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China economic reforms may result in $14.4 trillion GDP, growth at 6 percent – Asia Society report

Sweeping economic reform initiated by China President Xi Jinping in November 2013 marked a turning point for the world's second biggest economy. If implemented fully, China's potential GDP growth can be sustained at 6 percent through 2020. One risk: Falling short of that growth rate could result in growth at half that projection, or worse, leading to a new economic crisis, according to a new study.

Dan Rosen, founding partner, Rhodium Group

Dan Rosen, founding partner, Rhodium Group

Dan Rosen, author of a report for the Asia Society Policy Institute, argues that China's growth model is no longer working. The drivers that contributed to China's post-1978 growth are weakening, with existing investments showing diminished returns and overall total-factor productivity, or TFP, falling. TFP is an economic term that broadly measures efficiency using input factors such as labor and capital. "Demographic dividends propelled China through the 1980s, 1990s, and 2000s, but the labor force is now at its largest and is poised to shrink," he writes.

Yet Rosen said China has not exhausted its growth potential. He forecasts decades of solid growth if President Xi can pull off bold economic reform. No small task.

"We conclude that the overhaul is well conceived and showing movement, and that if fully implemented can sustain growth at 6% through 2020," Rosen told the Global Markets Forum. "Keeping GDP at or above 6% though 2020 delivers a $14.4 trillion Chinese GDP, which supports $10 trillion in two-way financial flows and a Chinese trade deficit thanks to greater imports. That's great for the region and great for the global outlook."

Rosen has been analyzing China's economy for about two decades, first at the Peterson Institute, then at the White House/National Security Council and most recently at the Rhodium Group, a research and advisory group he co-founded.

from Global Markets Forum Dashboard:

GMF @HedgeWorld West, World Bank/IMF and Financial & Risk Summit Toronto 2014

(Updates with guest photos and new links).

Join our special coverage Oct. 6-10 in the Global Markets Forum as we hit the road, from the West Coast to Washington to the Great White North.

GMF will be live next week from the HedgeWorld West conference in Half Moon Bay, California, where we’ll be blogging insight from speakers including Peter Thiel, former San Francisco 49ers great Steve Young and other panelists' viewpoints on the most important investment themes, allocation strategies, reputation risk management ideas and more.

 

 

Eric Burl, COO, Man Investments USA

Eric Burl, COO, Man Investments USA

Our LiveChat guests at HedgeWorld West include Jay Gould, founder of the California Hedge Fund Association, on Monday; Rachel Minard, CEO of Minard Capital on Tuesday; and Eric Burl, COO of Man Investments, on Wednesday discussing the evolving global investor. If you have questions for them, be sure to join us in the GMF to post your questions and comment.

Follow GMF’s conference coverage and post questions live via our twitter feed @ReutersGMF as well, where we’ll post comments from other HedgeWorld panelists. They include: 

Bleak investment outlook sours mood at Russia forum

By Alexander Winning

What are the chances that Western investors will rush back to Russia if a shaky ceasefire in Ukraine leads to a more lasting peace? Pretty slim, judging by a keynote speech at a recent Russia-focused investment conference in London.

Dmitri Trenin, director of the Carnegie Moscow Centre, told the conference organised by Sberbank CIB, the investment-banking arm of Russia’s top state-controlled lender, there was little prospect of significant Western investment in Russia over the next 5 years:

I would be surprised if much foreign direct investment flowed into Russia from Germany and other Western countries. But there will be more investment coming from China.

Indian shares: disappointment may lurk

Should Indian shares really be at record highs?

The index is up 3.6 percent this year. Foreign funds have been pouring money into Mumbai shares, betting that the opposition BJP, seen as more reform-friendly than the incumbent Congress, will form the next government. They purchased $420 million worth of Indian stocks last Friday, having bought $1.4 billion over the past 15 trading sessions.

There is also the fact that the rolling crisis in emerging markets, having smacked India during its first round last May, has now moved on and is ravaging places such as Russia and Nigeria instead. The rupee has firmed almost 2 percent this year to the dollar, as last year’s 6.5 percent/GDP current account deficit has contracted to just 0.9 percent of GDP.  Many international funds such as Blackrock and JPMorgan Asset Management have Indian stocks on overweight and Bank of America/Merrill Lynch’s monthly survey showed investors’  underweight on India was one of the smallest for emerging markets.

Indian company earnings may have beaten forecasts by around 5 percent so far in the season. But prospects can hardly be described as attractive. Indian economic growth is running at less than 5 percent. Valuations are in line with historical averages and at a 4 percent premium to global emerging markets on a book-value basis. But John-Paul Smith at Deutsche Bank says it is “the least bad” of the BRICs and is neutral to overweight.

Waiting for current account improvement in Turkey

The fall in Turkey’s lira to record lows is raising jitters among foreign investors who will have lost a good deal of money on the currency side of their stock and bond investments.  They are also worrying about the response of the central bank, which has effectively ruled out large rate hikes to stabilise the currency. But can the 20 percent lira depreciation seen since May 2013 help correct the country’s balance of payments gap?

Turkey’s current account deficit is its Achilles heel . Without a large domestic savings pool, that deficit tends to blow out whenever growth quickens and the lira strengthens . That leaves the country highly vulnerable to a withdrawal of foreign capital. Take a look at the following graphic (click on it to enlarge) :

In theory, a weaker Turkish lira should help cut the deficit which has expanded to over 7 percent of GDP.  Let us compare the picture with 2008 when the lira plunged around 25 percent against the dollar in the wake of the Lehman crisis. At the time the deficit was not far short of current levels at around 6 percent of GDP.  By September 2009 though, this gap had shrunk by two-thirds to around 2 percent of GDP.

Red year for emerging bonds

What a dire year for emerging debt. According to JPMorgan, which runs the most widely run emerging bond indices, 2013 is likely to be the first year since 2008 that all three main emerging bond benchmarks end the year in the red.

So far this year, the bank’s EMBIG index of sovereign dollar bonds is down around 7 percent while local debt has fared even worse, with losses of around 8.5 percent, heading for only the third year of negative return since inception. JPMorgan’s CEMBI index of emerging market corporate bonds is down 2 percent for the year.

 

While incoming Fed boss Janet Yellen has assured markets that she doesn’t intend to turn off the liquidity taps any time soon, JPMorgan still expects U.S. Treasury yields to end the year at 2.85 percent (from 2.7 percent now). That would result in total returns for the EMBIG at minus 7 percent, the CEMBI  at minus 2 percent and GBI-EM at minus 7-9 percent, JPMorgan analysts calculate.

Turkish savers hang onto dollars

As in many countries with memories of hyperinflation and currency collapse, Turkey’s middle class have tended to hold at least part of their savings in hard currency. But unlike in Russia and Argentina, Turkish savers’ propensity to save in dollars has on occasion proved helpful to companies and the central bank. That’s because many Turks, rather than just accumulating dollars, have evolved into savvy players of exchange rate swings and often use sharp falls in the lira to sell their dollars and buy back the local currency. Hence Turks’ hard currency bank deposits, estimated at between $70-$100 billion –  on a par with central bank reserves — have acted as a buffer of sorts, stabilising the lira when it falls past a certain level.

But back in 2011, when the lira was in the eye of another emerging markets storm, we noticed how some Turks had become strangely reluctant to sell dollars. And during this year’s bout of lira weakness too, Turkish savers have not stepped up to help out the central bank, research by Barclays finds. Instead they are accumulating dollars — “rather than being contrarian, their behaviour now seems aligned with global capital flows,” Barclays  analysts write. While the lira has weakened to record lows this year, data from UBS shows that the dollarisation ratio, the percentage of bank deposits in foreign currency, has actually crept up to 37.6 percent from 34.5 percent at the start of the year. Here’s a Barclays graphic that illustrates the shift.

What are the reasons for the turnaround? In the past, those selling dollars to buy back cheap lira could be confident they would not be out of pocket because the central bank would support the lira with higher interest rates.  But ever since end-2010, when the bank embarked on a policy of determinedly keeping interest rates low, they no longer have this assurance. Barclays write:

Pakistan, Nigeria, Bulgaria… the cash keeps coming

The frontier markets juggernaut continues. Here’s a great graphic from Bank of America/Merrill Lynch showing the diverging fund flow dynamic into frontier and emerging equity markets.

What it shows, according to BofA/ML  is:

Frontier market funds with year-to-date inflows of $1.5 billion have decoupled from emerging markets ($2.1 billion outflows year-to-date)

In other words, frontier fund inflows since January equate to 44 percent of their assets under management (AUM), the bank says.

No more currency war. Mantega dumps the IOF

Brazil’s finance minister Guido Mantega, one of the most shrill critics of Western money-printing, has decided to repeal the so-called IOF tax, he imposed almost three years ago as a measure to fend off  hot money flows.

Well, circumstances alter cases, Mantega might say. And the world is a very different place today compared to 2010. Back then, the Fed was cranking up its printing presses and the currency war (in Mantega’s words) was raging; today the U.S. central bank is indicating it may start tapering off the stimulus it has been delivering. Nor is investors enthusiasm for emerging markets what it used to be.  Brazil’s currency, the real, is plumbing four-year lows against the dollar and local bond yields have risen 30 basis points since the start of May. Brazil’s balance of payments situation meanwhile, is deteriorating, which means it needs all the foreign capital  it can get, hot money or otherwise. And currency weakness spells inflation — bad news for Brazil’s government which faces voters next year.

The IOF did work — Brazil’s local debt markets received just over $10 billion last year, Bank of America/Merrill Lynch calculates — a third of 2010 levels, and much of the cash that was already invested, preferred to stay put (given the IOF is paid upon exiting the country).

Emerging local debt: hedges needed

The fierce sell-off that hit emerging market local currency debt last month was possibly down to low levels of currency hedging by investors, JPMorgan says.

Analysts at the bank compare the rout with the one May 2012, caused by exactly the same reason — higher U.S. yields. There was a difference though — back then EM currencies dropped more than 8% on the month but EM local bonds, unlike last month, were little changed.

Gauging hedging levels is usually a tricky business. But JPM uses the results of its monthly client surveys to analyse the differing moves: