World Cup waste

Jul 9, 2014 22:32 UTC

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A horrible semi-final loss to Germany isn’t the only depressing result to come out of the World Cup for Brazil. The economy isn’t doing so well, and the international soccer tournament doesn’t seem to be helping much. This wasn’t totally unexpected: a Moody’s report from the spring estimated that the World Cup would have exactly zero impact on Brazilian GDP. The report concludes that “while the event offers a potential reputational benefit, it could be marred by a reprise of the social unrest seen last June or if needed infrastructure was not ready.” So far, there’s not been a ton of unrest, but the infrastructure is incomplete.

Fusion’s James Young reports from Fortaleza that the promised light rail system for the host city lies unfinished, and “cars, buses, and motorbikes must bump over a wide, dusty patch of waste ground” to get to the stadium. Young’s story — worth reading in full — is about the middle class Brazilians, who are unlikely to get anywhere near the stadiums. In Brazil generally, Young writes, “while individual earnings and personal credit have grown … the services provided by the state—housing, urban infrastructure, and sanitation, for example—have rarely kept up.” Matt Slaughter and Jaana Remeswrite at Project Syndicate that while Brazil is the world’s seventh-largest economy, it ranks 95th in per capita GDP. That’s largely because it ranks so low in connectedness: “flows of goods, services, finance, people, and data and communications.”

A more recent report from Moody’s, out this week, estimates GDP growth at 1.3% this year and 1.5% in 2015 (the economy grew by 2.5% in 2013, and 7.5% in 2010). Inflationis at nearly 6.5%. A recent Gallup poll revealed that 55% of Brazilians think the World Cup is going to hurt the economy, despite government claims that the event created a million jobs and a sense that the cup is at least good for the country’s reputation. Brazilians should be mad about the event’s economic waste, writes Cullen Roche, because “it’s one of those situations where the government tries to do something for the public good, but sacrifices the long-term for the near-term. It’s just not good business or good government.”

“In football and in living standards, Brazilians have experienced an abrupt downgrading of their prospects from promising to hugely problematic,” writes Mohamed El-Erian. However, on the brighter side, he thinks Brazilians’ disappointment over the World Cup loss is likely to show up in the upcoming October elections. That, in turn, “could lead to a market rally as investors become more optimistic about the possibility of economic reforms under a new government after the elections.” UBS’s head of emerging market strategy, Geoffrey Dennis, has similar thoughts. He told Bloomberg:

It is such a humiliating defeat that you wonder whether it will have a negative impact on Brazilians’ psyche. It’s going to confirm to the people that “Look, our economy is struggling, we cannot get any growth, now we don’t even have a decent football team either.”

— Shane Ferro

On to today’s links:

The Fed
FOMC minutes: The taper will end in October - Federal Reserve
Jeremy Stein: “There’s no free lunch when central banks try to use broad new regulatory powers to stabilize the financial system” - Ylan Mui

“Cohen is the second French bond executive in the U.S. to quit finance and pursue cooking dreams in the last month” - Bloomberg

Should the CFPB regulate bitcoin? - Joe Adler

A lot of the kids Peter Thiel pays not to go to college end up going anyway - Techcrunch

Productivity growth last year was the worst since the recession - Marketwatch

Sovereign Debt Problems
Sovereign creditworthiness is deteriorating - FT

Our Society Is Doomed
CYNK — with a $4 billion market cap and zero revenues as of today — has one employee who “devotes approximately 10 hours a week to the Company” - SEC

MORNING BID – Detangling Ukraine

Mar 3, 2014 13:59 UTC

Geopolitical situations are difficult ones to interpret from a markets perspective. For the time being, markets are responding to the escalation of hostilities in Ukraine – where Russia has bloodlessly taken control of the Crimea region and is threatening more action in the eastern part of the country – with a bit of negativity. The action is notable in U.S. equity futures, down more than one percent, and some buying in the safe haven that is U.S. Treasuries, along with bond markets around the globe.

Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management, said it well enough in describing the market views so far, that “the fallout for the equity markets may be minor over the medium-term. The short-term is more of a gamble. It should serve as a reminder that you don’t put grocery money for the next month in risky assets.”

This isn’t a surprise, of course, nor is it a surprise that the G7 nations are looking at ways to sanction Russia or to boot it out of the G8, easier in theory than in actual practice. The pass-through effects on the world are hard to determine. Ukraine is a big grain producer and disruption to those supplies would result in an inflationary environment there. Also, some of the exported oil out of Russia passes through Ukraine, so it’s not hard to imagine scenarios where the world economy is affected by some kind of escalation that goes beyond what people expect at this particular moment.

Citigroup strategist Tobias Levkovich, in a morning note, said as much: Companies with big international exposure are likely to keep underperforming but “this is far different than worrying that the near 70 percent of sales and earnings in North America would be threatened by events in the Crimea, which is rather unlikely.”

That still seems far-fetched, and the overnight trading in VIX futures does not betray a particularly lofty level of anxiety, with the March VIX contract jumping to about 16.5 from the Friday close of 15.10; with the spot VIX at 14, the level of worry remains subdued for the time being, though it will rise in morning trading today.

The most stark example of the effect on the markets is in the currency world, where the Ukrainian hryvnia has lost more than 20 percent so far this year, as well as the Russian ruble, which has also dropped substantially, though not as much as its Ukrainian cohort. The overnight action is not encouraging here either, as Moscow stocks are off sharply – 11 percent! – and the ruble has dropped another 2 percent.

MORNING BID – Making it up on volume

Feb 4, 2014 14:50 UTC

Monday was the worst day in the stock market since June. And while you can go through all the machinations and point out that the market is still down just 5 to 6 percent from its record high – and you’d be right – that doesn’t really translate to a strong environment at this time.

Not when the selloff continues through to overseas markets, with the Nikkei down 4 percent, Hong Kong losing more than 2 percent and ending at the day’s lows, and Europe down as well. So far the US market is experiencing something of a dead-cat bounce, but we’ll see how long that can last.

Part of the problem comes from the ignominious statistics that arrived with Monday’s selloff, most of which related to volume. Specifically, just a shade under 3 million E-mini futures contracts traded on Monday amid the sharp decline in the S&P, one that saw big selloffs in the transportation stocks (along with everything else – just 10 stocks ended the day higher).

That one-day volume is the biggest for the E-minis since Feb. 25 of last year, so that registers as (to use a genteel term) a puke-fest, or rather, a “distribution day,” a sign that sellers are right now much more motivated than buyers. A chart of the last several days of futures trading shows the volume has been higher on the down days and weak on the up days. (Furthermore, volume in CBOE VIX futures hit an all-time high in January, so investors were at least buying cheap protection against a market decline.)

The market’s predilection has been to react more harshly to the bad news than good – another indicator that right now, equity managers see stocks as fairly valued, given the economic environment and the reduction in Fed monetary stimulus.

Earnings season in general has been better than expected – the growth rate has ticked up to about 9.7 percent for the fourth quarter, and revenue growth is at 0.9 percent – better than expected, anyway. But the market’s not taking any solace from this (downgraded estimates for all of 2014 have something to do with it) – instead reacting harshly to a plunge in new orders in the ISM survey and lackluster car sales figures, even though weather clearly had an effect.

The declines Monday might be the beginning of the end of the selloff – a few more days like this and there might just be enough in the way of distribution days to where investors have truly had enough. But we came into the year at valuation levels higher than the historic norm (pick your valuation stat, be it forward P/E ratio or the cyclically adjusted P/E ratio, if you like), and so several months of churning activity wouldn’t be a surprise, nor would it be seen as unhealthy.

What isn’t clear is how much the market will continue to take cues from the weakened emerging markets, which haven’t finished with their selling, either.

MORNING BID – Contagion abounds, and the Super Bowl

Jan 31, 2014 13:57 UTC

On Thursday, this column suggested that a bunch of stock markets selling off in tandem did not satisfy the definition of contagion. Central banks dumping U.S. assets, weak auctions of government debt in seemingly less related countries, and big sell offs in less affected currencies? That’s getting closer to the mark.

Foreign central banks cut their holdings of U.S. debt stored at the Federal Reserve by the most in seven months in the past week, in a bid to defend weak currencies. “It makes sense,” said Scott Carmack, fixed income portfolio manager at Leader Capital, which has $1 billion under management. “It will probably continue as emerging markets try to prop up their currencies.”

So, overall foreign holdings of securities like Treasuries, mortgage-backed securities and agency debt at the Fed fell by $20.77 billion to $3.325 trillion in the week ended Wednesday, the biggest drop since June. The overall draw-down has come to about $55 billion since the Fed first said it would cut back its monthly bond buying. Debt and equity funds, meantime, continue to shift away from the emerging markets, with EPFR reporting a pullback of about $10 billion from such funds; debt funds have shed $4.6 billion so far in 2014, about one-third of 2013′s total drawdown of $14.3 billion (and that’s for a full year).

While in some ways, the most attractive solution for some of these countries to try to stem capital flight is through higher interest rates (making their debt more attractive to investors who need a bigger return over inflation, which is too hot in places like Brazil and Turkey), higher rates aren’t going to entirely solve the problem. And so you get the spectacle of Hungary cutting its 1-year Treasury bill auction and yields rising by about two-thirds of a percentage point just to garner enough interest for what they did manage to sell.

Hungary’s less in danger than some other countries. It’s got a big current account surplus rather than a deficit, but that hasn’t stopped investors from pulling back there either, driving the forint to a two-year low against the dollar.

The ongoing weakness in currencies – which many analysts say has not yet run its course – is going to pinch economic growth in tandem with higher rates. This can sometimes launch a vicious cycle that has consumers in those countries saving money rather than spending it – again, because of inflation. Combine that with a slowing in capital flows, and a weak export environment thanks to the China slowdown, and it gets a lot uglier, as Reuters’ Sujata Rao pointed out in an overnight story.

She quotes Steve O’Hanlon, a fund manager at ACPI Investments, who summarizes it well by saying: “Markets are pricing a pretty dire situation in emerging markets (but) is EM cheaper given potential future output? I wouldn’t say so but it’s getting there. When currencies stop selling off, if (governments) produce real reforms, I will be investing in those markets. If you don’t see any reforms, the rate hikes will just destroy growth, discourage investors and make the situation far worse.”

On the U.S. side of things, the stock market might see a bit of relief, however briefly. The outperformance by bonds against stocks this month might spur some reallocation trades, helping the market on its last day of the month. So it’s got that going for it, which is nice. Of course, futures are getting hit hard this morning, so maybe this is false hope.

From a more grounded (well, ridiculous) perspective, it’s the Super Bowl this weekend in the U.S.

Strategists have long made sport of the vaunted “Super Bowl Indicator,” which, for a long time, stipulated that when teams in the National Football Conference (the 49ers, Giants, Cowboys, to name a few) were victorious, the stock market was in line for a good year, but when teams in the American Football Conference (Dolphins, Raiders) won the big game, the equity market was set for a bad year.

That was modified a few years ago to include old NFL teams that had migrated to the AFC – the Steelers and the Baltimore Colts (this column does not recognize teams that move in the middle of the night.) So that puts us in a unique position this year.

First off, the AFC team is the Broncos, so a win by them should put the market on track for weakness for the rest of 2014. This is, of course, undermined by the fact that when the Broncos do win (and they won in early 1998 and early 1999), the market does pretty darned well. Furthermore, their opponent, the Seattle Seahawks, spent most of their existence in the NFC before moving to the AFC a few years back. If the Steelers and Colts can be grandfathered into the good side of the ledger, it stands to reason that the Seahawks ought to be included on the bad side of the ledger, no?

MORNING BID – The prime directive

Jan 30, 2014 14:08 UTC

So, it’s been a few days. Which means the markets have hit that point in the Star Trek episodes when the Klingons were temporarily short of torpedoes, which gave the Enterprise crew time to suss out what was going on.

Some of the missiles were fired. Big rate hikes from Turkey and South Africa, that followed a rate hike from India, and a few conclusions are inescapable:

  1. The selling hasn’t run its course yet
  2. Rate hikes aren’t enough to turn the tide in favor of a struggling currency because people extrapolate that higher rates are going to pinch growth
  3. People may have been holding out hope that the Federal Reserve would have nodded in some way to the emerging markets and got no quarter from Ben Bernanke as he dropped the mic and disappeared in a puff of smoke at his last-ever Fed meeting.

Add in the latest – a decline in China’s manufacturing – and the pullback certainly has not run its course. Overnight volumes and trading during the NY cash session showed once again that the better volumes have been on the selling, rather than the buying.

The question now is how far this can go? And that depends on what kind of developments we’re looking at. If there’s a massive flight of capital, the selling will remain indiscriminate, and long-running. It’s not too encouraging that the Turkish lira’s rally was good for a few hours and not much more, and nobody even tried to take the South African rand that much higher at all.

But let’s hold fast on the ‘contagion’ notion for a bit here, because ‘contagion’ does not simply mean ‘a whole load of people selling stocks.’ So we’ve seen actions from central banks in India, Turkey, South Africa and earlier Indonesia, and Citigroup suggests Russia could take surprise action in a couple of weeks as well. Having central banks take the initiative to force adjustments in policy is preferred on some levels to the damage markets can dish out (though markets can keep dishing it out also).

But the true measure of contagion relates to how quickly short-term funds leave a country, how much of a country is dependent on foreign funding of longer-term obligations (do foreigners own all the short term debt? If so, not good – Turkey’s short-term external debt is equal to 116 percent of its FX reserves, leaving it unable to defend against capital flight, according to Morgan Stanley,) current account balances, and a few other factors. In a note late Wednesday, Morgan Stanley threw in China exposure to the mix as well, noting that those exporting lots of commodities – be it fuel, metal or ore – are in a more precarious position.

The more troubled nations when it comes to debt issues – like Brazil, Turkey or South Africa – are a bit less exposed to China than Malaysia or South Korea, but they’re plenty exposed, and the latter two don’t have problems with current account deficits and as much in the way of short-term funding. Closer to home, Goldman Sachs notes that just 5 percent of S&P 500 sales derive from emerging markets, and that during EM selloffs, the S&P tends to fall about half as much – with the most exposed naturally being materials and energy sectors.

So there’s some comfort on the U.S. side of things. Still, with US growth not helping emerging markets and China’s slowing and adjustment to the debt it has in its economy weighing heavily, the contagion problem is a very real one that may rear its head in a bigger way. If a slew of rate hikes can head off massive capital flight, the slow growth that comes from higher rates may be something individual economies can deal with. However, that’s only if this is enough of a confidence-inducing measure to keep investors somewhat invested. That’s a big ‘IF.’

MORNING BID – Turkey, the Fed, and we all float down here

Jan 29, 2014 14:46 UTC

The messy sell-off in emerging markets was stemmed overnight after Turkey surprised everyone by raising rates to 12 percent – but it didn’t last. Major averages in Britain and Germany opened at their highs of the day but have since faded, and even though the big rate increases in Turkey, South Africa and India are meant to stem capital flight, so far the market’s shooting first and asking questions later. S&P futures were up about 20 points after the Turkey rate hike – an odd move for such a localized event – and we’re seeing the reaction now, which, to quote Tom the cat about the ‘white mouse no longer being dangerous,’ “DON’T…YOU…BELIEVE…IT.” So we’re lower, and continue to head lower, and for those of you new to the markets, this is what’s called a selloff.

The big question: Will the Federal Reserve defer its tapering campaign in recognition of emerging-markets difficulty? One could say the Fed cannot be expected to act as the underwriter for global risk-taking, but you’d be laughed out of the room, given the performance of assets around the world in the last several years as the Fed went into full-QE mode.

On the other hand, there’s a difference between providing broad support to the markets (via helicopter or not) and an actual admission that you’re changing policy to respond to specific issues worldwide, and such a move strikes us as the latter, not the former. With that in mind, it would be remiss to think the Fed does not continue at its measured pace, dipping down to $65 billion in bond purchases per month this time, as Janet Yellen takes the reins and we find out what kind of situation the new Fed head has gotten herself into while Ben Bernanke eases into what one hopes is a steady and muted retirement (think Johnny Carson, not Alan Greenspan).

For one, eventually reducing the monthly stimulus to zero at least gives the Fed room to ratchet up that stimulus again if they really need to.
Furthermore, the emerging markets, in a sense, are already gone. No, it’s not a disaster yet – but the implosion of China’s shadow banking system, the resignation of every Turkish official in Ankara, and the, well, uh, never mind, Argentina is Argentina, and isn’t going to be solved by the Fed put. The Fed might give it lip service in its statement but any more than that really ratchets up the moral hazard.

Furthermore, when one takes a look at the relative strength of emerging markets stocks with the U.S. market, it’s clear EM has been struggling for a while anyway. A comparison of relative performance between the MSCI EM index (.MSCIEF, or EEM.P if you’re into the ETF thing) is at 0.7 or so, and U.S. markets have been the steady outperformer since the beginning of 2013, and that outperformance accelerated throughout the year but particularly in the second quarter when the Fed started talking about reducing stimulus in the first place.

That doesn’t mean they can or will reverse course – it makes no sense. But less liquidity washing ashore means a bad investment can no longer be covered by smoke and mirrors. The MSCIEF’s relative performance index is still looking terrible, having fallen below the 30 level that indicates an oversold condition. It’s not quite at the nadir of the June 2013 or May 2012 selloffs, but it’s close, so if there’s a place one might expect some buying, it’s now. But it’s not happening yet – and that does raise questions about whether we’ll see more soothing words from central banks.

Back in the USA, the Treasury is readying its first-ever auction of two-year floating-rate securities, likely to see demand from various types of investors.
There are currently more than $200 billion in agency and “supra-sovereign” floating rate notes outstanding, mostly from Federal Farm Credit and Federal Home Loan Bank, per Morgan Stanley data. So, Treasuries should add nicely to the mix here, and it’ll quickly become a very big dog in a very small pond (dogs can jump in ponds, go with the analogy). So the $15 billion will add to the week’s mix of other supply.

For one thing, this gives the Treasury the chance to manage its issuance a bit more by reducing the number of short-dated auctions of bills, instead issuing this note that resets based on market rates for floating-rate notes. It will helpfully cut back on the weird dislocations that the market has seen of late in bills that are maturing just as the United States is set to run afoul of the debt limit (again) or face some kind of annoying only-in-Washington-type spectacle.

(Of course, if it was all two-year floaters, then in the month it had more floaters coming just as a budget crisis hit, those yields would go through the roof. So you can’t entirely solve the Washington problem this way, and floating-rate notes as far as we know cannot hold Congressional office).

The other advantage for the Treasury is the lack of what’s called “term premium,” which Morgan Stanley says will lead to interest-rate payment savings.
Term premium refers to how much additional interest you have to offer someone who is taking the risk of buying longer-dated securities (and therefore risking wide swings in interest rates or other unforeseen events over a five-year period vs. say, six months). But floating rate notes have no such provision (they float, after all), so that *should* save Treasury some money.

Reuters’ bond correspondent Richard Leong points out they’re expected to sell with a yield of 0.10 percentage point, almost a quarter less in the two-year fixed-rate note supply sold on Tuesday. So, that’s savings for Uncle Sam until the FRN yield rises above the fixed-rate two-year notes. Overall, the interest rate should be greater than what’s embedded in notes, though, which is good for money market funds (they hold about $276 billion of floating rate notes already).

FRNs are great in an environment where interest rates are on the rise, which has been the case for several months now (until this month that is), and therein, of course, lies the danger. If rates fall, well, not so great, as the interest rate on the notes would be chipped away.

MORNING BID – Emerging Markets, Apple, Ma Bell, and whatever else one can think of

Jan 28, 2014 13:56 UTC

In the words of Inigo Montoya, let me explain. No, there is too much. Let me sum up.

The market’s most immediate issues remain tied specifically to what’s going on overseas, particularly in Turkey. There, monetary authorities are meeting on a potential interest rate hike as a way of getting on top of the inflation problem (inflation’s at 7.5 percent, and the central bank’s lending rate is, uh, 7.75 percent).

So that’s a problem: Inflation is running real hot, the lira is in free-fall, and as Reuters’ Mike Peacock in London points out, the consensus view for a rate hike puts it at about 10 percent for when the bank announces its decision at midnight Istanbul time, 5:00 p.m. Eastern time (1000 GMT). Will that be enough to put a floor under the lira? Perhaps.

Now, U.S. companies don’t exactly have a lot of exposure to Turkey, and in this emerging markets rout we’re in the midst of right now, there’s a real question as to whether we’ve reached that “contagion” level. Sure, everything is selling off, but that’s not quite the definition, and it will take a little bit more time and effort – that is, more wholesale selling, liquidation of positions across various countries – to really call this a contagious effort. There are worrisome signs on that front, though. An analysis by Reuters’ Sujata Rao-Coverley, Dan Bases and Vidya Ranganathan points out that the increased funding through publicly traded fixed-income markets rather than bank lending means these markets are more intertwined, leading to the possibility of more selloffs that feed on each other.

Emerging markets with big current account deficits.

Back in 1998, bank loans were the funding mechanism for lots of emerging countries. Furthermore, the sheer dollar volume now dwarfs what was out there in the 1998 Asian contagion that later saw the collapse of the ruble. EM bonds are now in the range of $10 trillion, versus $422 billion in 1993, per JP Morgan; funds benchmarked to EM have assets of $603 billion, more than double what existed in 1997. EM ETFs? About $300 billion now – compared with nothing in 2004. And let’s remember the main ETF for emerging markets – EEM is the symbol – which is routinely the second-most active ETF in the United States. Long-term investing this ain’t, and the flight exacerbates the worries.

After three days of selling, emerging markets have stabilized a bit on Tuesday, so that’s something. Again, these selloffs often combine magnitude and time, with the swiftness only one part of it – the sheer ongoing nature of it is the other part. But that doesn’t mean preparations aren’t in order: David Kotok of Cumberland Advisors said his firm is raising cash levels, noting volatility tends to spike in forex markets when central banks have held interest rates near zero for a long time (which they have).

The real watcher is likely China’s shadow banking system and the possibility of problems there. Banks have been selling massive amounts of exposure to investment trusts to individuals for some time with promises of big returns and using that money invested for lots of lending; one of those trusts distributed by ICBC had to be bailed out this week. If there’s more of that to come, it’s a real question of what’s going on with the banking system’s health there – and that again leads to some uncomfortable conclusions about growth in China, which is far worse a problem than any crisis in Turkey, given its sheer size and influence.

Meanwhile, on a domestic front, Apple’s earnings weren’t what was expected. Sure, the company exceeded revenue forecasts and earnings forecasts, but it fell short of expectations on iPhone sales by a lot, and nobody’s happy about this. The stock was hit hard in after-hours action, and was, of late, down about 6 percent. Of course, selling 51 million phones over a three-month period isn’t exactly shabby, and the company is still making money hand-over-fist.

The disappointment comes, in part, from the realization that Apple’s growth rates just aren’t what they used to be, and that Samsung is widening its global lead in the smartphone market, with one report putting its sales at 86 million phones in the quarter. Samsung, of course, is selling more low-end phones, so it’s not like Apple is getting its head handed to it here, but its market share is down to about 17.6 percent from 22 percent, according to Strategy Analytics.

Carl Icahn’s recent calls for the company to get more aggressive in giving money back to shareholders through a big buyback are going to probably only get louder. This raises the chances that the company doubles down on the financial engineering strategy of growing earnings that admittedly has helped the shareholders of names like IBM, AT&T and Exxon Mobil, but doesn’t speak well from the innovation front for a lot of these names.

The company – the most valuable in the United States – had been banking on a big deal in China to sell even more phones, but the market is starting to look saturated on that front, Pacific Crest analyst Andy Hargreaves told Reuters’ Bill Rigby. And Apple doesn’t have a game-changing product on the horizon either right now, so that means the investment thesis comes down to volume. It’ll keep making scores of money, but reduced market share and pretty new colors and bells and whistles won’t be enough when “hardware can only go in one direction, and that’s flat or down,” said Alex Gauna of JMP.

If Apple is headed in the direction of AT&T, it’s going to eventually turn into one of those companies where investors get excited about special factors pumping up earnings results, and AT&T’s going to have that today when it reports results. What’s going on here? Pension related stuff – the market’s gains mean companies with lots of pension assets can mark those positions to market (read: make them bigger). And where previous years of losses can hurt those positions for the likes of Verizon, Ma Bell and UPS, this year it’s a help.

Verizon’s adjustment boosted S&P 500 earnings per share by 42 cents this quarter, and AT&T could make just as big a splash this time around. So AT&T is expected to record a gain of about $7.6 billion in the fourth quarter as a result of this, which is massive. Now, David Randall wrote a story a few days ago noting that few fund managers buy a stock based on this sort of thing – AT&T’s primary business is, uh, selling telephones, no, wait, ah yes, telecommunications – so if the business stinks, never mind the pension stuff.

But it’s nice that the pension funds are fully funded or better now, just in time for a big market correction.

MORNING BID – The selloff continues in emerging markets

Jan 27, 2014 14:00 UTC

It takes a lot to overshadow the heart of earnings season and a Federal Reserve meeting but the rout in emerging markets has managed to make that happen. This week is an important one. As my Reuters London colleague Mike Dolan pointed out, it will go a long way toward determining whether this is a rapid hot-money flight that gets stemmed after a brief correction or the start of a prolonged rout.

Fund withdrawals in recent weeks have shown a steady pullback from the emerging markets, though strategists at Bank of America-Merrill Lynch believe a “contagion” point hasn’t been reached yet – that would take several more weeks of similar outflows. It remains to be seen whether that will happen or not.

Already some managers, including those interviewed by Reuters’ David Randall and Ashley Lau in a ‘How to Play It’ piece over the weekend, are starting to see buying opportunities in the countries that are less dependent on external funding and a bit less messed up in the whole “governing” thing (no, Argentina, not you, you’re pretty messed up).

The selling has continued through Monday, although for now it appears U.S. futures are inclined to move higher, though one never knows ahead of key earnings releases this week. A report overnight on capital shortfalls for European banks is also not helping sentiment in the developed world, so if anything, U.S. markets might be inclined to fade a quick rally at the open just to avoid exposure at a time when the weakest hands in the market seem to be driving the action.

Which of course leaves the Fed. There’s been rumblings that the central bank ought to pay more attention to its effects worldwide, but of course that would take the existing “Fed put” and turn into a global insurance wrap inviting people to buy stocks and punish savers in fixed income. So while there’s some concern that the Fed would elect to hold off on more cuts to its stimulus, that just doesn’t seem like a logical choice. The moral hazard is too great, even considering how much credibility the central bank lost through the Greenspan years and most of Bernanke’s.

MORNING BID: The deepening EM selloff

Jan 24, 2014 16:01 UTC

The contagion is building. Major world markets are taking it on the chin, U.S. stocks have slumped, and major asset managers in Europe are seeing shares fall, with some citing corporate exposure to emerging markets in general and Spanish exposure to Latin America in particular.

Safe havens – from Treasuries to gold to the yen and Swiss franc – are way up. And really, while specific country issues are in play here, (Argentina is, well, Argentina), the removal of liquidity on one side of the world and a slowing economy on the other is enough to shake out some long-held notions of what’s going to be the environment.

Coming into the year, a prevalent view was that 2014 would work out as something similar to 2013; stock multiples would rise more, bond prices would fall, keeping yields higher, and investors would keep moving money into stocks, with the primary analysis being something along the lines of, “What else ya gonna do?” But January has, if anything, been a lesson in debunking just about all of the preconceived notions the market held onto at the end of last year.

U.S. stocks still haven’t done all that badly. Bond yields are lower, though, which wasn’t expected, and that comes at a time when fund managers are operating with some pretty dug-in ideas. As Bank of America-Merrill Lynch put it in a comment Thursday: “No one thinks stock markets will fall this year; our January survey revealed just 6% of investors believe bond yields will decline in 2014 and the level of distaste for Emerging Markets was tangible.”

Merrill itself falls into this category; they’re on the bullish side too, with their preferences being the US, Japan, real estate and high yield, relative to commodities, emerging markets and bonds. So those bets are being tested as well.

It’s not enough to say that what’s happening represents some kind of comeuppance from all of those who have gotten fat and happy on the market’s extended gains. After all, plenty of people dislike emerging markets, and they’re still dropping regardless of sentiment (and regardless of the usual contrarian “it’s gonna end!” type opinions starting to emerge, tentatively).

The pain trade is really rewarding investors by going into the bond market. The world economy does seem to be improving – though a weak Chinese manufacturing survey set off a cascade of selling across emerging markets that roped in some of the world’s weakest sisters already dealing with their own issues (Turkish lira, Russian ruble, South American bond markets, particularly Argentina and Venezuela.)

The selling has resulted in a bit of soul-searching. Manik Narian, emerging markets strategist at UBS in London, told Reuters’ Sujata Rao-Coverley that, “until now, there has been a lot of dedication shown by institutional investors in EM debt but possibly that’s being shaken now. There are signs it’s becoming a more broad-based move.”

The removal of liquidity figures to be an ongoing theme throughout the year, and that’s going to hit the more vulnerable markets – those nations with ugly balance-of-payments statements that reflect importing capital to pay for domestic spending.

It’s what felled Iceland a few years back, and looks to hurt Argentina once again, prompting the country to try to stop defending the peso, causing the worst one-day drop since 2002 on Thursday. (The economy minister said today that it wouldn’t allow it to continue to devalue, so file that under “Empty Threat of the Day.”)

The real question is how far the selling goes, how far developed market selloffs will go, and whether those looking for disaster are finally being vindicated.

MORNING BID – Only a dream in Rio

Jan 15, 2014 17:35 UTC

Among the BRIC nations, Brazil’s the one that’s been repeatedly whacked with a brick in the last couple of years, seeing its currency depreciate and its stock market trashed as it steadily ratchets up interest rates to an expected 10.25 percent this evening (or perhaps even 10.50 percent).

Most emerging nations were hit hard in the last year as the Federal Reserve announced it would start changing its strategy toward reduced bond buying, which will reduce some liquidity among dealers and result in less cash sloshing around in the vast ocean of world markets.

The last year was a rough one for Latin America overall, with most major averages sinking anywhere from 25 to 35 percent, but Brazil was in the unlucky position of already being kicked when it was down.

The MSCI Brazil Index now posts just a 4.1 percent return (annualized) over the past five years, which compares unfavorably with the other BRIC giants of China, India or Russia, to say nothing of Indonesia, Korea, Mexico or Peru.

So like Joe Btfsplk of the Li’l Abner comic, always walking with a dark cloud following him around (nobody got that reference to a Depression-era comic strip? Ok, never mind), Brazil has been faced with the poor choices of letting inflation get out of hand or continuing to try to pull a Volcker-style situation out of one’s hat, breaking inflation’s back in a way that somehow still results in things getting better later.

The IPCA consumer price index rose nearly 6 percent in 2013, as price increases have outpaced expectations for four years running (economic predictions in Brazil being about as accurate as they are in the United States).

Optimism in Brazil has dimmed of late, falling for the first time since the 2009 global financial crisis, according to public polling firms there.

The inflation problem is likely to get worse, according to Brown Brothers Harriman researchers, who said controlled prices were up just 1.5 percent in 2013 – meaning all other prices rose at more than a 7 percent clip in that year – adding “it’s likely that the pass-through impact from the weaker currency has not yet shown up fully in the numbers.” So, they’re forecasting a bump in the Selic rate to 10.5 percent from 10 percent, rather than the half-measure implied by a quarter-point hike.

Whether that brings back investors is another story: Latin American flows have been weak all year, according to Lipper data. The region hasn’t seen steady inflows since 2009, and that didn’t change in 2013, with more outflows.

The weakening real and slipping equity market would seem to provide an opportunity – this is, after all, the world’s seventh largest economy, as the World Bank says.

Years of rapid growth, though, have given way to the more recent 2 to 2.5 percent rate of growth, fine for a fully developed economy like the US (ok, it’s not, but work with me), but not so much for a faster-growing nation, and 2013 saw more than $12 billion in net forex outflows, the worst in a decade.

With Brazil’s current account deficit large and growing ($54 billion at the end of 2012, ranking it seventh worldwide), if sentiment turns even further from emerging markets, it’s Brazil, already getting hit this year, that could get it worse.