Global Investing

from Global Markets Forum Dashboard:

More volatility expected as Fed rate rise looms – Cumberland Advisors’ David Kotok

A healthy dose of fear has re-entered financial markets in the final three months of the year. The Chicago Board Options Exchange VIX, a widely tracked measure of market volatility, rose to a two-month high on Wednesday.

David Kotok, Cumberland Advisors

David Kotok, Cumberland Advisors

Varying news reports offered threats from the Ebola virus and a stagnating European economy as tangential reasons. Perhaps another point is many investors view the U.S. Federal Reserve’s pending decision to raise interest rates as a rumbling train far off in the distance that they now hear headed their way. Closer to the horizon are headlines that can no longer lean on “Fed easing” to explain away rising asset prices and a rising stock market.

“We are in a new period of volatility and it's been developing for the last two or three months,” David Kotok, chairman and chief investment officer of investment advisory firm Cumberland Advisors told the Global Markets Forum on Wednesday. “When you suppress all interest rates to zero you dampen volatility and you distort asset pricing. Now the outlook for interest rates is changing so we are restoring volatility.”

The changes, he said, are evident in a rising U.S. dollar, falling commodity prices and the spread between the high yield and U.S. bond markets.

“These are examples of how things change when you return to more normal volatility and extract and stop monetary stimulus,” Kotok said.

Buying back into emerging markets

After almost a year of selling emerging markets, investors seem to be returning in force. The latest to turn positive on the asset class is asset and wealth manager Pictet Group (AUM: 265 billion pounds) which said on Tuesday its asset management division (clarifies division of Pictet) was starting to build positions on emerging equities and local currency debt. It has an overweight position on the latter for the first time since it went underweight last July.

Local emerging debt has been out of favour with investors because of how volatile currencies have been since last May, For an investor who is funding an emerging market investments from dollars or euros, a fast-falling rand can wipe out any gains he makes on a South African bond. But the rand and its peers such as the Turkish lira, Indian rupee, Indonesian rupiah and Brazilan real — at the forefront of last year’s selloff –  have stabilised from the lows hit in recent months.  According to Pictet Asset Management:

Valuations of emerging market currencies have fallen to a point where they are now starkly at odds with such economies’ fundamentals. Emerging currencies are, on average, trading at almost two standard deviations below their equilibrium level (which takes into account a country’s net foreign asset holdings, inflation rate and its relative productivity).

Indian shares: disappointment may lurk

Should Indian shares really be at record highs?

The index is up 3.6 percent this year. Foreign funds have been pouring money into Mumbai shares, betting that the opposition BJP, seen as more reform-friendly than the incumbent Congress, will form the next government. They purchased $420 million worth of Indian stocks last Friday, having bought $1.4 billion over the past 15 trading sessions.

There is also the fact that the rolling crisis in emerging markets, having smacked India during its first round last May, has now moved on and is ravaging places such as Russia and Nigeria instead. The rupee has firmed almost 2 percent this year to the dollar, as last year’s 6.5 percent/GDP current account deficit has contracted to just 0.9 percent of GDP.  Many international funds such as Blackrock and JPMorgan Asset Management have Indian stocks on overweight and Bank of America/Merrill Lynch’s monthly survey showed investors’  underweight on India was one of the smallest for emerging markets.

Indian company earnings may have beaten forecasts by around 5 percent so far in the season. But prospects can hardly be described as attractive. Indian economic growth is running at less than 5 percent. Valuations are in line with historical averages and at a 4 percent premium to global emerging markets on a book-value basis. But John-Paul Smith at Deutsche Bank says it is “the least bad” of the BRICs and is neutral to overweight.

Revitalised West knocks Brazil, Russia off global growth Top-30

By Shadi Bushra

Yet another sign of the growth convergence between developed and emerging markets. Two  of the “BRIC’ countries have dropped out of the Top-30 in a growth index compiled by political risk consultancy Maplecroft, while several Western powerhouses have nudged their way onto the list.

Maplecroft’s 2014 Growth Opportunities Atlas showed that Brazil and Russia — the B and R of the BRIC bloc — had dropped 26 and 41 places, respectively – due to slow economic reforms and diversification.  The United States, Australia and Germany meanwhile broke into the top 30 on the  index, which evaluates 173 countries on their growth prospects over the next 20 years.

The study’s results are indicative of the broader pattern this year of an emerging markets slowdown after years of robust growth fuelled by cheap money from the West and a decade of booming trade. But the two other BRIC countries — India and China — have retained their top spots, albeit with lower absolute scores. And India overtook China for first place due to its “catch-up growth potential,”  Maplecroft’s report said.

Red year for emerging bonds

What a dire year for emerging debt. According to JPMorgan, which runs the most widely run emerging bond indices, 2013 is likely to be the first year since 2008 that all three main emerging bond benchmarks end the year in the red.

So far this year, the bank’s EMBIG index of sovereign dollar bonds is down around 7 percent while local debt has fared even worse, with losses of around 8.5 percent, heading for only the third year of negative return since inception. JPMorgan’s CEMBI index of emerging market corporate bonds is down 2 percent for the year.

 

While incoming Fed boss Janet Yellen has assured markets that she doesn’t intend to turn off the liquidity taps any time soon, JPMorgan still expects U.S. Treasury yields to end the year at 2.85 percent (from 2.7 percent now). That would result in total returns for the EMBIG at minus 7 percent, the CEMBI  at minus 2 percent and GBI-EM at minus 7-9 percent, JPMorgan analysts calculate.

Barclays sees 20 pct rise in EM bond supply in 2014

Sales of dollar bonds by emerging governments may surge 20 percent over 2013 levels, analysts at Barclays calculate.  They predict $94 billion in bond issuance in 2014 compared to $77 billion that seems likely this year. In net terms –excluding amortisations and redemptions — that will come to $29 billion, almost double this year’s $16 billion.

According to them, the increase in issuance stems from bigger financing needs in big markets such as Russia and Indonesia along with more supply from the frontiers of Africa. Another reason is that local currency emerging bond markets, where governments have been meeting a lot of their funding needs, are also now struggling to absorb new supply.

The increase is unlikely to sit well with investors — appetite for emerging assets is poor at present, EM bond funds have witnessed six straight months of outflows and above all, the projected rise in sovereign supply will come on top of projected corporate bond issuance of over $300 billion, similar to this year’s levels. (See graphic)

September’s bond bonanza

What a half-month it has been for bond issuance! As we wrote here, many borrowers  — corporate and sovereign;  from emerging markets and developed  — have seen  this period as a last-chance saloon of sorts to raise money on global capital markets before the Fed starts to cut off the supply of free cash.

But the month so far has been different not only in the sheer volume of supply but also for the fact that issuance by governments of developing countries has surpassed emerging corporate bond sales. That’s something that hasn’t happened for a long time.

By the end of last week, sovereign issuance for September had hit $13.5 billion, more than any other month this year and a quarter of the total 2013 sovereign issuance so far, according to analysts at JPMorgan. In comparison, sovereign issuance historically averages $2.2 billion a month, rising to $5 billion every September following the summer lull.  Issuers were Russia with $7 billion, South Africa and Romania with $2 billion each; while South Korea and Indonesia raised $1 billion and $1.5 billion respectively. JPM writes:

Emerging markets: to buy or not to buy

To buy or not to buy — that’s the question facing emerging market investors.

The sector is undoubtedly cheap –  equity valuations are 30-50 percent cheaper than their 10-year average on a price-book basis; currencies have depreciated 15-20 percent in the space of 4 months and local bond yields have surged by an average 150 basis points. As we have pointed out before, cheapness is relative and the slowing economic and credit growth in many countries will undoubtedly manifest itself in falling EPS growth. Companies that cannot pass on high input costs caused by weak currencies, will have to take a further margin squeeze.

But many analysts have in recent days changed their recommendations on the sector. Barclays for instance notes:

Guarding against the inflation dog in emerging markets

The dog that didn’t bark was how the IMF described inflation. But might the fall in emerging market currencies reverse the current picture of largely benign inflation?

Nick Shearn, a portfolio manager at BlueBay Asset Management, sees the rise in inflation as not an if but a when, which makes inflation-linked bonds (linkers in common parlance) a good idea. These would hedge not only against EM but also G7 inflation — he calculates the correlation between the two at around 0.8 percent. He says linkers outperform as inflation uncertainty increases, hence:

As a result of the loose monetary policies of recent years that have been implemented to promote growth within emerging market economies, we believe rising as well as persistent inflation should become a trend….. Currently we are seeing the early signs of an inflation dynamic in isolated countries such as in Brazil. But, as inflation begins to rise across the region, inflation uncertainty will also begin to rise and consequently inflation-linked bonds should perform well.

Weekly Radar: Draghi returns to London

ECB chief Mario Draghi returns to London next week almost 10 months on from his seminal “whatever it takes” speech to the global financial community in The City  – a speech that not only drew a line under the euro financial crisis by flagging the ECB’s sovereign debt backstop OMT but one that framed the determination of the G4 central banks at large to reflate their economies via extraordinary monetary easing. Since then we’ve seen the Fed effectively commit to buying an addition trillion dollars of bonds this year to get the U.S. jobless rate down toward 6.5%, followed by the ‘shock-and-awe’ tactics of the new Japanese government and Bank of Japan to end decades.

And as Draghi returns 10 months on, there’s little doubt that he and his U.S. and Japanese peers have succeeded in convincing financial investors of central bank doggedness at least. Don’t fight the Fed and all that – or more pertinently, Don’t fight the Fed/BoJ/ECB/BoE/SNB etc… G4 stock markets are surging ever higher through the Spring of 2013 even as global economic data bumbles along disappointingly through its by now annual ‘soft patch’.  Looking at the number tallies, total returns for Spanish and Greek equities and euro zone bank stocks are up between 40 and 50% since Draghi’s showstopper last July . Italian, French and German equities and Spanish and Irish 10-year government bonds have all returned about 30% or more. And you can add 7% on to all that if you happened to be a Boston-based investor due to a windfall from the net jump in the euro/dollar exchange rate. What’s more all of those have outperformed the 25% gains in Wall St’s S&P 500 since then, even though the latter is powering to uncharted record highs. And of course all pale in comparison with the eye-popping 75% rise in Japan’s Nikkei 225 in just six months!! Gold, metals and oil are all net losers and this is significant in a money-printing story where no one seems to see higher inflation anymore.

But with both Fed and BoJ pushes getting some traction on underlying growth and the euro zone economy registering it’s 6th straight quarter of contraction in the first three months of 2013, maybe Draghi’s big task now is to convince people the ECB will do whatever it takes to support the 17-nation economy too and not only the single currency per se. Last year’s pledge may have been a necessary start to stabilise things but it has not yet been sufficient to solve the economic problems bequethed by the credit crisis.