Global Investing

Morocco fears its stock market is on the verge of being re-classified as a frontier market when  index provider MSCI announces its annual rejig of equity indices this month.

Maybe it should pray for relegation instead. A report at the end of last week by Citi notes the boom in frontier market equities — they have risen 15 percent since the start of this year, a stark contrast to their better known, more liquid emerging market cousins which have fallen around 5 percent so far this year. In fact the performance of the frontiers — comprising less liquid, smaller markets from Kenya to Kazakhstan — has been more akin to the U.S. or Japanese equity markets which have earned investors double-digit returns this year.

Citi notes that the seven best returning markets in the world this year are all in the so-called frontiers, while the nine worst laggards are from the emerging world. Check out the graphic below. It shows how markets such as Kenya, Bulgaria and the United Arab Emirates have rallied more than 40 percent this year.

Many will find the divergence unsurprising. These indices are more likely to comprise  smaller consumer stocks and banks — in demand at the moment as profits fall at the big industrial and commodity giants that dominate emerging indices.  In most of these markets and especially in sub-Saharan Africa, penetration of services such as bank credit and mobile telephony is far lower than in emerging markets and companies usually have less competition to contend with. What’s more, frontier stocks, for the most part, are cheaper than their emerging peers — Citi puts the average discount at the moment at  22 percent.

In other words, if you want a punt on the emerging market consumer, go to the frontiers.

Of all the emerging currency and bond markets that are feeling the heat from the dollar’s rise, none is suffering more than South Africa. A series of horrific economic data prints at home, the prospect of more labour unrest and the slump in metals prices are making this a perfect storm for the country’s financial markets.

Some worrying data from the Johannesburg Stock Exchange this morning shows that foreigners sold almost 5 billion rand (more than $500 million) worth of bonds during yesterday’s session alone. Over the past 10 days, non-resident selling amounted to 10.7 billion rand. They have also yanked out 1.2 billion rand from South African equities in this time. And at the root of this exodus lies the rand, which has fallen almost 15 percent against the dollar this year. Now apparently headed for the 10-per-dollar mark, the rand’s weakness has eaten into investors’ total return, tipping it into negative return for the year.

What a contrast with last year, when a record 93 billion rand flooded into the country on the back of its inclusion in Citi’s prestigious WGBI bond index.  That lifted foreign holdings of South African bonds to well over a third of the total. Investors at the time were more willing to turn a blind eye to the rand’s lacklustre performance, liking its relatively high yield and betting on interest rate cuts to help the duration component of the trade.

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.

A rate cut in Hungary is considered a done deal today. But a sharp downward move in the forint  is making future policy outlook a bit more interesting.

The forint fell 1.5 percent against the euro on Monday to the lowest level since July and has lost 2.6 percent this month. Monday’s loss was driven by a rumour that the central bank planned to stop accepting bids for two week T-bills. That would effectively have eliminated the main way investors buy into forint in the short term.   The rumour was denied but the forint continues to weaken.

Analysts are not too worried, attributing it to year-end position squaring. Benoit Anne, head of EM strategy at Societe Generale, points out the forint is the world’s best performing emerging currency of 2012 (up  11.3 percent against the dollar). Given the state of the economy (recession) and falling inflation, the forint move will not deter the central bank from a rate cut, he says.

Israel’s financial markets had a torrid time on Monday as swirling rumours of an imminent air strike on Iran caused investors to flee. The shekel lost 1.4 percent, the Tel Aviv stock exchange fell 1.5 percent and credit default swaps, reflecting the cost of insuring exposure to a credit, surged almost 10 percent.

There has been a modest recovery today as the rumour mills wind down. But analysts reckon more weakness lies ahead for the shekel which is not far off three-year lows.  Political risks aside, the central bank has been cutting interest rates and is widely expected to take interest rates, currently at 2.25 percent, down to 1.75 percent by year-end. Societe Generale analysts are among the many recommending short shekel positions against the dollar. They say:

Expect the dovish stance of the Bank of Israel to remain well entrenched for now.

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

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%.

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.

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)

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?