Global Investing

Deutsche’s emerging markets bear sticking to his guns

Emerging markets bear John-Paul Smith first made his call to underweight emerging equities at the end of 2010. In a note released late on Monday he points out that such a position would have paid off handsomely — since end-2010 emerging equities have underperformed MSCI’s World index by 27.5 percent and U.S. MSCI by 37.6 percent.

 

Smith, who is head of emerging equity strategy at Deutsche Bank, sees no reason to change his call. Reckoning that the cyclical heyday of emerging markets is past, he is advising clients to hold on to developed and U.S. equities at the expense of emerging markets. The reason? China, pivotal for the rest of the EM world for commodities, trade.

Smith writes:

We are maintaining our existing underweight recommendations for GEM versus DM/US and current country weightings within GEM because the ongoing structural deterioration in the sustainable growth rate of the Chinese economy will continue to be the dominant narrative for the GEM equity asset class, in our view. Since the start of the year it has been increasingly evident at the micro level that the massive increase in total corporate financing has not as yet fed through into anything resembling a commensurate pickup in final demand.

Recent data from China would appear to bear that out. Economic growth and industrial data have both disappointed while Fitch has downgraded the country’s local currency rating, warning of risks to the economy from so-called shadow banking. And corporate results have not been reassuring — over 70 percent of companies, whether Hong Kong- or mainland-listed, undershot earnings forecasts for 2012,  according to Thomson Reuters Starmine data.

Smith again:

From a more bottom-up perspective, the ongoing deterioration in the underlying return on invested capital has now reached a point which threatens the viability of the entire economy.

Show us the (Japanese) money

Where is the Japanese money? Mostly it has been heading back to home shores as we wrote here yesterday.

The assumption was that the Bank of Japan’s huge money-printing campaign would push Japanese retail and institutional investors out in search of yield.  Emerging markets were expected to capture at least part of a potentially huge outflow from Japan and also benefit from rising allocations from other international funds as a result.  But almost a month after the BOJ announced its plans, the cash has not yet arrived.

EM investors, who seem to have been banking the most on the arrival of Japanese cash, may be forgiven for feeling a tad nervous. Data from EPFR Global shows no notable pick-up in flows to EM bond funds while cash continues to flee EM equities ($2 billion left last week).

Tokyo Sonata calls the tune for investors

The jury may be out on whether Messrs. Abe and Kuroda will succeed in cajoling the Japanese economy from its decades-long funk but the cash is betting they will. Domestic and foreign investors have stampeded for Tokyo equities, and Morgan Stanley has been crunching the numbers.

Since 2005, Japanese investors built up a 14 trillion yen (over $140 billion) portfolio of foreign equities. But between January-March 2013, they offloaded a third of this — about $39 billion.  Going back to July 2012 when they first started bringing cash home, the Japanese have sold $53 billion in foreign equities, or 36 percent of equity holdings.

If one were to include all foreign portfolio investments, they sold a net $74 billion worth of assets in the first three months of 2013. Morgan Stanley says this is the the most since 2005. You can see their graphic below (click on it for a bigger version).

BRIC banks reap ratings reward from government support

The ability of Brazil, Russia, India and China to support their leading banks is tightly correlated to the credit rating on the banks, according to ratings agency Moody’s. The agency compares the ratings of four of the biggest BRIC banks which it says are likely to enjoy sovereign support if they run into trouble.

China’s Industrial & Commercial Bank of China (ICBC) tops the list of BRIC lenders with a rating of (A1 stable)  thanks to the central bank’s $3 trillion plus reserve stash.

Brazil’s Banco do Brazil  (Baa2 positive) is in investment grade territory but it still fares better than the State Bank of India (SBI) (Baa3 stable) and Russia’s Sberbank (Baa3 stable) at one notch above junk status.

Weekly Radar: Question mark for the ‘austerians’

One of the more startling moves of the week was the fresh rally in euro government debt – with 10-year Italian and Spanish borrowing rates falling to their lowest since late 2010 when the euro crisis was just erupting and 2-year Italian yields even falling to 1999 euro launch levels. The trigger? There’s been a slow build up for weeks on the prospect of new Japanese investor flows  seeking liquid overseas government bonds  – but it was signs of a sharp slowdown in Germany’s economy that seems to have had a perversely positive effect on the region’s asset markets as a whole. The logic is that German objections to another ECB rate cut will ebb, as will its refusal to ease up on front-loaded fiscal austerity across Europe. If its own economic engine is now suffering along with the rest, significantly just five months ahead of German Federal elections, then a tilt toward growth in the regional policy mix may not seem so bad for Berlin after all. And if euro economies are more in synch, albeit in recession rather than growth, then perhaps it will lead to a more effective regional policy response.

All that plays into the intensifying “growth vs austerity” debate, which had already shifted at the Washington IMF meetings last week and was sharpened this week by by EU Commission chief Barroso’s claim that the high watermark of EU’s austerity push had passed. On top of the Reinhart/Rogoff research farrago, it’s been a bad couple of weeks for the “austerians”, with only a UK Q1 GDP bounceback of any support for case of ever deeper fiscal cuts,  and investors smell a change of tack. Their reaction? Not only have euro government borrowing costs fallen  further, but euro equities too rallied for 4 straight days through Wednesday. Those arguing that investors would run screaming at the sight of a more growth-tilted policy mix in Europe may have some explaining to do.

Next week is back on monetary policy watch however. The ECB takes centre stage amid rate cut talks hopes for help for credit-starved SMEs. The FOMC meets stateside aswell just ahead of the critical US April employment report.

Mini rotation

Well, I think we’ve successfully put to bed the idea that there’s any structural shift from bonds to equities going on (see here, here and here). Maybe time to look a little more closely at the numbers to pull out some more discrete swings in allocations.

We’ve just published the latest data on mutual fund and ETF flows from Lipper and there are, as ever, some clues. The snapshot of our interactive graphic below shows flows into and out of bond funds during March. You can click on the image to access the full graphic, or just click here.

One notable trend, and it represents a continuation from last month too, is the move away from corporate debt funds.

Rwanda plays into African debt demand

Rwanda is planning to launch its debut $400 million 10-year Eurobond today, less than two decades (corrects time period) after it was torn apart by genocide. It is the latest chapter in the story of African bond issuance which has stepped up in recent years, exploiting investors’ hunger for yield.

The bond may yield well above 7 percent — attractive at a time when Italian 10-year yields, one of the riskier punts within the euro zone,  have fallen below 4 percent.  Frontier markets broker Exotix has the Rwandan deal as one of its five fixed income trades to watch. Their analysts say:

Rwanda’s economic fundamentals are not that bad, but potential bond investors will be concerned about aid dependence.

Why Abenomics is leading to a squid shortage in Japan

“Abenomics” — Prime Minister Shinzo Abe’s aggressive reflationary fiscal and monetary policy — is widely praised for injecting optimism into the world’s third largest economy and making Tokyo stocks the best performing equity market in the world this year.

However, in Japan, something odd is happening as a result of Abenomics — a big shortage of squid.

Japan Squid Fisheries Association (JAFRA) decided to halt all fishing operations this Friday and Saturday because a weaker yen is pushing petrol prices higher, to the extent that going out to the sea will bring a guaranteed loss. The yen has lost more than 13 percent against the dollar since the start of the year.

Will gold’s glitter dim in India?

Indians have reacted to the latest gold prices falls by — buying more gold. And why not? Aside from Indians’ well known passion for the yellow metal (yours truly not excluded) gold has by and large served well as an investment: annual returns over the past five years have been around 17 percent, Morgan Stanley notes.

Now, gold’s near 20 percent plunge this year has wiped some $300 billion off Indians’ gold holdings, Morgan Stanley estimates in a note (households are believed to own about 15,000 metric tonnes of gold). So is the gold rush in India over?

Possibly. Indian gold imports have doubled to around 3 percent of GDP in the past five years. That rise is partly down to greater wealth which translates into more wedding jewellery purchases. But the more unpleasant side of the equation is India’s inflation problem. Look at the following charts from MS that shows how negative real interest rates have encouraged savings in gold rather than financial instruments:

Weekly Radar: Second-guessing Japan flows as global growth slows

Figuring out what was driving pretty violent market moves this week was trickier than usual – and that says something about how much the herd has scattered this year, with ‘risk on-risk off’ correlations having weakened sharply. Just as everyone puzzled over a potential “wall of money” from Japan after the BOJ’s aggressive reflation efforts, the bottom seemed to fall out of gold, energy and broader commodity markets – dragging both equity markets and, unusually, peripheral euro zone bond yields lower in the process.  As dangerous as it may be to seek an overriding narrative these days, you could possibly tie all up these moves under the BOJ banner – something along these lines: the threat of a further yen losses pushes an already pumped-up US dollar ever higher across the board and undermines dollar-denominated  commodities, which have already been hampered by what looks like yet another lull in global demand. Developed market equities, whose Q1 surge had been reined in by several weeks of disappointing economic data and an iffy start to the Q1 earnings season, were then hit further by a lunge in heavy cap mining and energy stocks. The commodities hit may also help explain the persistent underperformance of emerging markets this year. What’s more the lift to Italian and Spanish government bonds comes partly from an assumption any Japanese money exit will seek U.S. and European government bonds and relatively higher-yielding euro government paper may be favoured by some over the paltry returns in the core ‘safe havens’ of Treasuries or bunds. The confidence to reach for yield has clearly risen over the past six months as wider systemic fears have receded – something underlined in dramatic style this week by a huge lunge in gold,  now lost almost 20 percent in the year to date.

While all that logic may be plausible, there have been dozens of other reasons floating around for the seemingly erratic twists and turns of the week.

The only truth so far is that everyone is still just guessing about the likely extent of a Japanese outflow and confidence about global growth has received another setback.