Global Investing

What a varied bunch emerging markets have become. At last week’s monetary policy meetings, we saw one rate rise (Serbia) and differing messages from the rest. Mexico turned dovish while hitherto dovish Brazilian central bank finally mentioned the inflation problem. Russia meanwhile kept markets guessing, signalling it could either raise rates next month or cut them.

This week, a cut looks likely in Turkey while South Africa and the Philippines will almost certainly keep interest rates steady.

Turkey’s main policy rate – the one-week repo rate – and overnight lending rate are widely expected to stay on hold at 5.50 percent and 9 percent respectively on Tuesday. But some predict a cut in the overnight borrowing rate – the lower end of the interest rate corridor, motivated partly by the need to keep the currency in check.   The lira is trading near 10-month highs, thanks to buoyant inflows to Turkish capital markets.  That has helped lower inflation from last year’s double-digit levels.

Goldman Sachs in fact, reckon the central bank will cut both the borrowing and lending rates by 25bps and also raise the Reserve Option Coefficient (the amount of foreign currency that lenders have to provide for the gold portion of their central bank reserves). They write:

We believe that the Bank has shifted focus towards the financial stability risks posed by accelerating capital inflows, and away from domestic inflation. We believe a combination of ROC hikes and (more visibly) cuts to the borrowing and lending rates, bringing the interest rate corridor down, will be used to lean against these inflows and their subsequent FX appreciation pressures.

Global markets have found themselves at an interesting juncture of underlying new year bullishness stalled by trepidation over several short-term headwinds (US debt debate, Q4 earnings, Italian elections etc etc) – the net result has been stalemate, something which has sunk volatility gauges even further. Not only did this week’s Merrill funds survey show investors overweight bank stocks for the first time since 2007, it also showed demand for protection against a sharp equity market drops over the next 3 months at lowest since at least 2008. The latter certainly tallies with the ever-ebbing VIX at its lowest since June 2007. Though some will of course now argue this is “cheap” – it’s a bit like comparing the cost of umbrellas even though you don’t think it’s going to rain.

Anyway, the year’s big investment theme – the prospect of a “Great Rotation” back into equity from bonds worldwide – has now even captured the sceptical eye of one of the market’s most persistent bears. SocGen’s Albert Edwards still assumes we’ll see carnage on biblical proportions first — of course — but even he says long-term investors with 10-year views would be mad not to pick up some of the best valuations in Europe and Japan they will likely ever see. “Unambiguously cheap” was his term – and that’s saying something from the forecaster of the New Ice Age.

For others, the very fact that Edwards has turned even mildly positive may be reason enough to get nervy! When the last bear turns bullish, and all that…

(corrects name of hedge fund in para 3 to Symphony Financial Partners)

Any doubt about the importance of a weaker yen in thawing the frozen Japanese economy will have been dispelled by the Nikkei’s surge to 32-month highs this week. Since early December, when it became clear an incoming Shinzo Abe administration would do its best to weaken the yen, the equity index has surged as the yen has fallen.

Those moves are giving sleepless nights to Japan’s neighbours who are watching their own currencies appreciate versus the yen. South Korean companies, in particular, from auto to electronics manufacturers, must be especially worried. They had a fine time in recent years  as the yen’s strength since 2008 allowed them to gain market share overseas. But since mid-2012, the won has appreciated 22 percent versus the yen.  In this period, MSCI Korea has lagged the performance of MSCI Japan by 20 percent. Check out the following graphic from my colleague Vincent Flasseur (@ReutersFlasseur)

David Baran, co-founder of Tokyo-based Symphony Financial Partners, notes the relative performance of Hyundai and Toyota (Hyundai shares have fallen 2.5 percent this year adding to 13.5 percent loss in the last quarter of 2012. Toyota on the other hand is up 5 percent so far in 2013 after gaining 31 percent in Oct-Dec last year). Baran says he has gone long the Nikkei and short the Seoul index (the Kospi) and (Hong Kong’s) Hang Seng, while taking a short position on the yen. He says:

What will happen first? A U.S. credit rating downgrade or the country’s unemployment falling below 7 percent?

Or Spain having no other option but to ask for a bailout?

Bank of America Merrill Lynch asked investors in its monthly fund manager survey what “surprises”  they saw coming up first this year.

And the result is: bad news will come first.

A U.S. debt downgrade got the top spot, with more than 35 percent of investors seeing that happen first, with crisis-hit Spain having to ask for more help a close second, at just over 30 percent.

When will Brazil’s central bank admit it has an inflation problem? Markets will be watching today’s rate-setting meeting for clues.

There is no doubt about the outcome of today’s meeting at the Banco Central do Brasil (BCB) — no one expects it to do anything but leave interest rates steady at the current 7.25 percent. But the BCB has been focused on growth for 18 months and has cut interest rates by 525 basis points in this time, its actions helping to drive the real 10 percent lower last year versus the dollar. The government meanwhile has unleashed huge doses of fiscal stimulus. The result, rather than a growth recovery, is a steady rise in inflation.

Goldman Sachs’ Latin America economist Alberto Ramos points out that Brazilian inflation came in above the 4.5 percent target for the third straight year in 2012 and the balance of inflation risks has deteriorated. Gasoline prices are to rise from next week and drought is making hydro-power generation more costly. Analysts polled by Reuters expect 2013 price growth at 5.53 percent. Ramos writes:

The international focus is on  gold-producing country Mali after days of French air strikes on al-Qaeda-linked Islamist rebel strongholds in the north of the West African country. France expects Gulf Arab states will help an African campaign against the rebels,  and a meeting of donors for the Mali operation is due at the end of the month. West African defence chiefs are meeting today to approve plans to speed up the deployment of 3,300 regional troops.

Mali isn’t normally on the radar screens of international portfolio investors, with little external debt and no developed capital markets.

But it is Africa’s third biggest gold producer, with London-listed Randgold the biggest investor and other foreign firms such as Anglogold also having investments.

Indonesia has just given the go-ahead for another leg down in the rupiah. It has cut its forecasts for the exchange rate to 9,700 per dollar compared to the 9,200 level at which the central bank used to step in. The currency has duly weakened and nervous foreigners have rushed to hedge exposure — 3-month NDFs price the rupiah at almost 10,000 to the dollar. The  rupiah last week hit a three-year low, its weakness coming on top of a dismal 2012 which saw it fall 6 percent as the current account deficit worsened. Traders in Jakarta are reporting dollar hoarding by exporters.

All that is spooking foreigners who own more than 30 percent of the domestic bond market. The currency weakness hit them hard last year as Indonesian bonds returned just 6 percent, a third of the sector’s 16 percent average (see graphic).

The central bank does not seem perturbed by the currency weakness. Luckily for it, inflation rates are still benign, which means a weak currency will probably remain in favour.

Emerging bonds have got off to a flying start in 2013, with debt funds taking in over $2 billion this past week, the second highest weekly inflow ever, according to fund tracker EPFR Global. Issuance is strong -  Turkey for instance this week borrowed cash repayable in 10 years for just 3.47 percent, its lowest yield ever in the dollar market.

Yet not everyone is optimistic and most analysts see last year’s returns of 16-18 percent EM debt returns as out of reach. The consensus instead seems to be for 5-8 percent as  tight spreads and low yields leave little room for further rallies — average yields on the EMBI Global sovereign debt index is just 4.4 percent.    Domestic bonds meanwhile could suffer if inflation turns problematic. (see here for our story on emerging bond sales and returns).

Now take a look at U.S. Treasury yields which are near 8-month highs. and could pose a headwind for emerging debt. Higher U.S. yields are not necessarily a bad thing for emerging markets provided the rise is down to a healthier economic outlook.  But that scenario could induce investors to turn their attention to equities and  indeed this is already happening. EPFR data shows emerging equity funds outstripped their bond counterparts last week, taking in $7.45 billion, the highest ever weekly inflow.

The first wave of Q4 US earnings, Chinese Q4 GDP  and European inflation dominate next week, while regional polls in Germany’s Lower Saxony the following Sunday give everyone a early peek at ideas surrounding probably the biggest general election of 2013 later in the year.

With a bullish start to the year already confirmed by the so-called “5 day rule” on Wall St, we now come to the first real test – the Q4 earnings season. There was nothing to rock the boat from Alcoa but we will only start to get a glimpse of the overall picture next week after the big financials like JPM, Citi and Goldman report as well as real sector bellwethers Intel and GE. Yet again the questions centre on how the slow-growth macro world is sapping top lines, how this can continue to be offset by cost cutting to flatter profits and – perhaps most importantly for investors right now – what’s already in the price.

For the worriers, there’s already been plenty of gloom from lousy guidance  and memories of Q3 where less than half the 500 beat revenue forecasts. But the picture is not uniformly negative from a market perspective. For a start, both top and bottom line growth estimates have already been slashed to about a third of what they were three months ago but should still outstrip Q3 if they come in on target. Average S&P500 earnings growth for Q4 is expected to be almost 3 percent compared to near zero in Q3 and revenue growth is expected at about 2 percent after a near one percent drop the previous quarter. What’s more, the market has been well prepared for trouble already — negative-to-positive guidance by S&P 500 companies for Q4 was 3.6 to 1, the second worst since the third quarter of 2001. So, wait and see – but there will have to be some pretty scary headlines for a selloff at this juncture.  It may be just as tricky to build any bullish momentum ahead of renewed infighting in DC over the debt ceiling next month, but the latter issue has been treated to date this year as a frustration rather than a game-changer.

Could Asia be headed for a debt crisis?

The very thought may seem ludicrous given the region’s mighty current account surpluses and brimming central bank coffers.  But a note from RBS analysts Drew Brick and Rob Ryan raises some interesting concerns.

Historically speaking, most EM crises have been borne on the back of excessive capital inflows, Brick and Ryan write. And in many Asian countries, the consequence of these flows has been over-easy monetary policy that has left citizens and companies addicted to cheap money. Personal and corporate indebtedness levels have spiralled even higher in the past five years as governments across the continent responded to the 2008 credit crunch by unleashing billions of dollars in stimulus.

First, some numbers and graphics:

a) Asia’s current account surplus stands now around $250 billion, less than half its 2007 peak as exports have slumped.