South African bond rush
It’s been a great year so far for South African bonds. But can it get better?
Ever since Citi announced on April 16 that South African government bonds would join its World Government Bond Index (WGBI), almost 20 billion rand (over $2.5 billion ) in foreign cash has flooded to the local debt markets in Johannesburg, bringing year-to-date inflows to over 37 billion rand. Last year’s total was 48 billion. Michael Grobler, bond analyst at Johannesburg-based brokerage Afrifocus Securities predicts total 2012 inflows at over 60 billion rand, surpassing the previous 56 billion rand record set in 2o1o:
The assumption..is based on the fact that South Africa will have a much larger and diversified investor base following inclusion in the WGBI expanding beyond the EM debt asset class
Currently South African bonds are restricted to emerging local bond indices. The most-widely used, JPMorgan’s GBI-EM, has less than $200 billion benchmarked to it and South Africa’s weighting is 10 percent. But the WGBI is a different matter altogether — around $2 trillion is estimated to track this index which currently includes just 22 countries, only three of them emerging markets. An expected 0.44 percent weighting for South Africa implies inflows of $5-$9 billion, analysts estimate.
Some of that cash has already come. How much more could roll in this year? Optimists point to Mexico – foreign ownership of the local debt market there rose to 31 percent from 24 percent over 2010, the year the country joined the WGBI, with $11 billion flowing in. But the picture in South Africa is in fact not that rosy. Inflows will undoubtedly pick up, benefiting both bonds and the rand but many reckon positioning in South African bonds is already pretty crowded – about a third of the market is in foreign hands already, analysts at Morgan Stanley reckon. Worse, the country faces a possible credit ratings downgrade this year (all three rating agencies have cut its ratings outlook to negative in recent months).
Kieran Curtis, a fund manager at Aviva Investors upped his holdings of South African local bonds after the WGBI news but is reluctant to go overweight, betting the market will benefit less than Mexico did two years ago. He cites two reasons — first South Africa’s budget deficit has been creeping higher and it follows that debt issuance will too. Second, the external backdrop is less supportive today than two years ago when the Fed was in full money-printing mode:
I wouldnt say I detect a very strong commitment in South Africa to restoring the budget to balance and those debt numbers can rise quickly when you have a 5-6 percent deficit. Also Mexico’s inclusion came at a time when U.S. Treasury yields were falling fairly quickly but now, with Treasury yields rising we may not get the same support for South Africa.
Hair of the dog? Citi says more LTROs in store
Just as global markets nurse a hangover from their Q1 binge on cheap ECB lending — a circa 1 trillion euro flood of 1%, 3-year loans to euro zone banks in December and February (anodynely dubbed a Long-Term Refinancing Operation) — there’s every chance they may get, or at least need, a proverbial hair of the dog.
At least that’s what Citi chief economist Willem Buiter and team think despite regular insistence from ECB top brass that the recent two-legged LTRO was likely a one off.
Even though Citi late Wednesday nudged up its world growth forecast for a third month running, in keeping with Tuesday’s IMF’s upgrade , it remains significantly more bearish on headline numbers and sees PPP-weighted global growth this year and next at 3.1% and 3.5% compared with the Fund’s call of 3.5% and 4.1%.
But its euro zone calls are gloomiest of all. First off, it sees two consecutive years of economic contraction of the bloc as a whole — a 1.0% shrinkage this year followed by 0.2% drop in 2013. Against this dire backdrop, it expects Spain to be forced to seek Troika (EU, IMF and ECB) support later this year that will be focussed on recapitalizing and restructuring its ailing banks and it also expects both Portugal and Ireland to need second bailouts from the same source.
And with that sort of pressure from deleveraging, austerity, sovereign debt stress and recession , the ECB will have to bring out yet another punchbowl, it reckons.
We expect that renewed EMU strains will prompt the ECB to launch at least one more multi-year LTRO and continue to pencil in one or two more rate cuts by end-2013.
Yet, just like the euphoric effects of both the binge and “morning after” drink, the problem with LTRO is that it risks causing more problems than it solves by tying the banks of weak peripheral euro states ever closer to their ailing sovereigns.
No hard landing for Chinese real estate
The desperate days when Chinese property developers offered free cars as an inducement to homebuyers look to be over.
Sales and earnings figures indicate some of the gloom is lifting as developers have enjoyed a second straight month of rising sales. Vanke, China’s biggest developer by sales, said last week that March sales had risen 24 percent year on year, while 2011 profits rose 30 percent. Another firm, China Overseas Land, posted a 21.5 percent profit rise last year.
The mood is reflected in stock prices. While the Shanghai shares index has risen less than 5 percent this year, a sub-index of Chinese property companies has risen 13 percent. Shares in Vanke and COL are up 13 percent and 22 percent respectively. A Reuters poll of fund managers showed that investors had upped their weighting for property stocks to 10.9 percent at the end of March, the highest level in two years.
The share rally has continued even though the government has dashed hopes it will soon wind down its two-year campaign to bring down property prices. It has also bucked a broad housing market slowdown (home prices fell for the fifth straight month in February) amid signs that Chinese authorities are unlikely to provide the economy with any further stimulus. Analysts at Citi said in a recent note:
Developers’ comfort under current tightening (policy) and confidence in a stable outlook suggests the toughest time for China’s property sector is over.
For a long time, the country’s real estate market — and the possibility of a crash there — has generated fear in the minds of China-watchers. That danger is by no means over — economic growth is cooling but inflation remains high. Companies too have warned that tough times still lie ahead.
But many such as Karine Hirn, Shanghai-based chief representative of asset manager East Capital, have never believed in an outright property sector collapse. China has an 80 percent home ownership rate and 25 million people work in construction, she points out. Real estate accounts for 13 percent of China’s GDP. So it is unlikely the government would ever have risked a property price crash. Hirn also points out that while sales in cities like Beijing and Shanghai are indeed slowing sharply,the market remains robust in Tier-3 cities – home to over half of China’s urban population.
Trash heap for sovereign CDS?
For all the ifs and buts about the latest euro rescue agreement, one of its most profound market legacies may be to sound the death knell for sovereign credit default swaps — at least those covering richer developed economies. In short, the agreement reached in Brussels last night outlined a haircut on Greek government bonds of some 50 percent as a way to keep the country’s debt mountain sustainable over time. But anyone who had bought default insurance on the debt in the form of CDS would not get compensated as long as the “restructuring” was voluntary, or so says a top lawyer for the International Swaps and Derivatives Association — the arbiter of CDS contracts.
ISDA general counsel David Geen said there would be no change in the ruling to account for the size of the haircut:
As far we can see it’s still a voluntary arrangement and therefore we are in the same position as we were with the 21 percent when that was agreed (in July)
Putting that in a bit more perspective, the International Monetary Fund’s Olivier Blanchard said in Dublin later on Thursday that the Greek deal could raise serious questions about the value of CDS as a hedging tool:
The general position is that if you are able to reduce the claims of creditors by a substantial amount without triggering a CDS event… that raises questions about the value of the CDS
If it’s true that CDS contracts on euro sovereign debts are effectively worthless to the extent that European governments can pressure their banks into accepting “voluntary” debt workouts, then that would mark a significant victory for politicians who have long argued that CDS speculation — especially by those not holding the underlying debt — was a major aggravator of the euro zone debt crisis. It’s worth remembering the words of IMF chief, then French finance minister, Christine Lagarde –who early last year questioned the “validity, solidity of CDSs on sovereign risks”.
The main charge against CDS is that it scared the horses excessively by creating panic among real creditors about default probabilities — becoming a self-fulfilling prophecy as debt refinancing suddenly became prohibitively expensive even though fiscal adjustment would always takes some time. There were also a concerns about potential conflicts of interest. Bans on “naked” CDS speculation were discussed and a whole “cat or canary” debate smouldered for the past two years. One of the biggest concerns among European officials was that triggering a “credit event” in CDS would reward this adverse speculation and fuel both direct financial and psychological contagion to other sovereigns. As a result, they set about ensuring the contractual bodyswerve that has subsequently satisfied ISDA.
The consensus is that a 50% haircut on Greek debt, short of triggering a credit event, will do more harm than good. Regulators are yet again undermining CDSs, the very instruments put in place to hedge against corporate and sovereign risk, leaving market participants questioning whether the focus was really on stabilizing the Euro Zone economy or it was a way to avoid a Lehman-style collapse of the Hellenic Republic of Greece.
From my perspective a Greek default would actually benefit the Euro Zone. This would provide a shot across the bow to Portugal, Spain or Italy to get their economies in order expeditiously, bringing more stability to the EU. The lynchpin to market stability is accurate, real-time pricing data. For example this afternoon, Greek CDSs were trading erratically with most showing a sharp tightening of their five-year spreads to around 54% upfront or 3,600 bps. This is a time when pricing data is vital. Without this information, customers have no visibility into the CDS market, inhibiting their ability to utilize this instrument to effectively hedge.
Ultimately we won’t know until sometime in 2012 how this will all play out. However, we do know we’re on the precipice of some market changing decisions within the CDS community as to whether these instruments can be used as an effective hedging tool moving forward.
–Jonathan Epstein, head of credit derivatives, SuperDerivatives
Back to the dance floor
It was Chuck Prince, former CEO of Citigroup, who famously said on July 9, 2007: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still standing.”
Little did he know the music did nearly stop for Citi with its shares tumbling to less than $2 in 2009 from $55 in 2007.
A year later, worldwide reflation from huge liquidity injection and stimulus packages helped the global economy from collapsing. The music may have started. The question is, should investors return to the dance floor?
Anthony Boeckh, president of U.S.-based Boeckh Investments, argues in his new book “The Great Reflation”, that they should, but only cautiously.
“Many people ask whether the Great Reflation will work… In one sense it already has; the crisis of 2008-2009 could have caused a depression but it didn’t,” Boeckh writes.
“But the Great Reflation certainly doesn’t solve any of the real problems… It did put some air back in the baloon but that was just Act I. Investors should be preparing for Act II. That will be all about correcting the structural problems, distortions and disequilibriums that came with 25 years of money and credit excesses and the series of asset bubbles.”
from DealZone:
R.I.P. Salomon Brothers
It's official: Salomon Brothers has been completely picked apart.
Citigroup's agreement to sell Phibro, its profitable but controversial commodity trading business, to Occidental Petroleum today puts the finishing touches on a slow erosion of a once-dominant bond trading and investment banking firm.
When Sandy Weill (pictured left) staged his 1998 coup -- combining Citicorp and Travelers, Salomon Brothers was a strong albeit humbled investment banking and trading force. Yet little by little, a succession of financial crises, Wall Street fashion and regulatory intervention has whittled away at the once-dominant firm.
Not long after the Citigroup was formed, proprietary fixed income trading -- once the domain of John Meriwether, was shut down after the Asian debt crisis fueled losses that Weill could not stomach.
The Salomon name disappeared long ago as investment bankers and underwriters were rebranded Citigroup Global Markets.
Now Phibro, the former Philips Brothers that merged with Salomon in the early 1980s, is to be cast off because its energy traders made too much money when the rest of the bank suffered losses and required a $45 billion of taxpayer bailout.
from Funds Hub:
The attraction of the toxic
Nothing like a bit of toxicity. Wealth managers at Citi are telling their clients to watch for a burst of hedge fund interest in bad assets. They reckon the biggest opportunity for hedge funds is probably around the Public-Private Investment Fund, which is part of the huge U.S. plan to stabilise the financial sector.
The idea is that the U.S. government will lend money to investors to buy up toxic assets from banks, thus setting a market price. But the notes are non-recourse ones, which means that any default is limited to the actual cost of whatever collateral is require. In short, it limits liability if asset prices fall.
As a result of this, Citi says, hedge funds are likely to find the system attractive. But it warns: "Returns are likely to be volatile, at least in the near term. To take advantage of these new opportunities, investors need a long time horizon and a lot of patience."
Who’s next for the Dow?
Arzu Cevik, director at Thomson Reuters Strategic Research, writes:
“With Citi shares trading below $1, the first time since 1970 that a “penny stock” traded on the Dow Jones Industrial Average, it is widely expected that it will be removed from the index.
“The company was added to the Dow in 1997 when it was still known as Travelers, and the last company to be removed from the Dow was AIG last September (when its stock hovered above $1) and was replaced by Kraft Foods.
“It’s also expected that General Motors may be removed from the Dow. GM shares are trading slightly above $1 and there’s speculation it may be headed toward bankruptcy.
“There are other stocks in the Dow that are now a part of Wall Street’s Dollar Menu. In fact, there are currently five Dow stocks trading in the single digit range.
“Who will take their place in the Dow? Mostly likely, another company whose stock is faring better or relatively better in this recessionary environment.
“There aren’t too many of those but if I had to guess, I’d say it would have to be a company with a strong brand name and one that is viewed as influential. Also, one whose shares aren’t trading in the single digits.
The cover story of the latest Barron’s declares optimistically “Sure, stocks could slide much further — but they probably won’t. By most measures, they are downright cheap.”The Stock Research Portal comments that the article contains a “fatal flaw”: “the heavy reliance many economists, analysts, others place on historic trends and their application to current day prospects. Right or not, I believe that after the turn of the century the world has become a quite different place.”Via Stock Research Portal (www.stockresearchportal.com)
For better or worse?
Wealth managers at Citi Private Bank are telling their clients to stay neutral in their exposure to hedge funds at the moment, whether the strategy be event driven, equity long/short or macro. The main reason is that capital markets are still stressed and many hedge funds still need to deleverage.
The firm points out, however, that hedge funds had a good news-bad news kind of year in 2008. Based on the HFRX Global Hedge Fund Index, it was the worst performance on record. The index lost 23.3 percent. Its next worst performance was 2002 — and that was only a 1.5 percent decline.
Losses were widespread across all kinds of strategies. Only merger arbitrage and systematic macro gained anything.
The good news, so to speak, was that that this dreadful performance was better than what you would have got from just plain equities. The S&P 500, for example, lost 38.5 percent, meaning that the hedge fund index outperformed by a whopping 15.2 percentage points.
It was that kind of year.
Bah Humbug
Value managers and contrarian analysts long derided as permanent bears have been poking their heads out of the woods to bring some early Christmas cheer to delegates assembled at the CFA Institute’s European Conference in Amstedam.
James Montier, global strategist at SocGen, who likes to swim with sharks in his spare time, opened the conference on Tuesday by saying that he was more optimistic about equities than he had been for a long time, with the UK and European markets approaching bargain basement prices.
But on day two, Matt King, managing director, credit products strategy at Citigroup, rained all over this parade. “I have a message for equity investors,” he said. “It’s worse than you think!”
He argued that next year will be just as miserable as 2008, if not more so, for the majority of investors, as European bank deleveraging is only a third of the way through. “For credit investors it’s not as bad as we are still earning carry, but equity investors continue to amaze me with their over-optimism,” he said.
Citigroup’s equity strategists are forecasting 40 to 50 percent falls in EPS, and King foresees a weak recovery, more like that of the 1930s, as defaults have such a long way to go.
“Things have only stabilised because everything is on central bank life support – there has been no improvement in the underlying fundamentals,” he said. Because European banks are still unable to lend – due to regulation requiring further deleveraging – companies won’t be able to refinance, and will have to do everything they can to pay down their debt, or face liquidation, like UK retailer Woolworth’s. This will lead to cuts in capex and headcount, creating a strongly deflationary environment, spelling bad news for an equity market recovery.
Merry Christmas everyone.
One should duly note the stock market bottomed in July 1932, which was months before the banking system went into its death spiral … and years before the Great Depression ended.
