Global Investing

Venezuelan bonds — storing up problems

Last week’s victory for Miss Venezuela in a global beauty pageant was a rare bit of good news for the South American country. With a black market currency exchange rate that is 10 times the official level, shortages of staples, inflation over 50 percent and political turmoil, Venezuela certainly won’t win any investment pageants.

This week investors have rushed to dump Venezuela’s dollar bonds as the government ordered troops to occupy a store chain accused of price gouging. Many view this as a sign President Nicolas Maduro is gearing up to extend his control over the private sector.  Adding to the bond market’s problems are plans by state oil firm PDVSA to raise $4.5 billion in bonds next week. Yields on  Venezuelan sovereign bonds have risen over 100 basis points this week; returns for the year are minus 25 percent, almost half of that coming since the start of this month.  Five-year credit default swaps for Venezuela are at two-year highs, having risen more than 200 basis points in November. And bonds from PDVSA, which is essentially selling debt to bankroll the government and pay suppliers, rather than to fund investments, have tanked too.

http://product.datastream.com/dscharting/gateway.aspx?guid=fbc53eb9-4cec-47e6-8edc-d4e53dcd4f17&action=REFRESH

 

Double-digit yields and high oil prices have made bond funds relatively keen on Venezuela but the latest sell-off is forcing a rethink. JPMorgan analysts have cut their recommendation on the bonds to underweight:

Now that spreads have spiked out of the recent range , lower oil prices will force a more pronounced macro correction, and social and political tension is rising, we no longer view risks as sufficiently compensated by yields.

The situation is bad enough but few reckon yet on the possibility of default. Kevin Daly at Aberdeen Asset Management says he has added to an underweight position on Venezuelan debt but believes default is unlikely — unless oil prices collapse to around $30 a barrel for a prolonged  period of time.  Nor is Maduro likely to attempt a Correa-style repudiation of debt, he says, because unlike Correa’s Ecuador, PDVSA has a lot of overseas assets that could be seized by creditors in event of a default.  That includes refineries and oil companies in the United States, Europe and the Caribbean. On the other hand, mayoral elections across Venezuela later this month could raise political tensions even further, Daly says, another reason to stay sidelined.

Value or growth? The dichotomy of emerging market shares

Investors in emerging markets are facing a tough choice. Should one buy cheap shares in the hope that poor corporate governance and profitability will improve some day? Or is it better to close one’s eyes and buy into expensively valued companies that sell mobile telephones, holidays and handbags — all the things high-spending emerging market consumers hanker after?

At the moment, investors are plumping for the latter, growth-at-any price investment strategy. Result: a lopsided emerging equity index in which consumer discretionary shares are up more than 5 percent this year, energy shares have lost 7 percent while MSCI’s benchmark emerging equity index is down 3 percent.

All markets have their share of cheap and expensive. But the dichotomy in emerging markets is especially stark. Analysis by Bank of America/Merrill Lynch of the biggest 100 emerging market companies revealed last week that the 20 most expensive stocks in this bucket are trading 11 times book value and 31 times earnings (both on trailing basis) while forward earnings-per-share (EPS) is seen at almost 30 percent. The top-20 companies all belong to the private sector and most are in the consumer-facing industries.  This year they have gained more than 50 percent.

Emerging equities: out of the doghouse

Emerging stocks, in the doghouse for months and months, haven’t done too badly of late. The main EM index,  has rallied more than 11 percent since its end-August troughs, outgunning the S&P 500′s 3 percent rise in this period. Bank of America/Merrill Lynch strategist Michael Hartnett reminds us of the extreme underweight positioning in emerging stocks last month, as revealed by his bank’s monthly investor survey.  Anyone putting on a long EM-short UK equities trade back then would have been in the money with returns of 540 basis points, he says.

Undoubtedly, the postponement of the Fed taper is the main reason for the rally.  Another big inducement is that valuations look very cheap (forward P/E is around 9.9 versus a 10-year average of 10.8) .

According to Mouhammed Choukeir, CIO , Kleinwort Benson:

Looking at valuations we think emerging markets are in an attractively valued zone, hence we think it’s a good investment. EMs are in negative momentum trend but have good valuations. We’re sitting on the positions we’ve built but if it hits a positive (momentum) trend we will add on it…. You wait for value and value will translate into returns over time.

Frontier markets: past the high water-mark

By Julia Fioretti

Ethiopia’s plans to hit the Eurobond trail once it gets a credit rating are highlighting how fast frontier debt markets are growing.

IFR data shows that sub-Saharan Africa alone issued $4.2 billion of sovereign debt in the year to September, compared to $3.6 billion in the same 2012 period. And returns on frontier market bonds have outgunned their high-yield emerging sovereign peers this year.

JPMorgan, which runs the most-used emerging debt indices of which the frontier component is called NEXGEM, says the year-to-date return on NEXGEM is around 0.7 percent – while paltry, it’s well above corporate and sovereign emerging bonds.

The hit from China’s growth slowdown

China’s slowing economy is raising concern about the potential spillovers beyond its shores, in particular the impact on other emerging markets. Because developing countries have over the past decade significantly boosted exports to China to offset slow growth in the West and Japan, these countries are unquestionably vulnerable to a Chinese slowdown. But how big will the hit be?

Goldman Sachs analysts have crunched the numbers to show which markets and regions could be hardest hit. On the face of it non-Japan Asia should be most worried — exports to China account for almost 3 percent of GDP while in Latin America it is 2 percent and in emerging Europe, Middle East and Africa (CEEMEA) it is just 1.1 percent, their data shows.

But they warn that standard trade stats won’t tell the whole story. That’s because a high proportion of EM exports are re-processed in other countries before reaching China which in turn often re-works them for re-export to the developed world. In other words, exports to China from say, Taiwan, may be driven not so much by Chinese demand but by demand for goods in the United States or Europe. So gross trade data may actually be overstating a country’s vulnerability to a Chinese slowdown.

Bernanke Put for emerging markets? Not really

The Fed’s unexpectedly dovish position last week has sparked a rally in emerging markets — not only did the U.S. central bank’s all-powerful boss Ben Bernanke keep his $85 billion-a-month money printing programme in place, he also mentioned emerging markets in his post-meeting news conference, noting the potential impact of Fed policy on the developing world. All that, along with the likelihood of the dovish Janet Yellen succeeding Bernanke was described by Commerzbank analysts as “a triple whammy for EM.” A positive triple whammy, presumably.

Now it may be going too far to conclude there is some kind of Bernanke Put for emerging markets of the sort the U.S. stock market is said to enjoy — the assumption, dating back to Alan Greenspan’s days, that things cant go too wrong for markets because the Fed boss will wade in with lower rates to right things. But the fact remains that global pressure on the Fed has been mounting to avoid any kind of violent disruption to the flow of cheap money — remember the cacophony at this month’s G20 summit? Second, the spike in U.S. yields may have been the main motivation for standing pat but the Treasury selloff was at least partly driven by emerging central banks which have needed to dip into their reserve stash to defend their own currencies. According to IMF estimates, developing countries hold some $3.5 trillion worth of Treasuries, of which just under half is in China. (See here for my colleague Mike Dolan’s June 12 article on the EM-Fed linkages)

David Spegel, head of emerging debt at ING Bank in New York says the decision reflects “an appreciation for today’s globalised world”:

Turkey’s central bank — a little more action please

In the selloff gripping emerging markets, one currency is conspicuous by its absence — the Turkish lira. But this will change unless the central bank adds significantly to its successful lira-defensive measures.

Hopefully at today’s policy meeting.

Like India or Indonesia which have borne the brunt of the recent rout, Turkey has a large current account deficit, equating to over 5 percent of its economic output. But what has made the difference for the lira is the contrast between the Turkish central bank’s decisive policy tightening moves and the ham-fisted tactics employed by India and Brazil.  (We wrote here about this).  See the following graphic (from Citi) that shows the central bank has effectively raised the effective cost of funding by 200 basis points to around 6.5 percent since its July 23 meeting.

 

Guillaume Salomon, a strategist at Societe Generale calls Turkey the “success story” given the relatively stable lira and expects the bank to raise the upper band of its interest rate corridor by another 50 basis points at least. He says:

Russia — the one-eyed emerging market among the blind

It’s difficult to find many investors who are enthusiastic about Russia these days. Yet it may be one of the few emerging markets  that is relatively safe from the effects of “sudden stops” in foreign investment flows.

Russia’s few fans always point to its cheap valuations –and these days Russian shares, on a price-book basis, are trading an astonishing 52 percent below their own 10-year history, Deutsche Bank data shows.  Deutsche is sticking to its underweight recommendation on Russia but notes that Russia has:

“become so unpopular with the investor community that it is a candidate for the ‘it’s so bad it’s good’ club as evidenced by the very cheap valuations and long-term  underperformance.

BRIC shares? At the right price

Is the price right? Many reckon that the sell off in emerging markets and growing disenchantment with the developing world’s growth story is lending fresh validity to the value-based investing model.

That’s especially so for the four BRIC economies, where shares have underperformed for years thanks either to an over-reliance on commodities, excessive valuations conferred by a perception of fast growth or simply dodgy corporate governance. Now with MSCI’s emerging equity index down 30 percent from 2007 peaks, prices are looking so beaten down that some players, even highly unlikely ones, are finding value.

Societe Generale’s perma-bear Albert Edwards is one. Okay, he still calls the bloc Bloody Ridiculous Investment Concept but he reckons that share valuations are inching into territory where some buying might just be justified. Edwards notes that it was ultra-cheap share valuations in the early 2000s that set the stage for the sector’s stellar gains over the following decade, rather than any turbo-charged economic growth rates. So if MSCI’s emerging equity index is trading around 10 times forward earnings, that’s a 30 percent discount to the developed index, the biggest in a very long time. And valuations are lower still in Russia and Brazil.

“Contrarian” Deutsche (a bit) less bearish on emerging stocks

For an investor in emerging equities the best strategy in recent years has been to take a contrarian stance, says John-Paul Smith at Deutsche Bank.

Smith, head of emerging equity strategy at Deutsche, has been bearish on emerging stocks since 2010, exactly the time when bucketloads of new cash was being committed to the asset class. Investors who heeded his advice back then would have been in the money — since end-2010 emerging equities have underperformed U.S. equities by almost 40 percent, Smith pointed out a couple of months ago.

Things have worsened since then and MSCI’s emerging equity index is down around 12 percent year-to-date, almost the level of loss that Deutsche had predicted for the whole of 2013. June outflows from emerging stock funds, according to EPFR Global last week, were the largest on record. But true to form, Smith says he is no longer totally bearish on emerging equities.  Maybe the presence or absence of those he calls “marginal international investors” — people who joined the EM party too late and are quick to take fright — is key. Many of these positions appear to have been cleaned out. Short positions or high cash balances dominate the books of dedicated players,  Smith writes: