Global Investing

Weekly Radar: Market stalemate sees volatility ebb further

Global markets have found themselves at an interesting juncture of underlying new year bullishness stalled by trepidation over several short-term headwinds (US debt debate, Q4 earnings, Italian elections etc etc) – the net result has been stalemate, something which has sunk volatility gauges even further. Not only did this week’s Merrill funds survey show investors overweight bank stocks for the first time since 2007, it also showed demand for protection against a sharp equity market drops over the next 3 months at lowest since at least 2008. The latter certainly tallies with the ever-ebbing VIX at its lowest since June 2007. Though some will of course now argue this is “cheap” – it’s a bit like comparing the cost of umbrellas even though you don’t think it’s going to rain.

Anyway, the year’s big investment theme – the prospect of a “Great Rotation” back into equity from bonds worldwide – has now even captured the sceptical eye of one of the market’s most persistent bears. SocGen’s Albert Edwards still assumes we’ll see carnage on biblical proportions first — of course — but even he says long-term investors with 10-year views would be mad not to pick up some of the best valuations in Europe and Japan they will likely ever see. “Unambiguously cheap” was his term – and that’s saying something from the forecaster of the New Ice Age.

For others, the very fact that Edwards has turned even mildly positive may be reason enough to get nervy! When the last bear turns bullish, and all that…

In the meantime, we’ll just have to keep monitoring the incoming news and data for direction. The balance of risks is still on the upside over the course of the year, but there will be bumps. Year-to-date on the MSCI World is still up almost 3 percent as vol ebbs and euro peripheral debt auctions and sovereign debt prices continue to fly.

We still have to see Q4 China GDP this week and the US earnings season is just cranking up. Judging by JPM and Goldman on Wednesday , the banks look ok so far. GE will get into the real world economy a bit more on Friday. Next week we then have the big techs like Apple and Microsoft and this is the sector making many anxious. Beyond that, the radar captures potential signals from Lower Saxony’s elections  on Sunday for September’s German parliamentary polls, we have the first eurogroup of the year on Monday and outstanding issues such as legacy bank debts, a Franco-German summit in Berlin, January’s flash PMIs worldwide and UK Q4 GDP. Israel elections jump into the mix and a South African interest rate decision too as the  drums sound again on the notorious ‘currency wars’.

Rupiah decline – don’t worry

Indonesia has just given the go-ahead for another leg down in the rupiah. It has cut its forecasts for the exchange rate to 9,700 per dollar compared to the 9,200 level at which the central bank used to step in. The currency has duly weakened and nervous foreigners have rushed to hedge exposure — 3-month NDFs price the rupiah at almost 10,000 to the dollar. The  rupiah last week hit a three-year low, its weakness coming on top of a dismal 2012 which saw it fall 6 percent as the current account deficit worsened. Traders in Jakarta are reporting dollar hoarding by exporters.

All that is spooking foreigners who own more than 30 percent of the domestic bond market. The currency weakness hit them hard last year as Indonesian bonds returned just 6 percent, a third of the sector’s 16 percent average (see graphic).

The central bank does not seem perturbed by the currency weakness. Luckily for it, inflation rates are still benign, which means a weak currency will probably remain in favour.

Asia’s ballooning debt

Could Asia be headed for a debt crisis?

The very thought may seem ludicrous given the region’s mighty current account surpluses and brimming central bank coffers.  But a note from RBS analysts Drew Brick and Rob Ryan raises some interesting concerns.

Historically speaking, most EM crises have been borne on the back of excessive capital inflows, Brick and Ryan write. And in many Asian countries, the consequence of these flows has been over-easy monetary policy that has left citizens and companies addicted to cheap money. Personal and corporate indebtedness levels have spiralled even higher in the past five years as governments across the continent responded to the 2008 credit crunch by unleashing billions of dollars in stimulus.

First, some numbers and graphics:

a) Asia’s current account surplus stands now around $250 billion, less than half its 2007 peak as exports have slumped.

A yen for emerging markets

Global Investing has written several times about Japanese mom-and-pop investors’  adventures in emerging markets. Most recently, we discussed how the new government’s plan to prod the Bank of Japan into unlimited monetary easing could turn more Japanese into intrepid yield hunters.  Here’s an update.

JP Morgan analysts calculate that EM-dedicated Japanese investment trusts, known as toshin, have seen inflows of $7 billion ever since the U.S. Fed announced its plan to embark on open-ended $40-billion-a-month money printing.  That’s taken their assets under management to $67 billion. And in the week ended Jan 2, Japanese flows to emerging markets amounted to $234 million, they reckon. This should pick up once the yen debasement really gets going — many are expecting a 100 yen per dollar exchange rate by end-2013  (it’s currently at 88).

At present, the lion’s share of Japanese toshin holdings — over $40 billion of it — are in hard currency emerging debt, JP Morgan says (see graphic).

The Watanabes are coming

With Shinzo Abe’s new government intent on prodding the Bank of Japan into unlimited monetary easing, it is hardly surprising that the yen has slumped to two-year lows against the dollar. This could lead to even more flows into overseas markets from Japanese investors seeking higher-yield homes for their money.

Japanese mom-and-pop investors — known collectively as Mrs Watanabe -  have for years been canny players of currency and interest rate arbitrage. In recent years they have stepped away from old favourites, New Zealand and Australia, in favour of emerging markets such as Brazil, South Africa and Turkey. (See here  to read Global Investing’s take on Mrs Watanabe’s foray into Turkey). Flows from Japan stalled somewhat in the wake of the 2010 earthquake but EM-dedicated Japanese investment trusts, known as toshin, remain a mighty force, with estimated assets of over $64 billion.  Analysts at JP Morgan noted back in October that with the U.S. Fed’s QE3 in full swing, more Japanese cash had started to flow out.

That trickle shows signs of  becoming a flood. Nikko Asset Management, the country’s third  biggest money manager, said this week that retail investors had poured $2.3 billion into a mutual fund that invests in overseas shares — the biggest  subscription since October 2006. This fund’s model portfolio has a 64 percent weighting to U.S. shares, 14 percent to Mexico and 10 percent to Canada while the rest is split between Latin American countries.

After bumper 2012, more gains for emerging Europe debt?

By Alice Baghdjian

Interest rate cuts in emerging markets, credit ratings upgrades and above all the tidal wave of liquidity from Western central banks have sent almost $90 billion into emerging bond markets this year (estimate from JP Morgan). Much of this cash has flowed to locally-traded emerging currency debt, pushing yields in many markets to record lows again and again. Local currency bonds are among this year’s star asset classes, returning over 15 percent, Thomson Reuters data shows.

But the pick up in global growth widely expected in 2013 may put the brakes on the bond rally in many countries – for instance rate hikes are expected in Brazil, Mexico and Chile. One area where rate rises are firmly off the agenda however is emerging Europe and South Africa, where economic growth remains weak. That is leading to some expectations that these markets could outperform in 2013.

There have already been big rallies. Since the start of the year, Turkey’s 10 year bond has rallied by 300 basis points; Hungary’s by almost 400 bps; and Poland’s by 200 bps. So is there room for more.

Fitch’s Xmas gift for Hungary leaves analysts agog

Hungary’s outlook upgrade to stable from positive by Fitch was greeted with incredulity by many analysts. Benoit Anne at Societe Generale wonders if the decision had anything to do with the Mayan prophecy that proclaiming the end of the world on Dec. 21:

What is the last crazy thing you would do on the last day of the world? Well, the guys at Fitch could not find anything better to do than upgrading Hungary’s rating outlook to stable. Now, that really makes me scared.

A bit brutal maybe but the point Anne wants to make is valid — nothing fundamental has changed in Hungary — its GDP growth and debt numbers are looking as dire as before and the central bank is still subject to political interference.

Hungary’s forint and rate cut expectations

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.

The BBB credit ratings traffic jam

Adversity is a great leveller. Just look at the way sovereign credit ratings in the developed and emerging world have been converging ever since the credit crisis erupted five years ago. JPMorgan  has crunched a few numbers.

Few were surprised last week by S&P’s decision to cut the outlook on Britain’s AAA rating to negative. That gold-plated rating is becoming increasingly rare — according to JP Morgan, just 15 percent of global GDP now rates AAA with a stable outlook — a whopping comedown from 50 percent in 2007. Only 13 developed economies are now rated AAA, compared to 21 before the crisis. And only one, Australia, now has a higher rating (AAA) than in 2007 — 16 of its peers have suffered a total of 129 downgrades in this period.  With 20 rich countries on negative outlook, more downgrades are likely.

Emerging sovereigns, on the other hand, have enjoyed 189 upgrades (43 percent of these were moves into investment grade). That has caused what JPM dubs “a traffic jam”  in the triple B ratings area, with 20 percent of world GDP now rated at this level, compared to 8 percent in 2009.

EM interest rates in 2013 – rise or fall

This year has been all about interest rate cuts. As Western central banks took their policy-easing efforts to ever new levels, emerging markets had little recourse but to cut rates as well. Interest rates in many countries from Brazil to the Czech Republic are at record lows.

Some countries such as Poland and Hungary are expected to continue lowering rates. Rate cuts may also come in India if a reluctant central bank finds its hand forced by the slumping economy. But in many markets, interest rate swaps are now pricing rate rises in 2013.

Are they correct in doing so? Emerging central banks will raise interest rates by an average 8 basis points next year, JP Morgan analysts predict.  UBS, in a recent note, reckons more EM central banks will raise rates than cut them. Analysts there offer the following graphic detailing their expectations: