Global Investing

Wages wag the tail of the DAX

This week, Germany celebrated its Tag der deutschen Einheit (Day of German Unity) marking twenty-two years since the wall was torn down between East and West.

Back in the present, Frankfurt’s main share index, the DAX, has outperformed all of its European peers this year and in dollar terms has outshone almost every other global equity index. Re-unification has been painful, fostering social tensions and still huge disparities between east and west, but some analysts argue that it is precisely those disparities, not least in wages, which have underpinned the primacy of German stocks today.

There are other crucial factors of course. Germany’s high-value and high cost exports such as BMW cars are in high demand in countries such as China and India, all the more because of the weak euro.  And despite the outperformance, the market seems to price German stocks as bargains — they currently trade around 10 times forward earnings compared to over 12 times for the world index. According to fund managers at Baring Asset Management:

Overall, we continue to see a compelling earnings environment…, yet this is not necessarily being translated into higher equity valuations… We also believe another positive driver for equities is dividend yield in Germany, which remains supportive at around 3.5% after inflation.

They reckon that this makes German stocks a great bet, as long as PE valuations remain low and dividend yields competitive.

Next Week: Managed expectations

Here’s a view of next week from our team’s weekly news planner:

Not unlike England’s performance at the Euro 2012 football tourament, EU summit expectations have been successfully lowered in advance by all concerned and  so it will be hard to disappoint as a result!

The gnawing realization in markets is that the really game-changing steps by Germany on some form of debt pooling now look unlikely before next year’s general election there and so investors may have to hang on tight to what can get done in the meantime if the system is to hold together. Yet for all the understandable policy scepticism, there are a lot of big changes on the table — from banking union, more flexible budget-cutting programs, infrastructure growth pushes, a roadmap at least to euro bonds and a euro finance ministry and the launch of the ESM next month (barring a last-minute torpedo from the German constitutional court at least).  It may be a little too easy to dismiss all that is happening just because there’s not going to be a grand instant fix ready for Monday. The ESM alone should have powerful stabilization powers for markets at least. What’s more, Merkel says ”over my dead body” to Euro bonds in one breath, and then “when conditions are right” in another. Assuming she’s referring to her political body, then even these may not be a million miles away.

But the saga has become as much about politics and personalities now as percentages and public opinion, and so you always have to factor in the chance of a major bust-up or row. Broad agreement itself, as a result, may be a relief for a bit come next week — at least until Thursday’s next Spanish debt auction!

Hungary can seek IMF aid now. But can it cut rates?

The European Union has given Budapest the green light to seek aid from the IMF. (see here)  In fact, the breakthrough after five months of dispute does not let Hungary completely off the hook  — to get its hands on the money, Viktor Orban’s government will have to backtack on some controversial recent legislation, starting with its efforts to curb the central bank’s independence.  It remains to be seen if Orban will actually cave in.

But markets are reacting as if the IMF money is in Hungary’s pocket already. There have been sharp rallies in Hungarian dollar bonds,  CDS and currency markets (see graphic below from Capital Economics). The Budapest stock market has posted its best one-day gain since last November while the yield on local 10-year bonds have collapsed almost 100 bps. Hungarian officials are (a bit prematurely)  talking of issuing bonds on world markets.

What investors are hoping for now is a cut to the 7 percent interest rate. Hungary’s central bank jacked up rates by 100 bps in recent months to defend the forint as cash fled the country. Now there is a chance those rate rises can be reeled back in. After all, the moribund economy could really use a dash of monetary easing. Thanasis Petronikolos, head of emerging debt at Baring Asset Management has been overweight Hungary and  recalls that after 2008 crisis, the central bank was able to quickly take back its 300 bps of currency-defensive rate hikes.

Hungary’s plan to get some cash in the bank

Hungary says it might borrow money from global bond markets before it lands a long-awaited aid deal with the International Monetary Fund. That pretty much seems to suggest Budapest has given up hope of getting the IMF cash any time soon. Given the fund has already said it won’t visit Hungary in April, that view would seem correct.

There is some logic to the plan.

Hungary desperately needs the cash — it must  find over 4 billion euros just to repay external debt this year.

It is also an attractive time to sell debt.  Appetite for emerging market debt remains strong. Emerging bond yield premiums over U.S. Treasuries have contracted sharply this year and stand near seven-month lows. Moreover, U.S. Treasury yields may rise, potentially making debt issuance more costly in coming months.

Teflon Treasuries?

The pleasant surprise of Friday’s upbeat U.S. employment report rattled the U.S. Treasury bond market, as you’d expect, encouraging as it did some optimism about a sustained U.S. economic recovery, tempering fears of deflation and casting some doubts on the likelihood of another bout of quantitative easing or bond buying by the Federal Reserve.  And investors wary of seemingly teflon Treasuries are always keen to use such a backup in U.S. borrowing rates as a reason to rethink a market where supply is soaring and national debt levels are accelerating and where the country has just entered a presidential election year.

The release then by Eurostat on Monday of 2011 government debt  levels for the European Union and euro zone — where bond markets have been in chaos for the past couple of years — provided another reason to look sceptically at Treasuries as it showed aggregate EU and euro zone debt more than 10 percentage points of GDP lower than in the United States.

And with no fresh debt reduction plan likely this side of November’s presidential elections, the comparative U.S. debt trajectory over the coming years looks alarming.

Hungary’s Orban and his central banker

“Will no one rid me of this turbulent central banker?”  Hungarian Prime Minister Viktor Orban may not have voiced this sentiment but since he took power last year he is likely to have thought it more than once.  Increasingly, the spat between Orban’s government and central bank governor Andras Simor brings to memory the quarrel England’s Henry II had with his Archbishop of Canterbury, Thomas Becket, over the rights and privileges of the Church almost 900 years ago. Simor stands accused of undermining economic growth by holding interest rates too high and resisting government demands for monetary stimulus.  The government’s efforts to sideline Simor are viewed as infringing on the central bank’s independence.

So far, attacks on Simor have ranged from alleging he has undisclosed overseas income to stripping him of his power to appoint some central bank board members. But  the government’s latest plan could be the last straw – proposed legislation that would effectively demote Simor or at least seriously dilute his influence. Simor says the government is trying to engineer a total takeover at the central bank.  “The new law brings the final elimination of the central bank’s independence dangerously close,” he said last week.  
 
The move is ill-timed however, coming exactly at a time when Hungary is trying to persuade the IMF and the European Union to give it billions of euros in aid. The lenders have expressed concern about the law and declined to proceed with the loan talks.  But the government says it will not bow to external pressure and plans to put the law to vote on Friday. That has sparked general indignation – Societe Generale analyst Benoit Anne calls the spat extremely damaging to investor confidence in Hungary. “I just hope the IMF will not let this go,” he writes.

Central banks and governments often fail to see eye to eye. But in Hungary, the government’s attacks on Simor, a respected figure in central banking and investment circles,  is hastening the downfall of the already fragile economy. For one, if IMF funds fail to come through, Hungary will need to find 4.7 billion euros next year just to repay maturing hard currency debt. That could be tough at a time when lots of borrowers — developed and emerging — will be competing for scarce funds.  Central European governments alone will be looking to raise 16 billion euros on bond markets, data from ING shows. So Orban will have to tone down his rhetoric if he is to avoid plunging his country into financial disaster.

Can Eastern Europe “sweat” it?

Interesting to see that Poland wants to squeeze out more income from its state-owned enterprise (SOE) sector in the face of slowing economic growth and financing pressures.

Warsaw wants to double next year’s dividends from stakes in firms ranging from copper mines to utility providers to banks.

Fellow euro zone aspirant Lithuania has also embarked on reforms aimed at increasing dividends sixfold from what UBS has dubbed “the forgotten side of the government balance sheet”. It wants to emulate countries such as Sweden and Singapore where such companies are managed at arm’s length from the state and run along strict corporate standards to consistently grow profits.

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.

We’re all in the same boat

The withering complexity of a four-year-old global financial crisis — in the euro zone, United States or increasingly in China and across the faster-growing developing world — is now stretching the minds and patience of even the most clued-in experts and commentators. Unsurprisingly, the average householder is perplexed, increasingly anxious and keen on a simpler narrative they can rally around or rail against. It’s fast becoming a fertile environment for half-baked conspiracy theories, apocalypse preaching and no little political opportunism. And, as ever, a tempting electoral ploy is to convince the public there’s some magic national solution to problems way beyond borders.

For a populace fearful of seemingly inextricable connections to a wider world they can’t control, it’s not difficult to see the lure of petty nationalism, protectionism and isolationism. Just witness national debates on the crisis in Britain, Germany, Greece or Ireland and they are all starting to tilt toward some idea that everyone may be better off on their own — outside a flawed single currency in the case of Germany, Greece and Ireland and even outside the European Union in the case of some lobby groups in Britain. But it’s not just a debate about a European future, the U.S.  Senate next week plans to vote on legisation to crack down on Chinese trade due to currency pegging despite the interdependency of the two economies.  And there’s no shortage of voices saying China should somehow stand aloof from the Western financial crisis, even though its spectacular economic ascent over the past decade was gained largely on the back of U.S. and European demand.

Despite all the nationalist rumbling, the crisis illustrates one thing pretty clearly – the world is massively integrated and interdependent in a way never seen before in history. And globalised trade and finance drove much of that over the past 20 years. However desireable you may think it is in the long run, unwinding that now could well be catastrophic. A financial crisis in one small part of the globe will now quickly affect another through a blizzard of systematic banking and cross-border trade links systemic links.

from MacroScope:

The thin line between love and hate

The opinion on Turkey’s unorthodox monetary policy mix is turning as rapidly as global growth forecasts are being revised down.

Earlier this month, its central bank was the object of much finger-wagging after it defied market fears over an overheating economy by cutting its policy rate. It defended the move, arguing that weaker global demand posed a greater risk than inflationary pressures.

Investors were not persuaded. When I told one analyst about the Turkish rate move, he practically sputtered down the phone: "You're not kidding?!"