Global Investing

Emerging Markets: the love story

It is Valentine’s day and emerging markets are certainly feeling the love. Bank of America/Merrill Lynch‘s monthly investor survey shows a ‘stunning’ rise in allocations to emerging markets in February. Forty-four percent of  asset allocators are now overweight emerging market equities this month, up from 20 percent in January — the second biggest monthly jump in the past 12 years. Emerging markets are once again investors’ favourite asset class.

Looking ahead, 36 percent of respondents said they would like to overweight emerging markets more than any other region, with investors saying they would underweight all other regions, including the United States. Meanwhile investor faith in China has rebounded  with only 2 percent of investors believing the Chinese economy will weaken over the next year, down from 23 percent in January. China also regained its crown of most favoured emerging market in February.

Last year, the main EM index plummeted more than 20 percent as emerging assets fell from favour. So what is the reason for this renewed passion in 2012?

Firstly December’s LTRO — a multi-billion euro liquidity arrow from the cupids at the ECB has revived investor appetite for riskier emerging assets, boosting the index to around six-month highs since the start of the January. A second significant factor behind the resurgence in  risk sentiment is that the market is daring once again to hope for an improvement in global growth, says Gary Baker,  BofAML Global Research head of European equities strategy.

The big beneficiaries of all this have been emerging markets.  It’s not just about liquidity. Clearly the actions of the ECB have been vitally important… but what you’ve also seen is an improvement in global growth optimism. If optimism over growth is improving  then there may well be a more fundamental underpinning to the movement.

Greece’s interest burden, post-PSI, will remain huge

It seems Greece has finally reached a deal on austerity measures needed for a bailout. But what about PSI?

(ECB President Mario Draghi just said he heard it was close to a deal. It’s been close for a few weeks though…)

JP Morgan says Greek PSI is hardly going to change the heavy interest burden on the country and the issue of default will inevitably come up.

January in the rearview mirror

As January 2012 drifts into the rearview mirror as a bumper month for world markets, one way to capture the year so far is in pictures – thanks to Scott Barber and our graphics team.

The driving force behind the market surge was clearly the latest liquidity/monetary stimuli from the world’s central banks.

The ECB’s near half trillion euros of 3-year loans  has stabilised Europe’s ailing banks by flooding them with cheap cash for much lower quality collateral. In the process, it’s also opened up critical funding windows for the banks and allowed some reinvestment of the ECB loans into cash-strapped euro zone goverments. That in turn has seen most euro government borrowing rates fall. It’s also allowed other corporates to come to the capital markets and JP Morgan estimates that euro zone corporate bond sales in January totalled 46 billion euros, the same last year and split equally between financials and non-financials..

Sparring with Central Banks

Just one look at the whoosh higher in global markets in January and you’d be forgiven smug faith in the hoary old market adage of “Don’t fight the Fed” — or to update the phrase less pithily for the modern, globalised marketplace: “Don’t fight the world’s central banks”. (or “Don’t Battle the Banks”, maybe?)

In tandem with this month’s Federal Reserve forecast of near-zero U.S. official interest rates for the next two years, the European Central Bank provided its banking sector nearly half a trillion euros of cheap 3-year loans in late December (and may do almost as much again on Feb 29). Add to that ongoing bouts of money printing by the Bank of England, Swiss National Bank, Bank of Japan and more than 40 expected acts of monetary easing by central banks around the world in the first half of this year and that’s a lot of additional central bank support behind the market rebound.  So is betting against this firepower a mug’s game? Well, some investors caution against the chance that the Banks are firing duds.

According to giant bond fund manager Pimco, the post-credit crisis process of household, corporate and sovereign deleveraging is so intense and loaded with risk that central banks may just be keeping up with events and even then are doing so at very different speeds. What’s more the solution to the problem is not a monetary one anyway and all they can do is ease the pain.

from Mike Dolan:

Sparring with central banks

Just one look at the whoosh higher in global markets in January and you'd be forgiven smug faith in the hoary old market adage of "Don't fight the Fed" -- or to update the phrase less pithily for the modern, globalised marketplace: "Don't fight the world's central banks". (or "Don't Battle the Banks", maybe?)

In tandem with this month's Federal Reserve forecast of near-zero U.S. official interest rates for the next two years, the European Central Bank provided its banking sector nearly half a trillion euros of cheap 3-year loans in late December (and may do almost as much again on Feb 29). Add to that ongoing bouts of money printing by the Bank of England, Swiss National Bank, Bank of Japan and more than 40 expected acts of monetary easing by central banks around the world in the first half of this year and that's a lot of additional central bank support behind the market rebound.  So is betting against this firepower a mug's game? Well, some investors caution against the chance that the Banks are firing duds.

According to giant bond fund manager Pimco, the post-credit crisis process of household, corporate and sovereign deleveraging is so intense and loaded with risk that central banks may just be keeping up with events and even then are doing so at very different speeds. What's more the solution to the problem is not a monetary one anyway and all they can do is ease the pain.

Emerging markets facing current account pain

Emerging markets may yet pay dearly for the sins of their richer cousins. While recent financial crises have been rooted in the United States and euro zone, analysts at Credit Agricole are questioning whether a full-fledged emerging markets crisis could be on the horizon, the first since the series of crashes from Argentina to Turkey over a decade ago. The concern stems from the worsening balance of payments picture across the developing world and the need to plug big  funding shortfalls.

The above chart from Credit Agricole shows that as recently as 2006, the 34 big emerging economies ran a cumulative current account surplus of 5.2 percent of GDP. By end-2011 that had dwindled to 1.7 percent of GDP. More worrying yet is the position of “deficit” economies. The current account gap here has widened to 4 percent of GDP, more than double 2006 levels and the biggest since the 1980s. The difficulties are unlikely to disappear this year, Credit Agricole says,  predicting India, Turkey, Morocco, Tunisia, Vietnam, Poland and Romania to run current account deficits of over 4 percent this year.

Some fiscally profligate countries such as India may have mainly themselves to blame for their plight. But in general, emerging nations after the Lehman crisis were forced to embark on massive spending to buck up domestic consumption and offset the collapse of Western export markets. For this reason, many were unable to raise interest rates or did so too late. As the woes of the Turkish lira and Indian rupee showed last year, the yawning funding gap leaves many countries horribly exposed to the vagaries of global risk appetite.

Contemplating Italian debt restructuring

This week’s evaporation of confidence in the euro zone’s biggest government debt market — Italy’s 1.6 trillion euros of bonds and bills and the world’s third biggest — has opened a Pandora’s Box that may now force  investors to consider the possibility of a mega sovereign debt default or writedown and, or maybe as a result of,  a euro zone collapse.

Given the dynamics and politics of the euro zone, this is a chicken-or-egg situation where it’s not clear which would necessarily come first. Greece has already shown it’s possible for a “voluntary” creditor writedown of  the country’s debts to the tune of 50 percent without — immediately at least — a euro exit. On the other hand, leaving the euro and absorbing a maxi devaluation of a newly-minted domestic currency would instantly render most country’s euro-denominated debts unpayable in full.

But if a mega government default is now a realistic risk, the numbers on the “ifs” and “buts” are being being crunched.

Japan fires latest FX wars salvo; other Asians to follow

Emerging central banks that sold billions of dollars over the summer in defence of their currencies might soon be forced to do the opposite. Japan’s massive currency intervention on Monday knocked the yen substantially lower not only versus the dollar but also against other Asian currencies.  The action is unlikely to sit well with other central banks struggling to boost economic growth and raises  the prospect of a fresh round of tit-for-tat currency depreciations. Already on Monday, central banks from South Korea and Singapore were suspected of wading into currency markets to buy dollars and push down their currencies which have recovered strongly from September’s selloff.  The won for instance is up 6.9 percent in October against the dollar — its biggest monthly gain since April 2009.  The Singapore dollar is up 4.5 percent, the result of a huge improvement in risk appetite.

Despite the interventions, the yen ended the session more than 2 percent lower against both the won and the Singapore dollar,  and most analysts reckon Japan’s latest intervention is by no means its last. That’s bad news for companies that compete with Japan on export markets and will keep neighbouring central banks watching for the BOJ’s next move. “Asian central banks are likely to play in the same game, and keep currencies competitive via regular interventions,” BNP Paribas analysts said.

But the race to the bottom has been underway for some time.  After all central banks in the West have cut rates, as in the euro zone, and embarked on more quantitative easing, as in the UK.  One bank, Switzerland’s, has gone as far as to effectively establish a ceiling for its currency.  And in Asia, Indonesia surprised markets with an interest rate cut this month while Singapore eased monetary policy. Many expect South Korea’s next move also to be a rate cut even though inflation is running well above target.  Analysts at Credit Agricole predicted this week’s G20 meeting to yield no fruitful discussion on what they termed “currency manipulation”. “This lack of co-ordinated policy could trigger an escalation in ongoing currency wars,” Credit Agricole analyst Adam Myers told clients. That would in turn lead to a renewed acceleration in central banks’ dollar reserves, he added.

Phew! Emerging from euro fog

Holding your breath for instant and comprehensive European Union policies solutions has never been terribly wise.  And, as the past three months of summit-ology around the euro sovereign debt crisis attests, you’d be just a little blue in the face waiting for the ‘big bazooka’. And, no doubt, there will still be elements of this latest plan knocking around a year or more from now. Yet, the history of euro decision making also shows that Europe tends to deliver some sort of solution eventually and it typically has the firepower if not the automatic will to prevent systemic collapse.
And here’s where most global investors stand following the “framework” euro stabilisation agreement reached late on Wednesday. It had the basic ingredients, even if the precise recipe still needs to be nailed down. The headline, box-ticking numbers — a 50% Greek debt writedown, agreement to leverage the euro rescue fund to more than a trillion euros and provisions for bank recapitalisation of more than 100 billion euros — were broadly what was called for, if not the “shock and awe” some demanded.  Financial markets, who had fretted about the “tail risk” of a dysfunctional euro zone meltdown by yearend, have breathed a sigh of relief and equity and risk markets rose on Thursday. European bank stocks gained almost 6%, world equity indices and euro climbed to their highest in almost two months in an audible “Phew!”.

Credit Suisse economists gave a qualified but positive spin to the deal in a note to clients this morning:

It would be clearly premature to declare the euro crisis as fully resolved. Nevertheless, it is our impression that EU leaders have made significant progress on all fronts. This suggests that the rebound in risk assets that has been underway in recent days may well continue for some time.

The Big Five: themes for the week ahead

Five things to think about this week

TUSSLE FOR DIRECTION
- The tussle between bullish and bearish inclinations — with bears gaining a bit of ground so far this month — is being played out over both earnings and economic data. Alcoa got the U.S. earnings season off to a good start but a heavier results week lies ahead and could toss some banana skins into the market’s path. Key financials, technology bellwethers (IBM, Google, Intel), as well as big names like GE, Nokia, Johnson and Johnson will offer more food for thought for those looking past the simple defensive versus cyclical split to choices between early cylicals, such as consumer discretionaries, and late cyclicals, such as industrials, based on the short-term earnings momentum. Macroeconomic data will need to confirm the picture painted by last week’s unexpectedly German strong orders and production figures to give bulls the upper hand.

FINANCIAL FOCUS
- The heavy financial results slate (Goldman, JP Morgan, Bank of America, Citi) will show the extent to which balance sheets are being cleansed of toxic assets and the health of, and outlook for margins, trading revenues, etc. The relative performance of the firms reporting could put the spotlight on the split between investment banking and retail exposure. In Europe, Swedbank’s results will be watched for Baltic exposure while clarity is still being sought on what banks plan to do with the large chunk of ECB one-year money which they continue to park back at the ECB in the form of overnight deposits.

JAPANESE DILEMMA
- The BOJ’s policy meeting poses thorny questions on quantitative easing (QE), with the policy debate complicated by sharp gains in the yen. The yen has risen as much as 10.5 percent in three months against the dollar and is nearing the 90 threshold which is viewed by the foreign exchanges as the point at which the Japanese authorities start ratcheting up the rhetoric. Further sustained yen gains will fuel market debate about the fallout for carry trades and for exporters — and by extension economic activity.