For Institutional Use Only1 Emerging Markets: What’s an Investor to Do? Outlook to 2010 and beyond Sara Zervos, Oppenheimer Funds

For Institutional Use Only 1

Emerging Markets: What’s an Investor to Do?

Outlook to 2010 and beyond

Sara Zervos, Oppenheimer Funds


It’s been a Wild Ride this Past Year


The Ride Up, 2008Then:

Inflation was primary concern

Food and commodity induced inflation was a war central banks couldn’t fight easily

Slowing growth in developed world, EM steaming along

US already hurting from housing market

Commodity exporters booming, importers suffering

Current accounts severely imbalanced

US (-4.9%), Turkey (-5.7%), China (9.4%), Russia (6.1%)


The Ride Down, Q4 2008 - 2009

Now: Inflation? What inflation?

Output gaps in abundanceCommodity prices “higher” but stable

Sub-trend Growth GloballyDeveloped markets expected -3.3% 2009EM expected 0.5%, without China, -1.4% (JPM estimates)

Current accounts converging toward balanceTrade collapsed


Inflation on Downward Trend

Arthur SteinmetzTeam Leader/Portfolio Manager

(% annual change)

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

Brazil China Indonesia Turkey U.S.


GDP Growth SufferingReal GDP, % change at annual rate,

over one quarter

-25.00

-20.00

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

Brazil China Mexico Turkey USASource: JPM


Current Accounts on the MoveImbalances Dissipating

-10.0

-5.0

0.0

5.0

10.0

15.0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

% o

f GD

P

United StatesChinaIndonesiaBrazilHungaryTurkey

Source: JPM


A round-trip ride in the Markets, as well

Investment themes pre-crisis 2008Credit: De-coupling, credit at all time tights Interest Rates: Pay, pay, pay FX: bullish commodity exporters, bearish importers

Investment themes Q4 2008 – Q1 2009De-lever: Sell everything, if you must, and if you canBuy dollars, receive rates Focus on policies in Washington, D.C. and China

Investment theme mid 2009: markets back to normal?Buy credit, buy equities, buy EMFX


Interest Rates Change CourseTwo year interest rates

0

2

4

6

8

10

12

14

16

18

%

0

1

2

3

4

5

6

%

South Africa Brazil Israel (RHS) US (RHS)


FX: South Korea and Colombia

Exchange Rates

800

900

1000

1100

1200

1300

1400

1500

1600

1400

1600

1800

2000

2200

2400

2600

2800

usdkrw (LHS)

usdcop (RHS)


Where do we stand?

Growth Inventory replenishing

Massive fiscal stimulus driving Q2 growth rebound Chinese demand drives growth abroad Temporary (?) boost in consumption due to targeted programs (cash for

clunkers, tax incentives, etc) Consumer confidence growing, but are they spending? What happens when the stimulus runs dry?

Trade flows still low

FDI resilient into China, Brazil


Growth Outlook for 2009, 2010:Still Below Potential

Forecast in Aug 2008 Current forecast

Forecast in Dec 2008 Current forecast

China 9.6 8.4 9.0 9.0 9.0Hong Kong 4.5 -4.0 4.0 4.8 4.1India* 8.0 6.2 7.7 7.2 7.5Indonesia 4.7 3.5 5.0 4.5 5.0Korea 4.8 -1.1 4.0 3.9 4.5Malaysia 4.6 -3.0 4.7 4.4 5.5Philippines 4.3 1.3 4.5 5.0 4.5Singapore 4.3 -2.8 5.0 4.9 4.5Taiwan 4.4 -3.8 4.6 5.0 4.5Thailand 4.6 -2.6 4.0 6.1 5.0Emerging Asia 7.6 3.8 7.2 6.8 7.3

Bulgaria 5.5 -5.0 2.5 -1.5 6.0Czech 3.5 -3.0 -0.5 2.0 6.0Egypt* 7.2 4.4 4.0 5.0 6.0GCC 3.6 1.8 4.1 4.3 4.4Hungary 2.8 -6.0 0.5 -0.5 3.0Israel 4.0 -2.0 1.0 2.0 4.0Kazakhstan 5.0 -1.0 4.0 1.8 9.0Nigeria 9.9 3.4 7.4 7.5 8.0Poland 4.8 -1.0 2.5 1.8 5.5Romania 4.0 -4.0 2.0 1.5 6.0Russia 7.0 -8.5 3.5 4.5 6.0South Africa 2.7 -2.0 2.4 2.5 3.9Turkey 5.2 -4.7 2.0 3.0 5.5Ukraine 3.5 -11.5 -0.5 3.0 4.5CEEMEA 5.2 -3.6 2.9 3.4 4.8

Argentina 3.0 -3.0 2.0 2.0 4.5Brazil 3.8 -1.0 3.5 3.5 3.5Chile 3.0 -1.5 4.0 3.2 5.3Colombia 3.6 -0.5 4.0 3.0 5.0Ecuador 2.5 -2.0 3.5 0.5 3.5Mexico 3.0 -5.5 4.0 3.8 3.5Peru 6.1 2.2 6.6 4.7 7.0Venezuela 3.5 -2.5 2.5 1.5 3.5Latin America 3.5 -2.9 3.6 3.3 3.9

Emerging Markets 5.9 -0.1 5.0 4.9 5.7

20102009 Potential GDP growth


Inflation not an immediate worry

Falling, or stable at low levels, in MOST countries

Exception – India and China, Israel?

India visible

Israel: still within target but signs are showing (rate hike already)

China: deflation slowing


Commodities

OPEC forecasts world oil demand to turn positive in 2010

World real GDP growth and oil consumption are highly correlated

Fundamentals drivers call for positive outlook: OPEC compliance high, non-OPEC supply growth minimal, lower inventories, higher utilization rates ahead

Prices have stabilized, yet forecasts for next year are varied, due to micro and technical factors as well


So, the recession is over, what do we do now?

Uncertainty is as high as ever

Are we facing a “double dip” growth scenario?

Does the U.S. (and Europe..and China..) have an exit strategy from quantitative easing and fiscal stimulus?

Will the consumer start spending?

Will the swine flu be a factor once the northern hemisphere enters winter?

Will the US Dollar suffer?


How to Frame Investment Decisions in and Uncertain World

Create macroeconomic scenarios

Assign probabilities

Focus on country specific information in each scenario

Forecast returns and make asset allocation decisions


Ex-ante 2010 investment outlookStart with the global macroeconomic outlook

“Too Hot” Above potential GDP growth Falling unemployment Climbing commodity prices, rising interest rates

“Too Cold” Back into recession, rising unemployment

“Just Right” Slow resumption to trend growth Unemployment rates stabilize at high levels Monetary policy remains loose


Oppenheimer International Fixed Income Team Forecasts

PROBABILITY

OF

SCENARIO

FED

FUNDS

RATE

10yr U.S.

TREASURY

YIELD

WTI

OIL

PRICE

($/bbl)

BAA-

RATED

BOND

SPREADS

S&P 500

EUR/USD

USD/JPY

“TOO HOT” – Global economy continues to accelerate into H1

2010 to above-trend growth rates, causing unemployment

rates to decline.

40% 0.21% 4.24% $81 248bp 1176 1.40 105

“TOO COLD” – Global economic recovery stalls out in H1 2010

and growth rates dip back down again. Unemployment rates rise

further.20% 0.18% 3.18% $46 349bp 864 1.34 90

“JUST RIGHT” – Global growth continues at a trend-like pace (2-

2.5%) in H1 2010 putting no downward pressure on unemployment rates.

40% 0.18% 3.75% $66 291bp 1043 1.43 98


Emerging Market Credit Outlook

5 year CDS (bps)

0

200

400

600

800

1000

1200

1400

01/02/08 04/02/08 07/02/08 10/02/08 01/02/09 04/02/09 07/02/09

0

500

1000

1500

2000

2500

3000

3500

Turkey Indonesia Brazil Venezuela (RHS)Source: Deutschebank


Spreads unlikely to tighten much more

But in a zero-interest rate world, yields are still appealing Demand for new issues to remain highMoney still to be invested, inflowsBank credit not abundant, only highly rated companies issuing

debt Ability to pay still high (in “too hot” or “just right”) High beta countries and quasi-sovereign credits likely to tighten


Credit: clip the coupons Overweight Argentina – highest yielding and potential upside as the country moves to access international capital markets Overweight Venezuela – but get ready to trim exposure as country fundamentals are still deteriorating Overweight quasi-sovereignsRussia state owned or supported entities (VTB, Gazprom,

Russian Agricultural Bank, for example)Latin american infrastructure/commodities (EPM, TGI,

Petrobras, Pemex, Panama Canal Railways)Asian development banks, electricity related companies, etc.


Interest Rates

Curves are steep, and already pricing in hikes

Carry is king, buy long end bonds where rates are relatively high and no hikes on the horizon (Brazil, Mexico, Turkey, Hungary, Indonesia)

Get ready to pay rates in the front end where the easing cycle is clearly over (Israel, Czech, Poland, Korea, China, India)

Clip the coupons, until inflation rears its ugly head


Foreign Exchange As growth slowly recovers, and zero rates prevail in G10, buy higher yielding EMFX

Brazil, Turkey, Hungary, South Africa, Indonesia, Mexico

Volatility likely through 2009 as data wavers between recovery and slowdown (differing views of trend GDP growth)

The dollar may suffer as fiscal deterioration and Fed bal sheet expansion takes hold, absent a traditional recovery

G10 fx already overvalued, much of EM still undervalued


EMFX undervalued relative to Developed FX

70

75

80

85

90

95

100

105

110

115

120

125

130

73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Broad "other important trading partners" USD index

Broad "Major currencies" USD index

Source: US Federal Reserve


A Closer look at the BRICs: Brazil

Brazil was growing fast when credit crisis hitFast, decisive action by central bank offset liquidity issues

Is the market right on interest rate bounce?Election year coming, fiscal deterioration is apparent, but CB

and market forecasts take account of this

Likely to be one of fastest countries to return to trend growthAttracting capital flows of all kinds

Our favorite local currency investment for 2009-2010


BRICs, Continued: Russia

Economic fundamentals still deteriorating Huge unwind of corporate leverage dragging on resources and economy Growth -8.5-9% for 2009, rebound to 4.5% possible in 2010 with oil price recovery Rising NPLs a trouble for non-state supported financial institutions Risk of capital flight on RUB We like the state-supported corporate debt – high yield, high state support, low risk of default


BRICS, continued: India

Massive fiscal and economic stimulus has kept economy growing 6% 2009, expecting 7.5% 2010

Inflation starting to move higher, interest rate increases expected early next year

Inflows to equity markets key driver for currency

Pay rates, short usdinr


BRICS, continued: China

“THE” engine of world growth – investment led V-shaped recovery Growth sustainable through 2010Even without export recovery, economists expect 9-10%

growth in 2010 Policymakers concerned about bubbles, fine tuning lending and interest rates Domestic consumption picking up, though exports still lagging Longer term reforms beginning (social safety net) Bond market not open, fx stable, equities key moving asset


2010: Off the roller coaster, on to the carousel


Up and down


Round and round


It will hopefully be more fun than last year!

El Fin!

Documents

For Institutional Use Only1 Emerging Markets: What’s an Investor to Do? Outlook to 2010 and beyond Sara Zervos, Oppenheimer Funds