By Luis Arcentales: Mexico remains in the midst of a two-tier recovery,
characterized by a robust industrial rebound coupled with sluggish
consumption and anemic investment. Against this backdrop, the
economy is likely to remain heavily dependent on the US cycle. Part of
Mexico’s weak momentum in domestic demand seems to be explained
by the negative income shock the country has experienced due to a
relative deterioration in the terms of trade. After expanding at a pace in
excess of 5% annualized during 1H10, growth has cooled off and
should continue to expand at a moderate pace thanks to the support
from US industrial activity. The deficit of the current account remains
contained at this point (-0.2% of GDP in 1H10), although some
deterioration is likely to take place ahead.
Fiscal accounts have improved due to the combination of higher oil
prices and output, a strong bounce in VAT and tax revenues, as well as
under-execution of expenditures. The authorities are committed to a
gradual reduction of the fiscal deficit through 2012, as delineated in the
fiscal reform of 2009 which projected to lift revenues by near 1.0% of
GDP. The 2011 budget approved in mid-November had a deficit of
2.5% of GDP; most of the parameters in the budget seem reasonable, if
not necessarily conservative as was the case in 2010.
Strategy – Neutral
Technical position and valuations have improved over the last few
months, but like many other Latin American credits, Mexico remains
expensive to fair value. The shape of the curve has largely normalized,
and at presents we favour the very long end which trades 20bp to 25bp
cheap to Brazil despite showing better average rating (high BBB for
Mexico, BBB- for Brazil).
Mexico Rich & Cheap Model*
'22
Jan '14
'16
'40
'34'33
'13
Feb '14
'15
'17
Mar '19'20
Dec '19
'31
10Y
5Y
2Y3Y
0bp
50bp
100bp
150bp
200bp
250bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Mexico Credit View
Buy 2033Buy 2034Buy 2040Buy 5Y CDSSell 2015
Credit View
Bea
rish
Bu
llish
Asset Preference
BullFlattening
Mexico Valuations: Spread to Fair Value* (bp)
-33
-60
-40
-20
0
20
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Mexico Technicals: Exposure versus Average
-1.0%-0.5%0.0%0.5%1.0%1.5%2.0%2.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Mex ico Av g. BBB
Source: EPFR, Morgan Stanley Research
Mexico Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB-GDP Growth
3.9%
Inflation
3.8%
Fiscal Bal./GDP
-2.3%
Govt Debt/GDP
35%
Current Acc./GDP
-1.3%
Av g. BBB
Mex ico
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
30
November 30, 2010 EM Credit Portfolio
Panama (BBB-)
Fundamentals
By Rosa Velasquez: The economy is recovering at a robust pace: real
GDP expanded by 6.1% during 1H10 (up from 2.8% in 1H09) and
6.24%Y in July 2010. We expect the growth momentum to continue
through the end of the year.
The fiscal accounts are improving. The NFPS deficit narrowed to 0.3%
of GDP in 1H10, down from 0.9% in 1H09 and well below the official
NFPS/GDP 2010 limit of 2%. The primary balance improved as well,
increasing to 1.0% of GDP in 1H10 from 0.6% in 1H09. Monthly
inflation rose by 0.5% in August, bringing inflation to 3.6%Y, up from
1.8% in August 2009.
On the external side, the current account registered a deficit of US$1.3
billion in 1H10. Nevertheless, the deficit was virtually covered by strong
FDI flows of US$1.1 billion (up 26% from 1H09). The debt/GDP ratio
stood at 42.4% on June 30, 2010, down from 45.1% in December 2009.
Strategy – Underperform - -
Apart from the current account, Panama is on solid ground. Despite
underperforming peers in the last six months, the credit is still trading
rich to fair value. Technical position is not supportive either. Given the
limited liquidity on the credit, we recommend sticking with the main
benchmarks (essentially the 2020 global).
Panama Rich & Cheap Model*
'29
'12
'36 S'27
'26'20'15 Cds 10Y
Cds 5Y
0bp
50bp
100bp
150bp
200bp
250bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Panama Credit View
Buy 2020
Buy 5Y CDS
Credit View
Bea
rish
Bu
llish
Asset PreferenceUnchanged
Panama Valuations: Spread to Fair Value* (bp)
-51
-100-80-60
-40-20
0
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Panama Technicals: Exposure versus Average
-0.5%
0.0%
0.5%
1.0%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Panama Av g. BBB
Source: EPFR, Morgan Stanley Research
Panama Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB-GDP Growth
6.3%
Inflation
2.9%
Fiscal Bal./GDP
-1.1%
Govt Debt/GDP
42%
Current Acc./GDP
-8.9%
Av g. BBB
Panama
Source: IMF *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
31
November 30, 2010 EM Credit Portfolio
Peru (BBB-)
Fundamentals
By Daniel Volberg: With GDP growing above 9% on a year-on-year
basis, Peru’s economy continues to be one of the strongest in Latin
America (and indeed in EM). Somewhat surprisingly, despite very
strong growth inflation remains near the 2% target. However, this near-
double-digit GDP growth does pose demand driven inflation risks for
next year.
Yet the central bank has paused the rate hiking cycle, leaving the policy
rate on hold at 3.00%. The decision to pause rate hikes appears to be
largely due to concerns that rising rates – though necessary to slow
growth and head of inflation risks – were contributing to currency
strengthening. Faced with this dilemma, we expect the central bank to
resume tightening monetary policy next year, but at a slower pace as
the authorities engage in a tight balancing act between growth and the
currency.
Strategy – Neutral
The credit has been consistently underperforming the market since mid-
August. Initially, Peru started to underperform due to political turmoil
triggered by the results of local elections, but it continued to do so as
the market perceived Peru as quite expensive on a pure valuation
basis. Macro fundamentals remain very strong, however, which should
limit the downside; we believe the country should now perform more in
line with the index. We favour the recently issued 2050 global bond,
which offers substantial pick-up relative to the 2037 benchmark; also, its
very long duration should make this bond outperforming in a rally
scenario.
Peru Rich & Cheap Model*
'50
'15
'37 S'33
'25
'19'16
Cds 10Y
Cds 5Y
0bp
50bp
100bp
150bp
200bp
250bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Peru Credit View
Buy 2050Buy 2037Buy 2025Sell 2016Buy 5Y CDS
Credit View
Bea
rish
Bu
llish
Asset Preference
BullFlattening
Peru Valuations: Spread to Fair Value* (bp)
-43
-80
-60
-40
-20
0
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Peru Technicals: Exposure versus Average
-1.0%
-0.5%
0.0%
0.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Peru Av g. BBB
Source: EPFR, Morgan Stanley Research
Peru Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BB+GDP Growth
5.5%
Inflation
3.1%
Fiscal Bal./GDP
-0.7%
Govt Debt/GDP
26%
Current Acc./GDP
0.6%
Av g. BBB
Peru
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
32
November 30, 2010 EM Credit Portfolio
Philippines (BB)
Fundamentals
By Pieter Van Der Schaft: Economic prospects remain positive, with
2010 full-year GDP growth likely to exceed the government’s 5-6%
forecast after 7.9% GDP growth during 1H10 amid continuing growth in
foreign worker remittances (+7.4%Y during 8M 2010). Moreover,
subdued inflation (+3.8%Y, and within the 3.5-5.5% inflation target) has
allowed BSP to keep rates on hold, while strong foreign capital inflows
(BSP’s FX reserves rose by US$9 billion during 9M 2010 to US$53.5
billion, equivalent to 13 months’ import coverage) and a further shift in
government funding towards domestic and offshore PHP issuance have
further improved the Philippines’ external funding profile. Finally,
prospects are for political stability as President Aquino has started his
six-year term, while Congressional elections are not due until 2013.
That said, we believe that two risks remain: i) potential fiscal
slippage related to the government’s narrow tax revenue base; and
ii) the Philippines’ traditional sensitivity to rising food and oil prices,
which may also be exacerbated by possible crop damage due to
typhoon Megi. We view these risks as moderate though as: i) strong
GDP growth is tentatively showing up in stronger growth in revenue
collections; this may facilitate government efforts to reduce the fiscal
deficit to 2% of GDP by 2013; and ii) the Philippines has a strong
external liquidity profile.
Strategy – Neutral
Early November, S&P upgraded the Philippines by one notch to BB,
reflecting a continuous improvement in fundamentals. However, the
credit remains well overpriced compared to peers, in our view. Given its
high-beta nature, it should still perform reasonably well in a rally
scenario. We rate the Philippines as neutral in our portfolio.
Philippines Rich & Cheap Model*
'24
Old-'16
'17
'34'32
'31'30
'25
'13
'14
'15
N '16
Jan '19
'20
Jun '19'21
5Y
10Y
0bp
50bp
100bp
150bp
200bp
250bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Philippines Credit View
Buy 2034Buy 2032Buy 2031Sell 2021Sell 2020
Credit View
Bea
rish
Bu
llish
Asset Preference
BullFlattening
Philippines Valuations: Spread to Fair Value* (bp)
-76
-150
-100
-50
0
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Philippines Technicals: Exposure versus Average
-1.5%
-1.0%
-0.5%
0.0%
0.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Philippines Av g. BB
Source: EPFR, Morgan Stanley Research
Philippines Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BB-GDP Growth
4.0%
Inflation
4.0%
Fiscal Bal./GDP
-2.5%
Govt Debt/GDP
63%
Current Acc./GDP
2.3%
Av g. BB
Philippines
Source: IMF *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
33
November 30, 2010 EM Credit Portfolio
Poland (A-)
Fundamentals
By Pasquale Diana: Polish regional growth outperformance continues,
with GDP growth in 2Q reaching 3.5%Y, above expectations. We have
raised our 2011 forecast to 4.4% (from 3.2% previously), on the back of
a better trajectory into next year and a more optimistic view on public
and private capex ahead of the 2012 European football championships.
That said, we view with concern the lack of serious fiscal tightening, and
would note that Poland is the only country in Central Europe that has
not tackled the issue of the budget deficit decisively, partly also due to
the electoral calendar (elections in 2011). The ESA-95 deficit could
reach 8% of GDP this year, a level many would have deemed
unthinkable just a few quarters ago.
We think that the NBP will be among the first central banks to start
raising rates in CEE, in response to better growth, stronger domestic
demand and inflation moving stably above the 2.5% target. Our rate
profile shows that the MPC will raise rates by 100bp next year, in an
effort to normalize monetary conditions.
Strategy – Outperform +
Poland has been penalised lately, due to uncertainty on its debt
sustainability and the need for investors to hedge against a possible
GIPS-CEE contagion. In our view, investors should reduce their current
underweight, as CEE has still comfortable access to external funding
(i.e., the 1y CCS swap basis is improving) and a change in the fiscal
rules is unlikely. We favour the long end in the euro-denominated bond
curve.
Poland Rich & Cheap Model*
€ '19
€ '25
€ '13
€ '14
€ '16 € '17
€ '18 € '21
€ '20
€ '22
$ '12
$ '14
$ Jul-'15
$ Oct-'15 $'19
Cds 5Y
Cds 10Y
0bp
50bp
100bp
150bp
200bp
250bp
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Poland Credit View
Buy $2019Buy €2025Buy €2016Sell $2014
Credit View
Bea
rish
Bu
llish
Asset Preference
BullFlattening
Poland Valuations: Spread to Fair Value* (bp)
29
-20
0
20
40
60
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Poland Technicals: Exposure versus Average
-1.0%-0.5%0.0%0.5%1.0%1.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Poland Av g. Single A
Source: EPFR, Morgan Stanley Research
Poland Macro Fundamentals, 2011 Forecasts*
SCRM Rating: A-GDP Growth
4.4%
Inflation
2.8%
Fiscal Bal./GDP
-6.2%
Govt Debt/GDP
56%
Current Acc./GDP
-3.7%
Av g. A
Poland
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
34
November 30, 2010 EM Credit Portfolio
Romania (BB+)
Fundamentals
By Pasquale Diana: In the last GFS we revised the growth outlook
lower, and we now see 2010 GDP growth at -2.9% and 2011 growth at
-1.7%. Such a weak growth outlook is a function of additional fiscal
tightening on top of the original IMF package: a 5% VAT hike, an
increase in the retirement age to 65, the announcement of over 70,000
job cuts in the public sector and a 25% salary cut for state employees.
Most of the weakness should be seen in the next two/three quarters,
and this is enough to depress the near-term growth outlook significantly.
Romania has a low stock of debt (24% of GDP), but it is struggling to
contain the deficit (now running at 8% on an annual basis) to the 6.8%
the IMF is demanding. Moreover, the government does not enjoy a
stable majority and continues to face the threat of a no-confidence vote.
The latest confidence motion in October failed, but the tensions looks to
have abated only temporarily. The coalition remains quite shaky, and
with yet another electoral campaign looming (elections in 2012),
austerity will prove rather hard to implement.
Strategy – Outperform +
Uncertain political environment and challenging fiscal dynamics make
Romania a possible target of investors’ concerns on possible contagion
from Peripheral Europe (PE). In fact Romania spreads have increased
in the past two weeks or so, as well as Hungary. Our base case is for
no contagion from PE into the CEE region. Therefore we are still
comfortable with an ‘Outperform +’ stance on this credit.
Romania Z-Spread Curve
Hun € '17Hun € '17
Rom € '12
Rom € '15
Rom € '18
Bul '15Bul '15
Cds 5YCds 5Y
Bul € '13Bul € '13
0bp
50bp
100bp
150bp
200bp
250bp
300bp
350bp
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0
Mod. Duration
Z-sp
read
Source: Morgan Stanley Research
Romania Credit View
Sell 5Y CDSBuy €2018Buy €2015
Credit View
Bea
rish
Bu
llish
Asset PreferenceUnchanged
Romania Valuations: Spread to Fair Value* (bp)
162
0
100
200
300
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Romania Technicals: Exposure versus Average
-0.5%
0.0%
0.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Romania Av g. BB
Source: EPFR, Morgan Stanley Research
Romania Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB-GDP Growth
-1.7%
Inflation
4.8%
Fiscal Bal./GDP
-6.2%
Govt Debt/GDP
33%
Current Acc./GDP
-5.8%
Av g. BB
Romania
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
35
November 30, 2010 EM Credit Portfolio
Russia (BBB)
Fundamentals
By Alina Slyusarchuk: Russia GDP slowed down to 2.7%Y in 3Q10
after a robust recovery in 2Q, due to the extended heat wave. Activity in
early 4Q got off to a good start and we still expect the rest of 4Q to
prove strong helped by recovering credit activity and improving
corporate investment demand. We are positive for 2011, with a GDP
forecast at 4.3%. Note, that the government plans to increase social
spending prior to presidential elections in 2012. We therefore remain
concerned about upside inflation risks, although we are still optimistic
on household consumption (+5.5%Y in 2011).
We anticipate inflation pressures from food prices, monetary
aggregates growth and recovering consumer demand – our year-end
CPI forecast is at 8%Y for 2010. However, the Central Bank of Russia
should stay on hold until the end of the year and start tightening only in
2011, when the recovery is on firmer ground. Under the official 2011
budget, a deficit of 3.6% of GDP is planned after a 4.4% deficit in 2010
(on our forecasts). The 2011 budget funding will rely heavily on
domestic borrowing, which can potentially drain some liquidity.
Strategy – Outperform +
The Russian credit is one of our favourites in CEEMEA in terms of
fundamentals but, at current levels, the credit is arguably trading close
to fair value. In fact, we prefer implementing our bullish view through the
banking and oil sectors. Strong banking sector fundamentals position
the sector to benefit from the strong domestic demand and overall
macro story: we favour VTB 18p ’13 and Alfa Bank ’15 to play this
strategy. In the oil sector, we recommend the longer dated Gazprom
bonds, namely GAZPRU ’34 currently offered at z+329bp (YTW 6.85%)
(see Oil & Gas section on page 42).
Russia Rich & Cheap Model*
'18
Mf 7
'28
'30 R
'20'15
3Y2Y
5Y
10Y
0bp
50bp
100bp
150bp
200bp
250bp
300bp
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Russia Credit View
Buy 2030Buy 2020Buy Gazprom '34Sell 2015
Credit View
Bea
rish
Bu
llish
Asset Preference
BullSteepening
Russia Valuations: Spread to Fair Value* (bp)
23
0
20
40
60
80
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Russia Technicals: Exposure versus Average
-1.5%-1.0%-0.5%0.0%0.5%1.0%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Russia Av g. BBB
Source: EPFR, Morgan Stanley Research
Russia Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBBGDP Growth
4.3%
Inflation
8.5%
Fiscal Bal./GDP
-3.8%
Govt Debt/GDP
10%
Current Acc./GDP
2.2%
Av g. BBB
Russia
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
36
November 30, 2010 EM Credit Portfolio
South Africa (BBB+)
Fundamentals
By Andrea Masia: External and fiscal accounts remain the key drivers
for South Africa. Although we expect the current account deficit to
widen in 2H10 (expected -3.7% of GDP for 2010), large-ticket inward
direct investment transactions are likely to combine with strong, carry-
related portfolio inflows to fully fund the current account gap. This
should also help to stabilise inflation around current levels for longer,
engendering a relatively stable growth outlook (expected +3.5% for next
year, versus 3% for 2010).
With regard to the fiscal accounts, revenue outperformance continues
to exceed expenditure outlays, resulting in projections of future fiscal
deficits which are narrower than previously anticipated. Overall debt
levels, although on the rise, are still within comfortable limits. The risk is
for a disorderly correction in the currency that destabilises both inflation
and growth outlook.
Strategy – Underperform -
South African fundamentals remain solid; on the valuation side, the
credit is trading close to fair value. Positioning is neutral in absolute
terms, but a bit heavy when compared to the BBB average. South
Africa has outperformed considerably in the past month and this made
us change the stance from Neutral to Underperformance -.
The general strong demand for long-dated EM bonds has caused the
10-year sector to move towards rich levels. Investors looking for
duration should switch out of the 2020 into the 2022, in order to improve
the performance. In the short end, we prefer 2014 to the 2012, as the
former presents better carry and very steep roll-down.
