Global Investing

Adversity is a great leveller. Just look at the way sovereign credit ratings in the developed and emerging world have been converging ever since the credit crisis erupted five years ago. JPMorgan  has crunched a few numbers.

Few were surprised last week by S&P’s decision to cut the outlook on Britain’s AAA rating to negative. That gold-plated rating is becoming increasingly rare — according to JP Morgan, just 15 percent of global GDP now rates AAA with a stable outlook — a whopping comedown from 50 percent in 2007. Only 13 developed economies are now rated AAA, compared to 21 before the crisis. And only one, Australia, now has a higher rating (AAA) than in 2007 — 16 of its peers have suffered a total of 129 downgrades in this period.  With 20 rich countries on negative outlook, more downgrades are likely.

Emerging sovereigns, on the other hand, have enjoyed 189 upgrades (43 percent of these were moves into investment grade). That has caused what JPM dubs “a traffic jam”  in the triple B ratings area, with 20 percent of world GDP now rated at this level, compared to 8 percent in 2009.

To judge the scale of that re-rating, look at JP Morgan’s EMBI Global sovereign emerging debt index.  The bank says 63 percent of the EMBIG now rates as investment grade — up from 2 percent in 1993 and around 40 percent in 2007. JPM writes:

The years 2011-2012 will be  remembered for the deepening of the Eurozone crisis and a wave of sovereign ratings downgrades across the US, Europe and Japan…The gap between DM and EM sovereign ratings has narrowed, with a growing concentration of EM and DM in the triple-B rated bucket.

One of the big stories of the past decade has been the massive jump in central bank reserves, with total reserves having quintupled from a decade ago to around $10.6 trillion.

But the growth has not been uniform. And over the past 18 months slowing world growth and trade has stalled reserve accummulation across the developing world, making some countries increasingly vulnerable to financial shocks, according to analysts at Capital Economics.

They point out for instance that, although most emerging economies are less vulnerable than in the past, Ukrainian reserves have fallen by a quarter in the past year while in Venezuela they declined by 40 percent. Egyptian reserves halved since end-2011, forcing it to agree to an IMF aid deal. Foreign exchange reserves in these countries may not be sufficient to protect against balance of payment crises should trade flows and investments slow further, they reckon.

The past 24 hours have brought news of more fund launches targeting emerging corporate debt;  Barings and HSBC have started a fund each while ING Investment Management said its fund launched late last year had crossed $100 million.  We have written about the seemingly insatiable demand  for corporate emerging bonds in recent months,  with the asset class last month surpassing the $1 trillion mark.  Data from Thomson Reuters shows today that a record $263 billion worth of EM corporate debt has already been underwritten this year by banks, more than a fifth higher than was issued in the same 2011 period (see graphic):

The biggest surge has come from Latin America, the data shows, with Brazilian companies accounting for one-fifth of the issuance. A $7 billion bond from Brazil’s state oil firm Petrobras was the second biggest global emerging market bond ever.

The top 10 EM corporate bonds of the year:  Petrobras issued the two biggest bonds of $7 billion and $3 billion, followed by Venezuela’s PDVSA and Indonesia’s Petramina. Brazil’s Santander Leasing was in fifth place, Mexican firms PEMEX and America Movil were sixth and seventh.  Chilean miner CODELCO, Brazil’s Banco do Brasil and  Russia’s Sberbank also entered the list.

The 60-70 basis-point post-election surge in Venezuela’s benchmark foreign currency bond yields  is already starting to reverse.

Despite disappointment among many in the overseas investment world over a comfortable re-election in Venezuela of populist left-wing President Hugo Chavez  on Sunday there are quite a few who are already wading in to buy back the government’s dollar bonds.  Not surprising,  as Venezuelan sovereign bonds yield some 10 percentage points on average over U.S. Treasuries and 700 basis points more than the EMBIG sovereign emerging bond index.  It’s pretty hard to keep away from that sort of yield, especially when your pockets are full of cash, the U.S. Federal Reserve is pumping more in every month and Venezuela is full of expensive oil .

The feeling among investors clearly is that while a victory for opposition candidate Henrique Capriles would have been preferable, Chavez is not not a disaster either  given that his policies are helping maintain a steady supply of thse high-yield bonds. And with oil prices over $110 a barrel, it is highly unlikely he will shirk on repaying debt.

Investors who have been buying up Venezuelan bonds in hopes of an opposition victory in this weekend’s presidential election will be heartened by the results of a poll from Consultores 21 which shows Henrique Capriles having the edge on incumbent Hugo Chavez.  The survey shows the pro-market Capriles with 51.8 percent support among likely voters, an increase of 5.6 percentage points since a mid-September poll.

Venezuelan bonds have rallied hard ever since it became evident a few months back that Chavez, a socialist seeking a new six-year term, would face the toughest election battle of his 14-year rule. Year-to-date returns on Venezuelan debt are over 20 percent, or double the gains on the underlying bond index, JP Morgan’s EMBI Global. And the rally has taken yields on Venezuela’s most-traded 2027 dollar bond to around 10.5 percent, a drop of 250 basis points since the start of the year.

But Barclays analysts are advising clients to load up further by picking up long-tenor 2031 sovereign bonds or 2035 bonds issued by state oil firm PDVSA:

Venezuela's Chavez with Lukashenko of Belarus

Which bond would you rather buy — one issued by a country with an unpredictable leader but huge oil reserves, or one with  a dictatorial president as well as empty coffers? The answer should be a no brainer. Not so. The countries are Venezuela and Belarus, and a basic comparison of their debt profiles shows how strangely risk can be priced in emerging markets.

Venezuela’s 2022 dollar bond yields 15.5 percent while the 2022 issue from state oil firm PDVSA trades at 17 percent yield. Venezuelan debt pays a 1200 basis point premium to U.S. Treasuries, according to the EMBI Global bond index.

Now check out Belarus. Dire public finances, a huge recent currency devaluation, and seeking an $8 billion bailout from the IMF, yet able to pay 11 percent on its 2018 issue. Its yield premium to Treasuries is 900 bps or three percentage points less than Venezuela.

Politics have turned nastier than usual this year in emerging markets. Nonetheless, if you were a buyer of emerging bonds, you would have been ill-advised to play safe. That’s because the best performing emerging credit so far this year is Ivory Coast, which at the end of January effectively defaulted on its $2.3 billion dollar bond. Yes really, according to JP Morgan, which runs the most widely-used emerging debt indexes.

That’s because the bond has risen about 15 points since the start of the year on hopes Alassane Ouattara — seen as the rightful winner of last year’s election — would wrest back the presidency from Laurent Gbagbo who had refused to quit office. Ouattara, now installed in the presidential palace, is expected to honour the bond. So if you’d bought this bond at the end of December you would have earned a notional return of 25 percent, according to JP Morgan. The index overall has returned just 1.6 percent.

In second place? Ecuador. It too defaulted in 2008 — on $3.2 billion in bonds — but has benefited recently from oil prices at well over $100 a barrel. That should help its economy grow 5 percent this year.  Another oil power, Venezuela, is in third place. Its bonds may be trading at a 10 percent yield premium to U.S.  Treasuries, reflecting its riskiness, but Venezuelan bonds returned close to 10 percent so far this year, JP Morgan told clients. Many fund managers have piled in, noting  that despite the unpredictability of its President Hugo Chavez, he is raking in oil export revenues and  has never shied away from repaying debt.