Global Investing

European banks: slow progress

The Cypriot crisis, stemming essentially from a banking malaise, reminds us that Europe’s banking woes are far from over. In fact, Stephen Jen and Alexandra Dreisin at SLJ Macro Partners posit in a note on Monday that five years into the crisis, European banks have barely carried out any deleveraging. A look at their loan-to-deposit ratios  (a measure of a bank’s liquidity, calculated by dividing total outstanding loans by total deposits) remain at an elevated 1.15. That’s 60 percent higher than U.S. banks which went into the crisis with a similar LTD ratio but which have since slashed it to 0.7.

It follows therefore that if bank deleveraging really gets underway in Europe, lending will be curtailed further, notwithstanding central bankers’ easing efforts. So the economic recession is likely to be prolonged further. Jen and Dreisin write:

We hope that European banks can do this sooner rather than later, but fear that bank deleveraging in Europe is unavoidable and will pose a powerful headwind for the economy… Assuming that European banks, over the coming years, reduce their LTD ratio from the current level of 1.15 to the level in the U.S. of 0.72, there would be a 60% reduction in cross-border lending, assuming deposits don’t rise… This would translate into total cuts in loans of some $7.3 trillion.

The coming storm is also likely to hit some innocent bystanders — emerging economies.

For years European banks have led the lending juggernaut in the developing world, accounting for 57 percent of total foreign claims in these countries. A pullback is already underway: Jen and Dreisen cite BIS data showing a 4 percent fall in European lending to EM since 2011. But with over 90 percent of cross-border lending to eastern Europe coming from European banks, more pain can certainly be expected.

After disappointing start to 2013, how will hedge funds catch up?

Despite the early-year rally in equity markets, some hedge funds seem to have had a disappointing start… yet again.

JP Morgan notes that the industry’s benchmark HFRI index was up 2.8% by end-February,  well below the 4.6% for MSCI All-Country index.

Some 4.2 percent of hedge funds suffered losses of at least 5% in the first two months of year, compared with 3.3% in the same period in 2012. Still, this is better than 2008/2009, when losses of this magnitude were seen at more than one in five of hedge funds. According to JP Morgan:

Abenomics rally: bubble or trend?

“Abenomics” is the buzzword in Japan these days — it refers to Prime Minister Shinzo Abe’s aggressive reflationary fiscal and monetary policies that triggered the yen’s 10 percent decline against the dollar and 17 percent rally in Tokyo stocks this year.

So it’s no wonder that the Japanese mutual fund market, the second largest in Asia-Pacific, enjoyed the largest monthly inflows in almost six years last month, raking in as much as $11 billion.

With all that new money coming in, will you be late to the game if you haven’t gone in already?

Hyundai hits a roadbump

The issue of the falling yen is focusing many minds these days, nowhere more than in South Korea where exporters of goods such as cars and electronics often compete closely with their Japanese counterparts. These companies got a powerful reminder today of the danger in which they stand — quarterly profits from Hyundai fell sharply in the last quarter of 2012.  (See here to read what we wrote about this topic last week)

Korea’s won currency has been strong against the dollar too, gaining 8 percent to the greenback last year. In the meantime the yen fell 16 percent against the dollar in 2012 and is expected to weaken further. Analysts at Morgan Stanley pointed out in a recent note that since June 2012, Korean stocks have underperformed Japan, corresponding to the yen’s 22 percent depreciation in this period. Their graphic below shows that the biggest underperformers were consumer discretionary stocks (a category which includes auto and electronics manufacturers). Incidentally, Hyundai along with Samsung, makes up a fifth of the Seoul market’s capitalisation.

Shares in Hyundai and its Korean peer Kia have fared worst among major global automakers for the past three months – down 5 percent and 18 percent, respectively.  Both companies expect sales this year to be the slowest in a decade. Toyota on the other hand has risen 30 percent and expects to reach the top spot in terms of world sales for the first time since 2010.

Korean exporters’ yen nightmare (corrected)

(corrects name of hedge fund in para 3 to Symphony Financial Partners)

Any doubt about the importance of a weaker yen in thawing the frozen Japanese economy will have been dispelled by the Nikkei’s surge to 32-month highs this week. Since early December, when it became clear an incoming Shinzo Abe administration would do its best to weaken the yen, the equity index has surged as the yen has fallen.

Those moves are giving sleepless nights to Japan’s neighbours who are watching their own currencies appreciate versus the yen. South Korean companies, in particular, from auto to electronics manufacturers, must be especially worried. They had a fine time in recent years  as the yen’s strength since 2008 allowed them to gain market share overseas. But since mid-2012, the won has appreciated 22 percent versus the yen.  In this period, MSCI Korea has lagged the performance of MSCI Japan by 20 percent. Check out the following graphic from my colleague Vincent Flasseur (@ReutersFlasseur)

David Baran, co-founder of Tokyo-based Symphony Financial Partners, notes the relative performance of Hyundai and Toyota (Hyundai shares have fallen 2.5 percent this year adding to 13.5 percent loss in the last quarter of 2012. Toyota on the other hand is up 5 percent so far in 2013 after gaining 31 percent in Oct-Dec last year). Baran says he has gone long the Nikkei and short the Seoul index (the Kospi) and (Hong Kong’s) Hang Seng, while taking a short position on the yen. He says:

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.

Ireland descends from risky debt heights

Good news for Europe as the cost for insuring sovereign debt against default fell in the third quarter of 2012, according to the CMA Global Sovereign Credit Risk report.

Ireland slipped out of the 10 most risky sovereigns for the first time since the first quarter of 2010 according to CMA, making space for Lebanon to enter the club of the world’s ten most risky sovereign debt issuers.

Although Irish 5-year credit default swap spreads tightened to 317 basis points from 554 basis points in the third quarter, there is still a 25 percent chance that Ireland will not be able to honour its debt or restructure it over the next five years.

Mrs Watanabe in Istanbul

Japanese mom-and-pop investors’ penchant for seeking high-yield investments overseas is well known. Mrs Watanabe (as the canny player of currency and exchange rate arbitrage has come to be known) invests billions of yen overseas every year via  so-called uridashi bonds, debt denominated in currencies with high yields.  Data shows the lira has suddenly become the red-hot favourite with uridashi investors this year.

In a note entitled Welcome Mrs Watanabe, Barclays analysts estimate $2 billion in lira-based uridashi issuance this year, ahead of old favourite, the  Australian dollar.

So far, Japan’s exposure to Turkey is negligible at just 1.2 percent of their emerging market portfolio investments (Brazil is 4 percent, Korea 3 percent and Mexico 2 percent).  But Turkey’s high yields (almost 8 percent on one-year bonds) and the lira’s resilience mean the figure could rise to $5-$6 billion a year. That is almost half of total portfolio flows to Turkey in 2011, Barclays says.

Three snapshots for Thursday

Fears that Athens is on the brink of crashing out of the euro zone and igniting a renewed financial crisis have rattled global markets and alarmed world leaders, with Greece set to figure high on the agenda at a G8 summit later this week. This chart shows the impact on assets since the Greek election:

Euro zone banks now account for only 8% of total euro zone market value – they were over over 20% of the market in 2007:

Japan’s economy rebounded in January-March from a lull in the previous quarter, shaking off the pain of a strong yen and Europe’s debt crisis on solid consumer spending and rebuilding from last year’s earthquake.