South Africa Rich & Cheap Model*
'22
'12
'14
'19 '20'22
5Y
10Y
0bp
20bp
40bp
60bp
80bp
100bp
120bp
140bp
160bp
180bp
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
South Africa Credit View
Buy 2020
Buy 5Y CDS
Credit View
Bea
rish
Bu
llish
Asset PreferenceUnchanged
South Africa Valuations: Spread to Fair Value* (bp)
3
-100
10
203040
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
South Africa Technicals: Exposure versus Average
-1.0%
-0.5%
0.0%
0.5%
1.0%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
South Africa Av g. BBB
Source: EPFR, Morgan Stanley Research
South Africa Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB+GDP Growth
3.5%
Inflation
5.4%
Fiscal Bal./GDP
-3.5%
Govt Debt/GDP
37%
Current Acc./GDP
-4.5%
Av g. BBB
South Africa
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
37
November 30, 2010 EM Credit Portfolio
Turkey (BB)
Fundamentals
By Tevfik Aksoy: We expect real GDP growth to reach 7%Y in 2010 on
the back of robust growth in private consumption, investments and the
inventory cycle – despite the negative contribution of net exports
stemming from weak demand from Europe and relatively high oil prices.
We expect 2011 growth to be slower but still robust at around 4.2%. We
consider the main risk to these forecasts to be protracted weakness in
external demand. As Turkey is facing general elections in June 2011,
we expect the fiscal stimulus to be present at least in 1H11, essentially
resulting in a noticeable slowdown in 2H11.
Inflation is forecast to decline gradually to 7.6% at end-2010 and 6% at
end-2011, but in the meantime we expect the headline inflation rate to
hit 5.5-6%% in 1Q11 as base effects kick in. The current account deficit
is widening and likely to reach 5.7% of GDP in 2010. While financing is
unlikely to be an issue, we think that the quality of the financing mix is
less than ideal. The fiscal picture had been stable and safe thanks to
higher-than-anticipated growth that led to strong revenues. If the
government maintains the current practice of controlled discretionary
spending, we expect debt-to-GDP ratio to decline gradually.
Strategy – Underperform -
Investors are still largely underweight the credit, but momentum has
changed lately and positioning is moving towards more balanced levels.
Our SCRM model is anticipating a strong rating upgrade, but the credit
is already trading at rich value. We advise investors to keep their
current underweight as current valuation does not give cushion to
absorb possible volatility. We favour the 30y sector.
Turkey Rich & Cheap Model*
'30
Nov '19'18
Mar '19
'17'16
'15
'14'13
'20
'21'25
'34 '38
'36'40
€'19
€'17
€'16
€'14
€'12
3Y
2Y
5Y
10Y
60bp
80bp
100bp
120bp
140bp
160bp
180bp
200bp
220bp
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Turkey Credit View
Buy 2036Buy 2040Buy 2025Sell 2015Sell 2017
Credit View
Bea
rish
Bu
llish
Asset PreferenceSteepening
Turkey Valuations: Spread to Fair Value* (bp)
-13-20-10
010203040
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Turkey Technicals: Exposure versus Average
-2.5%-2.0%-1.5%-1.0%-0.5%0.0%0.5%1.0%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Turkey Av g. BB
Source: EPFR, Morgan Stanley Research
Turkey Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BBB-GDP Growth
4.2%
Inflation
6.0%
Fiscal Bal./GDP
-3.8%
Govt Debt/GDP
43%
Current Acc./GDP
-5.3%
Av g. BB
Turkey
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
38
November 30, 2010 EM Credit Portfolio
Venezuela (B+)
Fundamentals
Daniel Volberg: We continue to see medium-term deterioration in
Venezuela’s fundamentals, though the near term may prove more
manageable. In the near term, access to credit (even if at high rates)
has not been compromised and the asset cushions – more than $28
billion in international reserves and near $8-9 billion in other liquid dollar
assets held by the public sector – appear sufficient to provide a dose of
near-term comfort for investors.
That said there are major pitfalls. In the medium term Venezuela
appears to be facing a severe shortage of hard currency – roughly $20-
25 billion per year – that is forcing it to rapidly accumulate debt.
Meanwhile, major near-term risks seem to be the potential arbitration
penalties as well as headline risk associated with policy radicalization.
And in the one area that could significantly improve the overall outlook –
development of the Orinoco belt oil resources – progress appears to be
very limited.
Strategy – Outperform + +
Investors have been looking for yield, and deeply discounted
Venezuelan bonds should benefit from investors’ risk appetite. In the
short term – to the extent that the country has enough FX reserves and
risk of default is not imminent – Venezuelan bonds should outperform
as oil prices remain strong. In fact, benign technicals should support the
credit.
As we run our Par Bond Equivalent Spread model, the 2014 and 2025
global bonds appear to be the most compelling assets when taking into
account the recovery value. Our Rich & Cheap model also confirms the
attractiveness of these two bonds.
Venezuela – Rich & Cheap Model*
'28
'27
'24
Old '18
'13'22 S
'19 '23
'34
'38
'25'20
N '18'16
'14
3Y2Y
5Y7Y
10Y
700bp
800bp
900bp
1000bp
1100bp
1200bp
1300bp
1400bp
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0
Mod. Duration
Z-sp
read
Cheap+ Cheap-
Rich+ Rich-
Legend:
Source: Morgan Stanley Research; *See appendix
Venezuela Credit View
Buy 2025Buy 2014
Sell 2034Sell 2024
Credit View
Bea
rish
Bu
llish
Asset Preference
BullSteepening
Venezuela Valuations: Spread to Fair Value* (bp)
910
0
500
1000
1500
Nov -10Sep-10Aug-10Jun-10Apr-10Feb-10Dec-09
Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM model
Venezuela Technicals: Exposure versus Average
-1.0%-0.5%0.0%0.5%1.0%1.5%2.0%2.5%
Oct-10Jun-10Feb-10Oct-09Jun-09Feb-09Oct-08
Venezuela Av g. Single B
Source: EPFR, Morgan Stanley Research
Venezuela Macro Fundamentals, 2011 Forecasts*
SCRM Rating: BGDP Growth
-0.7%
Inflation
35.5%
Fiscal Bal./GDP
-3.8%
Govt Debt/GDP
15%
Current Acc./GDP
3.8%
Av g. B
Venezuela
Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals
M O R G A N S T A N L E Y R E S E A R C H
39
November 30, 2010 EM Credit Portfolio
Sector Views
M O R G A N S T A N L E Y R E S E A R C H
40
November 30, 2010 EM Credit Portfolio
Quasi-Sovereign Model
We introduced our quasi-sovereign (QS) model in August (see EM Quasi-Sovereigns – Valuations on a Global Basis, August 27, 2010) to establish a framework within which to value QS bonds on a consistent basis across the EM credit universe. The key investment thesis is to consider quasi-sovereigns as corporate credits, plus a put option to the government.
Quasi-sovereign corporates continue to be one of our preferred strategies to gain exposure to strong underlying macro fundamentals. Exhibit 45 shows that the CIS region represents the best risk/reward, and this is in line with our overall bullish view on CEEMEA credit.
The performance of the quasi-sovereigns in the past month has been mixed.
Asia – Korean QS spreads over the sovereign generally compressed during the period, driving the overall spread tightening of the Asian QS.
CEEMEA – ME QS (TAQA, TDICUH, MUBAD) showed similar spread compression as the Asian QS. CIS QS generally continue to lag the rest of the universe, with the exception of KAZATOM.
Latam – ENAP and CDEL were the best performers in Latam, with ELEBRA and ECOPET showing considerable spread widening during the past month.
Key recommendations based on the QS scoring: Asia: We prefer PETHAI ’14 to KOROIL ’14.
CEEMEA: KZOLKZ ’15 looks most attractive; we also like GAZPRU ’13.
Latam: We prefer the pick-up PETBRA ’18 offers over PEMEX ‘19.
Exhibit 45
Quasi-Sovereign Model
TENAGA '15
MISCMK '14
PETROL '14
HIGHWY '15KOSPO '14
KORELE '14
KOHNPW '14
KORGAS '14
KOROIL '14
PLNIJ '19
PSALM '19
KOLAHO '14
KORESC '15
PETHAI '15
AXIATA '20
GAZPROM '13
RZD '17
TNEFT '14
KZOLKZ '15
KAZATO '15
NAFTO '14
TAQA '14
TDICUH '14
MUBAD '14
ELEBRA '19
PETBRA '18
ENAP '14
CDEL '14
ECOPET '19
PEMEX '19
0
50
100
150
200
250
0.5 1.0 1.5 2.0 2.5 3.0 3.5
Quas
i-S
ove
reig
n v
s S
ove
reig
n (
Z-S
pre
ad)
Stronger Score Weaker Score Source: Morgan Stanley Research
M O R G A N S T A N L E Y R E S E A R C H
41
November 30, 2010 EM Credit Portfolio
Oil & Gas Sector
We maintain our bullish view on the EM O&G sector. The sector is highly strategic to EM economies and in our view is one of the most effective methods to capture the EM growth story (see EM Profile: EM Oil & Gas – Go Long to Capture the EM Growth, October 21, 2010).
Latam O&G names have underperformed. We use our EM O&G composite in Exhibit 47 as the basis to look at the performance of the EM oil and gas sector in the past month. Overall, the EM O&G composite spread has remained flat, with Latam O&G underperforming CEEMEA and Asia. Meanwhile, the DM O&G composite has tightened very marginally (3bp).
Issuance has been significant. EM O&G companies have issued US$14.2 billion in external debt in 2010, of which US$5.0 billion of this has come in 4Q10. The sector has rather modest Eurobond redemptions in 2011 of US$5.0 billion, but looking at potential capex funding requirements in 2011, we can expect external debt supply from the sector to be considerable. Assuming that demand-side dynamics remain relatively unchanged, we estimate that supply from the sector may be in excess of US$10 billion in 2011.
Commodity outlook: supply-side risks. Our commodity research team forecasts a 2011 base case oil price of US$100/bbl, increasing to US$105/bbl in 2012. The key driver of higher oil prices in 2011 and 2012 according to our commodity team is a decline in spare capacity which is expected to pose challenges to increasing global demand. As a result, prices will likely tick higher, driven by the need to ration demand (see Exhibit 46).
CIS region the most attractive. We continue to see the best value in the CIS O&G names, in particular the quasi-sovereign integrated operators. Our top pick in the sector is KZOKZ ’15, currently offered at z+420bp (YTM 5.6%). As highlighted earlier (see page 25), we like Kazakhstan’s macro fundamentals and view the state-owned operator KMG as the most effective way to capture the favourable Kazakh macro dynamics. As highlighted in CIS O&G – KazMunaiGaz: Life Outside the Indices, October 28, 2010, we see fair value of the KMG spread versus Gazprom of 60-75bp flat across the curve. At current prices, KZOKZ ’15 trades 110bp wider than the new GAZPRU ’15 – see Exhibit 48.
Exhibit 46
MS Oil Price Forecast – Bullish Outlook
Bear Case $70
Bull Case $150
$83.76
Yearend 2010$95
$105
11/28/10
$0
$25
$50
$75
$100
$125
$150
$175
Mar-2006 May-2007 Jun-2008 Aug-2009 Sep-2010 Nov-2011 Dec-2012
Historical MS Forecast (starting YE2010)
Current Price Forward Curve
Current Price & Forw ard Curve as of:
Nov-2010 Source: Morgan Stanley Research estimates
Exhibit 47
EM O&G Composite: Attractive Pick-Up vs DM
-100
0
100
200
300
400
500
600
700
800
Mar
-06
Ma
y-0
6
Jul-
06
Se
p-0
6
No
v-06
Jan
-07
Mar
-07
Ma
y-0
7
Jul-
07
Se
p-0
7
No
v-07
Jan
-08
Mar
-08
Ma
y-0
8
Jul-
08
Se
p-0
8
No
v-08
Jan
-09
Mar
-09
Ma
y-0
9
Jul-
09
Se
p-0
9
No
v-09
Jan
-10
Mar
-10
Ma
y-1
0
Jul-
10
Se
p-1
0
No
v-10
0
100
200
300
400
500
600
EM Oil&Gas Composite vs. DM Oil&Gas Composite (rhs) EM Oil&Gas Composite DM Oil&Gas Composite Source: Bloomberg, Morgan Stanley Research
Exhibit 48
Focus Trade: Buy KZOKZ ’15
$ '21 KZOKZ
$ '20 KZOKZ$ '18 KZOKZ
$ '15 KZOKZ
$ '13 KZOKZ
$ '37 GAZ
$ '34 GAZ
$ '22 GAZ
$ '19 GAZ
$ '18 GAZ
$ '16 GAZ
$ '15 GAZ
$ Jul-'14 GAZ$ 25-Mar-'14 GAZ
$ '20 GAZ
$ Mar-'14 GAZ
$ Jul-'13 GAZ
$ Apr-'13 GAZ
$ Mar-'13 GAZ
200
230
260
290
320
350
380
410
440
0 2 4 6 8 10 12 14
Duration
Sp
read
Source: Bloomberg, Morgan Stanley Research
M O R G A N S T A N L E Y R E S E A R C H
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November 30, 2010 EM Credit Portfolio
Exhibit 49
EM Oil & Gas: Benchmark Regional Curves
GAZPRU 9.625% '13
GAZPRU 7.343% '13
GAZPRU 7.51% '13
GAZPRU 8-Mar-14
GAZPRU'20GAZPRU 25-Mar-14
GAZPRU 8.125% '14
GAZPRU'15
GAZPRU'16 GAZPRU'18
GAZPRU'19
GAZPRU'22 GAZPRU'34
GAZPRU'37
PEMEX'14
PEMEX Mar-'15
PEMEX 5.75% Mar-'18PEMEX'19
PEMEX'20
PEMEX'21
PEMEX'35PEMEX'38
PETROL'12
PETROL'14
PETROL'15 PETROL'19
PETROL'22
PETROL'26
RASGAS'14
RASGAS'12
RASGAS'16RASGAS'14
RASGAS'20
RASGAS'19
RASGAS 6.332% '27
RASGAS 5.838% '27
PETBRA'13
PETBRA'14
PETBRA'16
PETBRA Mar-'18PETBRA Dec-'18PETBRA'19
PETBRA'20
PETBRA'40
40
90
140
190
240
290
340
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0Modified Duration
Z-s
pre
ad
Source: Morgan Stanley Research
Exhibit 50
Spreads versus Fundamentals (Free Cash Flow/Debt)
RILIN'20
SKENER'13
GSCCOR'17PETHAI'15IOCLIN'15
KOROIL'14
CNOOC'13
PETROL'19
PETRTT'19
ENAPCL'19 ECOPET'19
PEMEX'18PETBRA'18
QGTS'33RASGAS'19
QPETRO'11
DOLNRG'19
NAFTO'14
MOLHB'17KZOLKZ'18
VOSTOK'15
TNEFT'18
TMENRU'18
LUKOIL'19GAZPRU'18
RDSALN'18
TOTAL'16
BPLN'19
COP'18
REPSM'17
XOM'18
0
100
200
300
400
500
600
700
800
-75% -65% -55% -45% -35% -25% -15% -5% 5% 15% 25% 35% 45% 55% 65% 75% 85% 95%
FCF/Debt
Z-s
pre
ad
Source: Morgan Stanley Research
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November 30, 2010 EM Credit Portfolio
Appendix
EM Funds Technicals
EM Exposure Indicator (EMEI): This index tracks the beta risk exposure of EM debt-dedicated funds relative to their benchmark. EMEI is constructed
using a basket of 73 dedicated EM fixed income or FX funds. A reading of 0 represents a significant underweight, 50 is equivalent to a neutral stance and
100 reflects a substantial overweight in the part of fund managers relative to their benchmarks. A rising EMEI indicates that exposure of funds, collectively,
is rising relative to the market. Levels below 25 tend to be followed by rallies and levels above 75 tend to be followed by sell-offs. For a detailed description
of the model, see EM Profile: The Second Generation of EM Exposure Indices, November 9, 2010.
SovRank Model This model combines macro fundamentals, valuations and market risks using the results of SCRM, CC-MR and C-VOL in order to give a model-driven
assessment on the attractiveness of sovereign CDS. The sub-components of SovRank are detailed below:
The Sovereign Credit Rating Model (SCRM) focuses on fundamental changes. It aims at predicting the future level of sovereign credit ratings based
on key macro inputs; eventually we gauge in which extent the market is pricing-in these rating changes.
The CC-MR model focuses on mean-reversion patterns. In this model, rating upgrades and downgrades are assumed to be slow to take place so that
short-term movements in CDS are mainly driven by market considerations (e.g. supply/demand, risk appetite, etc.). To the extent that the model
assumes no changes in fundamentals (in the short term), the CDS of each country is meant to revert to the level it usually trades versus the credit
curve once technical factors also mean-revert.
The C-VOL model reflects the market risks on each country. We adjusting the CDS of each country by its level of volatility. Concretely, we divide CDS
levels by the volatility and normalise the result multiplying by the average volatility of the market. We then assess if the country is trading “rich” or
“cheap” taking into account its level of volatility.
For a detailed description of the models, see EM Profile: SCRM and SovRank, July 22, 2010.
Credit View pages
Credit rating. The credit rating shown in the top left corner (next to the country’s name) is the simple average of foreign currency long-term issuer rating
by S&P, Moody’s and Fitch.
Rich & Cheap model: For each bond, we calculate the difference between market z-spread and fair value on the fitted curve (i.e. the regression line). As
we keep an historical of this spread, a Z-score indicator is computed to gauge how far each bond is trading relative to its average spread versus the curve.
Depending on their Z-score level, bonds are then assessed as “cheap” or “rich” with a certain degree, as follows:
The ‘Cheap+’ status (very cheap) is given for bonds which meet two conditions simultaneously: 1.) their current spread (in absolute terms) trades
above the fitted curve and 2.) their current spread trades more than 1.5 standard deviation above their average level versus the regression line.
A ‘Cheap-’ (cheap) status is given for bonds which Z-score indicator is positive but does not meet the previous two conditions.
Symmetrically, the ‘Rich+’ status (very expensive) is given for bonds whenever they meet two conditions: 1.) their current spread (in absolute terms)
trades below the fitted curve and 2.) their current spread trades less than -1.5 standard deviation below their average level versus the regression line.
Bonds are given the ‘Rich-’ status (expensive) when their Z-score indicator is negative but it does not meet the previous two conditions.
It is important to stress that the model is linear. Although this can appear as an imperfect fit compared to other types of regressions (such as a logarithmic
or a polynomial), the linear regression is intended to capture the changes in the shape of the curves (i.e. changes in convexity) and the attractiveness of
each bond for a given duration exposure. From this point of view, the regression line is more a reference point rather than an actual ‘fit’. Note also that the
liquidity and the high (or low) dollar price of a bond are taken indirectly into account to the extent that we do not consider the spread relative to the
regression as the relevant variable (a bond can be systematically trading above or below the curve given its higher or lower coupon, or because of better
or worse liquidity levels), but rather the spread versus historical average. By doing so, these particular features are neutralised to a large extent to only
consider the volatility of the spread versus its average point.
Asset Preference: Our asset preference is based on our Rich & Cheap model (see above) but also takes into account our view on the curves (typically,
steepening or flattening). Note that our asset preference for each country does represent a trade recommendation per se; instead, we highlight the best
risk-reward opportunities for fund managers willing to get exposure on the credit.
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November 30, 2010 EM Credit Portfolio
Spread to Fair Value: Our country fair value estimate is derived from the SCRM model (see above under SovRank model). The chart shows the
difference between the 5-year CDS and the fair CDS level implied by the model given the SCRM projected rating.
Technicals – Exposure vs. Average: We show EM funds’ exposure versus 12-month historical average relative to benchmark. This is a better reflection
of shifts in exposure for countries which have been historically over-/underweight for a long period of time.
Macro Fundamentals: We represent macro forecasts in a radar chart, including GDP growth, inflation, fiscal balance (% of GDP), government debt (% of
GDP) and current account balance (% of GDP). The wider the radar chart (i.e. the wider the “web”), the better the fundamentals of the country relative to
other EM credits. We rank each indicator among EM countries and represent the ranking value in the chart. For growth, fiscal balance and current
account, the ranking is in ascending order (i.e. the higher these indicators, the better for the country); for inflation and debt/GDP the ranking is in
descending order (i.e. the lower these indicators, the better for the country). These indicators are Morgan Stanley forecasts, unless specified otherwise.
Other
Macro-Dynamic Trend Indicator (MDTI): MDTI measures the momentum in underlying EM macro fundamentals. The model tracks 30 EM
countries at present. The indicator tracks the rate of change in the year-on-year change in inflation, industrial production, trade balance and FX
reserves. Each of the four component series are equally weighed to derive the overall index reading. A rising MDTI suggests improving macro
fundamentals momentum, a falling MDTI deteriorating macro fundamentals momentum.
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November 30, 2010 EM Credit Portfolio
EM Strategy and Economics Teams
EM Fixed Income and Foreign Exchange Strategy
London
Rashique Rahman Team Head, EM Macro Strategy [email protected] +44 (0)20 7677 7295
Paolo Batori, CFA Head of EM Credit Strategy, CEEMEA [email protected] +44 (0)20 7677 7971
Regis Chatellier Global EM Credit Strategy [email protected] +44 (0)20 7677 6982
Vanessa Barrett EM Corporate Credit Strategy [email protected] +44 (0)20 7677 9569
Chuan Lim, CFA CEEMEA Local Markets Strategy [email protected] +44 (0)20 7677 7597
James Lord CEEMEA Macro Strategy [email protected] +44 (0)20 7677 3254 +44 (
Robert Tancsa Credit Relative Value, EM Analytics [email protected] +44 (0)20 7677 6671
Meena Bassily EM Strategy [email protected] +44 (0)20 7677 0031
New York
Rogerio Oliveira Head of EM Trade & Quant Strategy [email protected] +1 212 761 1204
Vitali Meschoulam Head of Latin America Strategy [email protected] +1 212 761 1889
Juha Seppala EM Quantitative Strategy [email protected] +1 212 761 1949
Rosa Velasquez Latin America Credit Strategy [email protected] +1 212 761 8278
Andrew Slusser EM Strategy [email protected] +1 212 761 0383
Hong Kong
Viktor Hjort Head of AXJ Credit Strategy/ [email protected] +852 2848 7479
Fixed Income Research
Stewart Newnham AXJ Currency Strategy [email protected] +852 2848 5320
Yee Wai Chong AXJ Currency Strategy [email protected] +852 2239 7117
Pieter Van Der Schaft Head of AXJ Rates Strategy [email protected] +852 3963 0550
Rohit Arora AXJ Rates Strategy [email protected] +852 2848 8894
Kelvin Pang AXJ Credit Strategy [email protected] +852 2848 8204
Nishant Sood AXJ Credit Strategy [email protected] +852 2239 1597
EM Economics
Manoj Pradhan Global [email protected] +44 (0)20 7425 3805
Tevfik Aksoy Head of CEEMEA Economics [email protected] +44 (0)20 7677 6917
/ Turkey, Israel and MENA
Mohamed Jaber MENA [email protected] +44 (0)20 7677 8189
Michael Kafe South Africa, Nigeria [email protected] +27 11 587 0806
Andrea Masia South Africa [email protected] +27 11 587 0807
Pasquale Diana Poland, Hungary, Czech, Romania [email protected] +44 (0)20 7677 4183
Alina Slyusarchuk Russia, Kazakhstan, Ukraine, Baltics [email protected] +44 (0)20 7677 6869
Gray Newman LatAm [email protected] +1 212 761-6510
Luis Arcentales Chile, Mexico [email protected] +1 212 761-4913
Daniel Volberg Argentina [email protected] +1 212 761-0124
Qing Wang Greater China [email protected] +852 2848 5220
Denise Yam China, Hong Kong [email protected] +852 2848 5301
Sharon Lam Korea, Taiwan [email protected] +852 2848 8927
Steven Zhang China, Hong Kong [email protected] +86 21 2326 0015
Ernest Ho China, Hong Kong [email protected] +852 2239 7818
Jason Liu Korea, Taiwan [email protected] +852 2848-6882
Chetan Ahya Asia ex-Japan, India [email protected] +65 6834 6738
Deyi Tan Singapore, Malaysia [email protected] +65 6834 6703
Shweta Singh ASEAN [email protected] +65 6834 6739
Tanvee Gupta India [email protected] +91 22 2209 7927
Morgan Stanley entities: London/South Africa – Morgan Stanley & Co. International plc; New York – Morgan Stanley & Co. Incorporated.; Hong Kong/Shanghai – Morgan Stanley Asia Limited.; Singapore – Morgan Stanley Asia (Singapore) Pte.; Japan – Morgan Stanley MUFG Securities Co., Ltd.; Dubai – Morgan Stanley & Co International plc (DIFC Branch); India – Morgan Stanley India Company Private Limited.
