Global Investing

Amid yen weakness, some Asian winners

Asian equity markets tend to be casualties of weak yen. That has generally been the case this time too, especially for South Korea.

Data from our cousins at Lipper offers some evidence to ponder, with net outflows from Korean equity funds at close to $700 million in the first three months of the year. That’s the equivalent of about 4 percent of the total assets held by those funds. The picture was more stark for Taiwan funds, for whom a similar net outflow equated to almost 10 percent of total AuM. Look more broadly though and the picture blurs; Asia ex-Japan equity funds have seen net inflows of more than $3 billion in the first three months of the year, according to Lipper data.

Analysts polled by Reuters see more drops ahead for the yen which they predict will trade around 102 per dollar by year-end (it was at 77.4 last September). Some banks such as Societe Generale expect a 110 exchange rate and therefore recommend being short on Chinese, Korean and Taiwanese equities.

But the weak yen may not be unilaterally bad news for Asian companies. Morgan Stanley analysts have compiled a list of Asian shares that could gain from falling yen costs. Take India’s Maruti-Suzuki. It has zero exposure to yen in terms of revenue but its cost exposure (due to import or components) is 34 percent. A similar picture at China Motor Corp. in Taiwan. Another Taiwanese firm, semiconductor maker Siliconware Precision has a 2 percent revenue exposure to Japan but the yen accounts for 15 percent of its cost base, according to MS data.

Other examples.  MS highlights Taiwan’s casings maker Catcher which holds 54 percent of its debt in yen. It calculates that every 1 percent fall in the yen translates to 1.3 percent upside to its annual income. Tour operators and airlines could also benefit if they are able to send more visitors to newly-cheap Japan.

New frontiers to outpace emerging markets

Fund managers searching for yield are increasing exposure to frontier markets (FM) as a diversification from emerging markets (EM), as the latter have been offering negative relative returns since January, according to MSCI data.

Barings Asset Management  said on Monday it plans to launch a frontier markets fund in coming weeks, with a projected 70 percent exposure to frontier markets such as Nigeria, Saudi Arabia, the UAE, Sri Lanka and Ukraine.

Emerging markets indices posted relative negative returns compared to developed and frontier markets in the first quarter, index compiler MSCI’s 2013 quarterly survey showed. The main emerging benchmark returned a negative 2.14 percent for the quarter, with the BRIC index also posting a loss, though a better performance of Latin American markets offered some promising signs  with a 0.48 percent increase.

Weekly Radar: Q1 earnings test as the herd scatters

US Q1 EARNINGS START/DUBLIN EURO GROUP MEETING/US T-SECRETARY LEW IN BERLIN-PARIS/US-FRANCE-ITALY GOVT BOND AUCTIONS/FRANCE NATL ASSEMBLY VOTES ON LABOUR REFORM/VENEZUELA ELECTIONS

World markets have started the second quarter in an oddly indecisive mood given that Q1 turned out to be yet another bumper start to the year, looking to extend record stock market highs on Wall St but lacking the juice of new information to make a decisive break while Europe splutters and emerging markets and commodities head south. Two important pieces of the U.S. jigsaw will likely emerge over the coming week  with this Friday’s US employment report and the start of the Q1 corporate earnings season next week.

But there’s clearly been a more general rethink further afield among global investors given the breakdown in cross-asset and cross-border correlations – meaning it’s no longer enough to just get Wall St right and adjust your global risk button accordingly. It looks much harder work to get regional or asset allocations and positioning right. As Wall St flirts with new highs and US and Japanese equity funds continue draw hefty inflows, there’s been a pullback from all things Europe surrounding the Cyprus saga and parallel growth disappointments across the region and EPFR data last week showed redemptions from euro stock, bond and money funds continued.

Emerging earnings: a lot of misses

It’s not shaping up to be a good year for emerging equities. They are almost 3 percent in the red while their developed world counterparts have gained more than 7 percent and Wall Street is at record highs. When we explored this topic last month, what stood out was the deepening profit squeeze and  steep falls in return-on-equity (ROE).  The latest earnings season provides fresh proof of this trend and is handily summarized in a Morgan Stanley note which crunches the earnings numbers for the last 2012 quarter.

The analysts found that:

–With 84 percent of emerging market companies having already reported last quarter earnings, consensus estimates have been missed by around 6 percent. A third of companies that have already reported results have beaten estimates while almost half have missed.

– Singapore, Turkey and Hong Kong top the list of countries where earnings beat expectations while earnings in Hungary, Korea and Egypt have mostly underwhelmed. Consumer durables companies recorded the biggest number and magnitude of misses at 82 percent.

Weekly Radar-”Slow panic” feared on Cyprus as central banks meet and US reports jobless

US MARCH JOBS REPORT/THREE OF G4 CENTRAL BANKS THURS/NEW QUARTER BEGINS/FINAL MARCH PMIS/KENYA SUPREME COURT RULING/SPAIN-FRANCE BOND AUCTIONS

Given the sound and fury of the past fortnight, it’s hard not to conclude that the messiness of the eventual Cyprus bailout is another inflection point in the whole euro crisis. For most observers, including Mr Dijsselbloem it seems, it ups the ante again on several fronts – 1) possible bank contagion via nervy senior creditors and depositors fearful of bail-ins at the region’s weakest institutions; 2) an unwelcome rise in the cost of borrowing for European banks who remain far more levered than US peers and are already grinding down balance sheets to the detriment of the hobbled European economy; and 3) likely heavy economic and social pressures in Cyprus going forward that, like Greece, increase euro exit risk to some degree. Add reasonable concerns about the credibility and coherence of euro policymaking during this latest episode and a side-order of German/Dutch ‘orthodoxy’ in sharp relief and it all looks a bit rum again.

Yet the reaction of world markets has been relatively calm so far. Wall St is still stalking record highs through it all for example as signs of the ongoing US recovery mount. So what gives? Today’s price action was interesting in that it started to show investors discriminating against European assets per se – most visible in the inability of European stocks to follow Wall St higher and lunge lower in euro/dollar exchange rate. European bank stocks and bonds have been knocked back relatively sharply this week post-Dijsselbloem too. If this decoupling pattern were to continue, it will remain a story of the size of the economic hit and relative underperformance. But that would change if concerns morphed into euro exit and broader systemic fears and prepare for global markets at large to feel the heat again too. We’re not back there yet with the benefit of the doubt on OMTs and pressured policy reactions still largely conceded. But many of the underlying movements that might feed system-wide stresses – what some term a “slow panic” like deposit shifts etc – will be impossible to monitor systematically by investors for many weeks yet and so nervy times are ahead as we enter Q2 after the Easter break.

Rotation schmotation

We’re at risk of labouring this point, but there has been some more evidence that this year’s equity rally has not been spurred by a shift away from fixed income. The latest data from our corporate cousins at Lipper offer pretty definitive proof that there has been no Great Rotation, at least not from bonds to stocks.

Worldwide mutual fund flows numbers for February showed an overall move into equity funds of more than $22 billion, and a net flow to bond funds of about half that. Over 3 months it’s a similar story, with a net inflow to equities of about $84 billion while bond funds sit close behind at about $75 billion. Little wonder then that there is some evidence at least of movements out of money market funds.

In fact, maybe HSBC called it about right last week. In a note, their cross-asset strategists reckoned a pick-up in economic growth might support a ‘minor’ cyclical rotation into equities from bonds, but a longer-term structural shift between the two asset classes as part of a ‘Great Rotation’ was less likely.

Weekly Radar: Cyprus hogs the headlines but contagion fears limited

CYPRUS BRINKMANSHIP/BERNANKE IN LONDON/BRICS SUMMIT/MARCH CONSUMER SENTIMENT IN EUROPE/JAPAN INFLATION-JOBS-PRODUCTION/US-UK Q4 GDP REVISIONS

Cyprus has hogged the headlines since Friday, with bank closures now extended to a full week as they try to sort out a very messy bailout - made worse by domestic policy missteps over taxing bank deposits. As with Italy’s elections, the saga certainly challenges any market assumption that the euro crisis had abated for good and it’s also loaded with a series of potential precedents – not least the biggest taboo of them all, a euro exit. This is where the politics, brinkmanship and smoke-filled-rooms come in.  Yet as Cyprus is so small and its banks in such a peculiar setup – given the scale of Russian and other foreign depositors – the euro group, ECB and IMF appear determined not to be pressured into a bailout above the already gigantic 60 percent of GDP.

And, as with Greece last year, they will likely stand firm and leave any decision to exit up to the Cypriots themselves. You can’t rule out that they may choose to go and regional risks rise somewhat as a result. But if the islanders are genuinely worried about a 6-10% tax on deposits, they may also think long and hard about the chance those deposits would be redenominated into a heavily devalued Cypriot pound. Just ask the Argentinians what that feels like. A deposit haircut may seem a like a half-decent deal by comparison if some other mix of Russian loans, pension raids or securitised future gas revenues doesn’t stack up.

Weekly Radar: Dollar building steam?

FOMC/FRANCO-GERMAN SUMMIT/GERMAN-FRENCH-SPAIN AUCTIONS/GLOBAL FLASH PMIS FOR MARCH/UK BUDGET-JOBS-CPI-BOE MINS/ICC HEARING ON KENYATTA/SAFRICA RATES

       The revved-up U.S. dollar – whose trade-weighted index is now up almost 5 percent in just six weeks – could well develop into one of the financial market stories of the year as the cyclical jump the United States has over the rest of G10 combines with growing attention being paid to the country’s potential “re-industrialisation”. As with all things FX, there’s a zillion ‘ifs’ and ‘buts’ to the argument. Chief among them is many people’s assumption the Fed will be printing greenbacks well after this expansion takes hold as it targets a much lower jobless rate. Others doubt the much-vaunted return of the US Inc. back down the value chain into metal-bashing and manufacturing, while some feel the cheaper energy from the shale revolution and the lower structural trade deficits that promises will be short-lived as others catch up. However, with the dollar already super competitive (it’s down 30-40 percent on the Fed’s inflation-adjusted index over the past 10 years) the first set of arguments are more tempting. Even if you see the merits in both sides, the bull case clearly has not yet been discounted and may have further to go just to match the balance of risks.  With Fed printing presses still on full throttle, this has been a slow burner to date and it may be a while yet before it gets up a head of steam — many feel it’s still more of a 2nd half of 2013 story and the dollar index needs to get above last year’s highs to get people excited. But if it does keep motoring, it has a potentially dramatic impact on the investment landscape and not necessarily a benign one, even if shifting correlations and the broader macro landscape show this is not the ‘stress trade’ of the short-lived dollar bounces of the past five years.

Commodities priced in dollars could well feel the heat from a steady dollar uptrend. And if gold’s spiral higher over the past six years has been in part due to the “dollar debasement” trade, then its recent sharp retreat may be less puzzling . Emerging market currencies pegged to the dollar will also feel the pressure as well as countries and companies who’ve borrowed heavily in greenbacks. The prospect of a higher dollar also has a major impact on domestic US investors willingness to go overseas, casting questions on countries with big current account gaps. As the dominant world reserve currency, a rising dollar effectively tightens financial conditions for everyone else and we’ve been used to a weakening one for a very long time.

Argentina back in court

Argentina squares off today in a U.S. Appeals court with the so-called holdout creditors who are demanding $1.3 billion in payments on defaulted bonds. A decision will probably take a few days but supporters of both sides have been mustering.

Emails have been pouring into journalists’ inboxes thick and fast from the Argentine Task Force, a lobby group that wants Argentina to settle with bondholders and identifies its goal as “pursuing a fair reconciliation of of the Argentine debt default”.  And yesterday, a noisy pots-and-pans protest was held outside the London offices of Elliot Associates (the parent company of one of the two hedge fund litigants)  by groups supporting Argentina in its battle against those it terms “vulture funds”.  Nick Dearden, director of the Jubilee Debt Campaign, a group that calls for cancelling poor countries’ debts, says:

If the vulture funds are allowed to extract their pound of flesh from Argentina today, we will see a proliferation of vulture funds in Europe tomorrow.

Russian companies next stop for Euroclear

The excitement continues over Russian assets becoming Euroclearable.   Euroclear’s head confirmed last week to journalists in Moscow that corporate debt would be the next step, potentially becoming eligible for settlement within a month. Russian equities are set to follow from July 1, 2014.

What that means is foreign investors buying Russian domestic rouble bonds will be able to process them through the Belgium-based clearing house, which transfers securities from the seller’s securities account to the securities account of the buyer, while transferring cash from the account of the buyer to the account of the seller.

The Euroclear effect in terms of foreign inflows to Russian bonds could be as much $40 billion in the 2013-2014 period, analysts at Barclays estimated earlier this month.  Yields on Russian government OFZ bonds should compress a further 50-80 basis points this year, says Vladimir Pantyushin, the bank’s chief economist in Moscow, adding to the 130 bps rally in 2012. Foreigners’ share of the market should double to 25-30 percent Pantyushin says, putting Russia in line with the emerging markets average.