Global Investing

Given almost biblical gloom about the world economy at the moment, you really have to do a double take looking at Wall Street’s so-called “Fear Index”. The ViX , which is essentially the cost of options on S&P500 equities, acts as a geiger counter for both U.S. and global financial markets.  Measuring implied volatility in the market, the index surges when the demand for options protection against sharp moves in stock prices is high and falls back when investors are sufficiently comfortable with prevailing trends to feel little need to hedge portfolios. In practice — at least over the past 10 years — high volatility typically means sharp market falls and so the ViX goes up when the market is falling and vice versa. And because it’s used in risk models the world over as a proxy for global financial risk, a rising ViX tends to shoo investors away from risky assets while a falling ViX pulls them in — feeding the metronomic risk on/risk off behaviour in world markets and, arguably, exaggerating dangerously pro-cyclical trading and investment strategies.

Well, the “Fear Index” last night hit its lowest level since the global credit crisis erupted five-years ago to the month.  Can that picture of an anxiety-free investment world really be accurate? It’s easy to dismiss it and blame a thousand “technical factors” for its recent precipitous decline.  On the other hand,  it’s also easy to forget the performance of the underlying market has been remarkable too. Year-to-date gains on Wall St this year have been the second best since 1998. And while the U.S. and world economies hit another rough patch over the second quarter, the incoming U.S. economic data is far from universally poor and many economists see activity stabilising again.

But is all that enough for the lowest level of “fear” since the fateful August of 2007? The answer is likely rooted in another sort of “put” outside the options market — the policy “put”, essentially the implied insurance the Fed has offered investors by saying it will act again to print money and buy bonds in a third round of quantitative easing (QE3) if the economy or financial market conditions deteriorate sharply again. Reflecting this “best of both worlds” thinking, the latest monthly survey of fund managers by Bank of America Merrill Lynch says a net 15% more respondents expect the world economy to improve by the end of the year than those who expect it to deteriorate but almost 50 percent still believe the Fed will deliver QE3 before 2012 is out.  In other words, things will likely improve gradually in the months ahead and if they don’t the Fed will be there to catch us.

What could possibly go wrong?? Well, lots — obviously. As Vanguard’s European CIO Jeff Molitor told us here this week: “No one can see around corners.” And the euro crisis of course remains top of the list of bogeymen. But here too the ECB has constructed its own “policy put” of sorts as ECB chief Draghi has pledged to bolster euro sovereign debt markets via the banks’ first ever bout of QE in the event of a request for a support progamme from ailing giants such as Spain and Italy.  What else? Hard landing signs in China? Fresh banking stress globally? All possible. But — all likely to be met with substantial policy reaction from the Fed at least if they hit the US economy badly again and threaten to  push already-high unemployment back up.

So calm is justified then?

Enter November’s U.S. Presidential election. The “Bernanke put”, as with the “Greenspan put” before it,  is rooted in the Fed’s dual mandate to pursue both full employment as well as price stability — a critical post-Depression orientation of the country’s entire macroeconomic policy approach that many economists insist has served the United States well over the past half century but which also riles many others, not least Paul Ryan, Republican presidential candidate Mitt Romney’s newly-appointed running mate for the position of Vice President.

One of the stories of this year has been the stupendous rally on emerging local currency debt, fuelled in part by inflows from institutional investors tired of their zero or negative-return investments in Western debt.  Norway’s sovereign wealth fund said last week for instance that it was dumping some European bonds and spending more of its $600 billion war chest in emerging markets.

Quite a bit of that cash is going to South Korea. Regulators in Seoul recently reported a hefty rise in foreigners’ bond holdings (see here for the Reuters story) and  Societe Generale has a note out dissecting the data, which shows that total foreign holdings of Korean bonds are now worth around $79 billion — back at levels seen last July.  Norwegians emerged as the biggest buyers last month,  picking up bonds worth 1.5 trillion won ($1.3 billion) , almost double what they purchased in the entire first half of 2012. Norway’s holdings of Korean Treasuries now total 2.29 trillion won, up from just 190 billion won at the end of 2011.

The growing interest from overseas investors would seem logical — South Korea stands on the cusp between emerging and developed markets, with sound policies, a current account surplus and huge currency reserves. And Socgen analyst Wee-Khoon Chong says the Norwegian crown’s recent strength against other currencies makes such overseas trades more attractive (the crown is up 6 percent versus the euro this year and has gained 5.3 percent to the Korean won). “Norwegians are the newbies into the KTB market,” Chong says. “They are probably recycling their FX reserves.”

Time was when investing in emerging markets meant buying dollar bonds issued by developing countries’ governments.

How old fashioned. These days it’s more about emerging corporate bonds, if the emerging market gurus at JP Morgan are to be believed. According to them, the stock of debt from emerging market companies now exceeds that of dollar bonds issued by emerging governments for the first time ever.

JP Morgan, which runs the most widely used emerging debt indices, says its main EM corporate bond benchmark, the CEMBI Broad, now lists $469 billion in corporate bonds.  That compares to $463 billion benchmarked to its main sovereign dollar bond index, the EMBI Global. In fact, the entire corporate debt market (if one also considers debt that is not eligible for the CEMBI) is now worth $974 billion, very close to the magic $1 trillion mark. Back in 2006, the figure was at$340 billion.  JPM says:

The Olympic medals have all been handed out and the athletes are on their way home.  Which countries surpassed expectations and which ones did worse than expected? And did this have anything to do with the state of their economies?

An extensive Goldman Sachs report entitled Olympics and Economics  (a regular feature before each Olympic Games) predicted before the Games kicked off that the United States would top the tally with 36 gold medals. It also said the top 10 would include five G7 countries (the United States, Great Britain, France, Germany and Italy), two BRICs (China and Russia), one of the developing countries it dubs Next-11  (South Korea), and one additional developed and emerging market. These would be Australia and Ukraine, it said.

Close enough, except that Hungary took the place of Ukraine as the emerging economy in the Top 10 and the United States actually took 46 gold medals — more than Goldman had predicted.

Lucky Australia. In a world of slowing economic growth its central bank today raised forecasts for 2012 GDP growth by a half point to 3.5 percent. That’s down to a mining boom, driven of course by China. But there’s a downside. Australia’s currency, the dollar (or affectionately, the Aussie), has steadily risen in recent years, and is up 3 percent versus the U.S. dollar this year. Unsurprisingly, the Reserve Bank of Australia tempered its good news on growth with a warning over the Aussie’s gains.

Analysts at Credit Agricole note that the Aussie’s gains this year have come in tandem with a rise in Japan’s yen. That in itself would have been highly unusual in the past: the yen is a so-called safe haven, the currency investors run to when all else is selling off, while the Aussie is a commodity currency, one that does well when world growth is looking good and risk appetite is high. CA analysts explain thus:

The role of the (Aussie) is probably changing from a traditional commodity currency to an increasingly attractive reserve currency.

There’s little or nothing to put your money into in Iran or Syria, and countries like Egypt and Tunisia are struggling to win investors back after their Arab Spring uprisings last year. But geopolitical risk is also seeping into other countries in the Middle East.

Lebanon is looking a tricky bet, as the country has seen clashes between supporters and opponents of the uprising against Syrian President Bashar al-Assad and the border region has been used by rebels to smuggle arms into Syria and take refuge from Syrian troops.

Farouk Soussa, Middle East economist at Citi in Dubai, says:

Syria is having a very big impact on people’s perceptions of risk in Lebanon. There is an increasing risk that if we do have regime change in Syria, it could mean change in Lebanon.

Belize’s so-called superbond has not proved to be a super investment proposition.

The country has set out proposals on how it might restructure the bond, which bundled together several old debts (hence its name) and the ideas have been greeted with horror by investors. Essentially, the government wants to reduce the principal of the bond by almost half while extending the maturity by 13 years, according to one of the proposals.  Interest rates on the issue, at 8.5 percent this year, could be cut to a flat 3.5 percent. Or investors could accept a 1 percent rate that steps up to 4 percent after 2019.

Markets had been expecting a restructuring ever since Prime Minister Dean Barrow said in February the country could not afford to keep up debt repayments. The bond duly fell after his comments but picked up a bit in recent months after Barrow assured investors the restructuring would be amicable.  Investors holding the bond are now nursing year-to-date losses of 24 percent, according to JP Morgan.

Following are notes from our weekly editorial planner:

Oh the irony. Perhaps the best illustration of how things have changed over the past few weeks is that risk markets now fall when Spain is NOT seeking a sovereign bailout rather than when it is! The 180 degree turn in logic in just two weeks is of course thanks to the “Draghi put” – which, if you believe the ECB chief last week, means open-ended, spread-squeezing bond-buying/QE will be unleashed as soon as countries request support and sign up to a budget monitoring programme. The fact that both Italy and Spain are to a large extent implementing these plans already means the request is more about political humble pie – in Spain’s case at least.  In Italy, Monti most likely would like to bind Italy formally into the current stance. So the upshot is that – assuming the ECB is true to Draghi’s word – any deterioration will be met by unsterilized bond buying – or effectively QE in the euro zone for the first time. That’s not to mention the likelihood of another ECB rate cut and possibility of further LTROs etc. With the FOMC also effectively offering QE3 last week on a further deterioration of economic data stateside, the twin Draghi/Bernanke “put” has placed a safety net under risk markets for now. And it was badly needed as the traditional August political vacuum threatened to leave equally seasonal thin market in sporadic paroxysms. There are dozens of questions and issues and things that can go bump in the night as we get into September, but that’s been the basic cue taken for now.  The  backup in Treasury and bund yields shows this was not all day trading by the number jockeys.  The 5 year bund yield has almost doubled in a fortnight – ok, ok, so it’s still only 0.45%, but the damage that does to you total returns can be huge.

Where does that leave us markets-wise? Let’s stick with the pre-Bumblebee speech benchmark of July 25. Since then,  2-year nominal Spanish government yields have been crushed by more than 300bps… as have spreads over bunds given the latter’s equivalent yields remain slightly negative.  Ten-year Spain is a different story – but even here nominal yields have shed 85bp and the bund spread has shrunk by 100bp.  The Italy story is broadly similar.  Euro stocks are up a whopping 12.5%, global stocks are up almost 7 percent, Wall St has hit its highest since May 1, just a whisker from 2012 highs.  Whatever the long game, the impact has and still is hugely significant. An upturn in global econ data relative to recently lowered expectations – as per Citi’s G10 econ surprise index — has added a minor tailwind but this is a policy play first and foremost.

So, climate change in seasonal flows? Well, it was certainly “sell in May” again this year – but it would have been pretty wise to “buy back in June”. Staying away til St Ledgers day would – assuming we hold current levels til then – left us no better off had we just snoozed through the summer.

Earlier this year it seemed that an increase in global bullishness meant the end of the road for risk-off investment strategies and, by extension, the rise in South African equities. However, 6 months later, the band is still playing, and the ship is refusing to go down.

South African equities have flourished in the face of the doomsayers, with returns this year doubling the emerging market benchmark equity performance. Both the all-shares index and the top-40 share have hit fresh all time highs this week, and prophecies of gloom for South African stocks appear to have missed the mark somewhat.

Part of the reason for this is that, when it comes to risk attitudes, much of the song remains the same. South Africa has certainly benefitted from its continued attractiveness to risk-off investors, as global bullishness has receded from whence it came. For instance, as it is relatively well sheltered from euro zone turmoil, and as major gold exporter, firms based in the gold sector are ostensibly an attractive investment for the globally cautious.

(The author is Head of EMEA Research at Thomson Reuters fund research firm Lipper. The views expressed are his own.)

By Detlef Glow

The exchange-traded fund (ETF) market has shown strong growth since its inception in Europe. Many fund promoters have sought to capitalise on this, seeking to differentiate themselves from rivals and match client needs by injecting some innovation into their product offerings. This has led to a broad variety of ETFs competing for assets, both in terms of asset classes and replication techniques.

Looking at assets under management, however, the European ETF market is still highly concentrated. The five top promoters account for more than 75 percent of the entire industry. On a fund-by-fund basis the concentration is even greater.