M O R G A N S T A N L E Y R E S E A R C H
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November 30, 2010 EM Credit Portfolio
Disclosure Section The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley & Co. Incorporated and/or Morgan Stanley C.T.V.M. S.A. and/or Morgan Stanley & Co. International plc and/or RMB Morgan Stanley (Proprietary) Limited and/or Morgan Stanley MUFG Securities Co., Ltd. and/or Morgan Stanley Asia Limited and/or Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H) and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley Smith Barney Australia Pty Ltd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813, which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley"). For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA.
Analyst Certification The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Regis Chatellier. Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.
Global Research Conflict Management Policy Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies.
Important US Regulatory Disclosures on Subject Companies Within the last 12 months, Morgan Stanley managed or co-managed a public offering (or 144A offering) of securities of Mexico, Panama, Peru, The Philippines, Korea Electric Power, Petrobras. Within the last 12 months, Morgan Stanley has received compensation for investment banking services from Brazil, Panama, Peru, The Philippines, Turkey, Gazprom, Korea Electric Power, Petrobras, Pemex. In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from Argentina, Brazil, Chile, Colombia, Panama, Peru, Turkey, Gazprom, Halyk Bank of Kazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTB Bank JSC, Alfa Bank, Pemex.. Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services from Brazil, Bulgaria, Korea, Panama, Peru, Russia, Gazprom, Halyk Bank of Kazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTB Bank JSC, Alfa Bank, Pemex. Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client relationship with, the following company: Argentina, Brazil, Chile, Colombia, Panama, Peru, The Philippines, Turkey, Gazprom, Halyk Bank of Kazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTB Bank JSC, Alfa Bank, Pemex. Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the past has entered into an agreement to provide services or has a client relationship with the following company: Brazil, Bulgaria, Korea, Panama, Peru, Russia, Gazprom, Halyk Bank of Kazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTB Bank JSC, Alfa Bank, Pemex. Morgan Stanley & Co. Incorporated makes a market in the securities of Petrobras. The equity research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues. Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making, providing liquidity and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in this report. Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.
STOCK RATINGS Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.
Global Stock Ratings Distribution (as of October 31, 2010)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.
M O R G A N S T A N L E Y R E S E A R C H
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November 30, 2010 EM Credit Portfolio
Coverage Universe Investment Banking Clients (IBC)
Stock Rating Category Count % of Total Count
% of Total IBC
% of Rating Category
Overweight/Buy 1122 40% 413 44% 37%
Equal-weight/Hold 1158 41% 411 43% 35%
Not-Rated/Hold 121 4% 22 2% 18%
Underweight/Sell 393 14% 103 11% 26%
Total 2,794 949
Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley received investment banking compensation in the last 12 months.
Analyst Stock Ratings Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index or the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis over the next 12-18 months. Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index or the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis over the next 12-18 months. Not-Rated (NR) - Currently the analyst does not have adequate conviction about the stock's total return relative to the relevant country MSCI Index or the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index or the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.
Analyst Industry Views Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below. In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below. Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below. Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
Important Disclosures for Morgan Stanley Smith Barney LLC Customers Citi Investment Research & Analysis (CIRA) research reports may be available about the companies or topics that are the subject of Morgan Stanley Research. Ask your Financial Advisor or use Research Center to view any available CIRA research reports in addition to Morgan Stanley research reports. Important disclosures regarding the relationship between the companies that are the subject of Morgan Stanley Research and Morgan Stanley Smith Barney LLC, Morgan Stanley and Citigroup Global Markets Inc. or any of their affiliates, are available on the Morgan Stanley Smith Barney disclosure website at www.morganstanleysmithbarney.com/researchdisclosures. For Morgan Stanley and Citigroup Global Markets, Inc. specific disclosures, you may refer to www.morganstanley.com/researchdisclosures and https://www.citigroupgeo.com/geopublic/Disclosures/index_a.html. Each Morgan Stanley Equity Research report is reviewed and approved on behalf of Morgan Stanley Smith Barney LLC. This review and approval is conducted by the same person who reviews the Equity Research report on behalf of Morgan Stanley. This could create a conflict of interest.
Other Important Disclosures Morgan Stanley & Co. International PLC and its affiliates have a significant financial interest in the debt securities of Brazil, Bulgaria, Chile, Colombia, Hungary, Indonesia, Kazakhstan, Korea, Lithuania, Mexico, Panama, Peru, The Philippines, Poland, Romania, South Africa, Turkey, Venezuela, Gazprom, Halyk Bank of Kazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTB Bank JSC, Alfa Bank, Pemex. The model portfolio is a hypothetical portfolio and is not intended to reflect actual trading performance. As a hypothetical model, the portfolio does not necessarily represent a portfolio of securities that the Firm holds or trades. Any references to losses, gains or positions with respect to the portfolio represent hypothetical not actual losses, gains or positions. Morgan Stanley produces an equity research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com. Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. The fixed income research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality, accuracy and value of research, firm profitability or revenues (which include fixed income trading and capital markets profitability or revenues), client feedback and competitive factors. Fixed Income Research analysts' or strategists' compensation is not linked to investment banking or capital markets transactions performed by Morgan Stanley or the profitability or revenues of particular trading desks. Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common equity securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities/instruments or derivatives of securities/instruments of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities/instruments or derivatives of securities/instruments of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons.
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