Posts tagged ‘emerging markets’
As we know, the taper tantrum last year had a baleful effect on emerging market assets and currencies. 2014 has turned out rather better for them – with one notable exception: Russia.
It feels like rather a long time since the annexation / independence of the Crimea back in March, and the illegal deposition / welcome overthrow of President Viktor Yanukovych beforehand feels much longer ago still. Yet with the EU menacing further sanctions later this month, economic stagnation in Russia could become recession. The low oil price is not helping; the rouble hit new lows again this week. And so: will Russia be plunged into crisis, as in 1998? Or is this a buying opportunity?
There is no denying the seriousness of Russia’s predicament. Currency weakness of 39% against the dollar since the middle of the year will entail higher inflation, also pushed up by sanctions, and interest rates have had to go up as a result with the Bank of Russia Key Rate up from 5.5% at the start of the year to 9.5% today. Last month alone, the country’s foreign exchange and gold reserves fell by over $28bn as the central bank intervened in the currency market, to little avail. Bond markets have weakened, with the cost of borrowing more than 2% higher in longer maturities than it was at the end of 2013. There is indeed a convincing bear case to be made for the Russian bear.
On the other hand, Russian fundamentals are hardly what they were in ’98. In those days the country’s reserves were below $10bn and its debt to GDP ballooned to just shy of 100% over the course of the crisis. Today Russia has reserve assets of over $428bn and gross debt to GDP on IMF numbers of 14%. In addition, under 30% of its bond liabilities are denominated in foreign currency.
The oil price is of course a concern. But the price of gas has risen, and with winter almost upon us in Europe Russia will be profiting in coming months from increased demand. Crucially, both commodities price in dollars, so the country’s gigantic trade surplus – averaging $19.3bn per month for the six months to August – represents a reliable inflow of hard currency.
We also have the Great Recession as a recent comparator. Brent crude dipped below $40 a few times in 2008-9, the rouble had depreciated against the dollar by over 55% at one point, those reserve assets plummeted from $593bn to $381bn, real GDP fell by 11.2% on the year to Q2 2009, and yet there was no default. GDP was back to its pre-recession peak by the end of 2011. By 2010 the currency had already re-stabilised and during that year reserves increased again by $41.7bn, all while the Brent crude future averaged just over $80, below where it stands today.
Is there, then, a bull case? It seems likely that Russia will weather the current crisis, but betting on this is a different matter. For one thing, much of the asset weakness is down to the currency. Russian equities have actually been rallying, and rose by almost 8% in local terms last week. For the year to date the MICEX price index is only 0.5% down. In dollar terms, however, the market has fallen more than 30%. On a p/e basis it looks cheap relative to other bourses but then it always does because of the country’s governance problems. This year its valuation has held at a higher level than at any other time since the flash crash of 2011.
Taking a punt on the rouble would be a brave endeavour to say the least. And there are as always other financial fish to fry. Russia’s underlying balance sheet and export strength should reassure those concerned about a re-run of the Yeltsin era. But even with the bear in such difficulties it is hard to work up any enthusiasm about taking hold of its paw.
China. My goodness but we’re all worried about her at the moment!
There was another splash on the FT this morning about warnings of hard times ahead for some private investors as bond and trust investment defaults are expected to increase (further from zero) in coming months. And of course there has also been much attention given to the Chinese property market, which may be in a bubble; which may be primed to burst.
All this sounds rather worrying. Before commenting further there are three facts we need to observe:
- China approaches any potential bear period in the default cycle from a strong position. The required deposit reserve ratio for major banks stands at 20%, headline real GDP growth of 7.5% per year counts as a recession and managing the strengthening of renminbi in a stately fashion has built up foreign currency reserves of $3.8trn (comfortably more than twice total gross government debt as forecast by the IMF for 2013 – which itself stands at an unterrifying 23% of GDP).
- Commentators cried wolf on the property market ages ago. Two years back – a very bearish time, let us remember – there was a lot of talk abroad about the imminent collapse of Chinese real estate. In fact, even before then (worried about something called “inflation”), the Chinese had been tightening monetary policy via interest rates, exchange rates, and that bank reserve ratio in a deliberate attempt to slow the economy which had already seen the country’s real estate climate indicator fall sharply (it remains well below its ten-year average today).
- Chinese reported EPS, as measured by the CSI 300 Index, have grown faster than earnings for the S&P 500 since the nadir of 2008, grew faster in 2013 and are forecast to grow faster this year too. This is a good reflection of relative rates of growth in GDP. The difference in price behaviour has resulted in a US valuation multiple of 17x, well off the 2009 low and above the ten-year average; and a Chinese earnings multiple of under 10x, well below the ten-year average and lower even than the previous nadir reached in the middle of the Great Recession.
So it seems very unlikely, to say the least, that trust and real estate worries in China will lead to anything like the effects of (say) the subprime mortgage debacle on the US, or if they do, that this is not already priced in.
That is not to discount the possibility of distress entirely of course. The boy who cried wolf, morals about honesty aside, was proved right in the end.
So let us turn to China’s undeniable problem: it is a deeply unfree country. Looking at the World Bank indicators on national governance, China ranks broadly in line with other EM economies such as India and Brazil on measures such as the efficacy of government, the rule of law and the control of corruption. But in terms of popular voice and government accountability she is among the worst in the world. Coming in at the 5th percentile China is less free than Iran, Belarus or the Congo, and significantly less so than Russia (which does appallingly on the other measures by comparison).
This means very limited freedom on investment opportunities for the Chinese (generating disproportionate interest in real estate, for instance, and complex trust structures), coupled with controls on capital movements and profit repatriation with which Western investors are very familiar.
In itself this lends only a limited amount of credence to the idea that the big, bad wolf stands at China’s door. It remains much easier to see Western economies being bankrupted by their banking systems. But for anyone looking for the structural problem with the Chinese economy: that is it.
As a final aside, we should also remember how those trillions in imported reserve dollars are invested. China is the biggest foreign holder of US government debt in the world, and towards the end of last year sold nearly $50bn worth (out of a $1.3trn total). That’s five times the amount of monthly “tapering” being undertaken by the Fed.
In other words, if the bears are right about China being on the brink of some kind of systemic collapse, it is utterly impossible for the world to remain immune; not least the Treasury market, which has had a nice rally this year so far. The decoupling of emerging market and developed-world performance has been an eye-catching feature of recent quarters, but – one way or another – it is not really sustainable.
Yesterday came the news that the US economy grew at a 3.2% annualised pace in the fourth quarter of last year. This encouraging sign came on top of Tuesday’s Q4 GDP data for the UK, which capped off the strongest year since before the Great Recession. Yet markets hardly noticed. Perhaps it’s the freak winter weather over the Atlantic, but January has got 2014 off to a bearish start.
At the time of writing the S&P 500, the FTSE 100 and the Euro Stoxx 50 are all down by 4-5% so far this year and the Nikkei has dropped by over 8%. Ten year yields in safe haven markets are about 0.3%-0.4% lower; Greek debt has sold off. Emerging market debt is weaker, and EM equity is also off, especially in Latin America. The trade weighted yen has strengthened for the first month since August, and the dollar has risen too. Highest profile currency losers have been Argentina and a few other EM nations. Gold is up; industrial metals, down. Credit spreads are wider.
Risk, in other words, is off again.
Explanations for this sorry start vary, as ever. There is a vague consensus that emerging markets are a problem, and talk of capital flight and current account deficits. Unfortunately this doesn’t quite add up though. Turkey saw its currency lose nearly 9% of its value against the dollar by the end of last week and yes, it runs a material current account deficit – 7.2% of GDP at the last count – but it hasn’t run a surplus since 2002, so it is not clear why this measure should suddenly assume overriding relevance. For that matter, the Russian rouble has fallen by over 7% against the dollar so far this year, and yet Russia has posted a current account surplus each quarter since the crisis of 1998 (amassing some of the most substantial reserve assets in the world as it did so). Then there is the other North American dollar. Yes, Canada also has a current account deficit – but nobody seems to be talking about that in relation to the 5.5% sell off worn by the poor old loonie. In fact, coupled with more moderate weakness in the Aussie dollar, the real currency story begins to look like US dollar strength with EM specifics a bit of a side-show. Though again, that might not square with higher gold.
The half-hearted media attention given to EM is understandable. There is no news like bad news: crises shift copy. Away from emerging-land, however, there are plenty of other discrepancies which have gone unnoticed. In the UK we have had real evidence of the extent to which stronger growth is good news for sovereign debt, and with recovery on the Continent picking up, Spanish and Portuguese bonds have outperformed German bunds in this month’s rally. Ten year Portuguese debt came within a hair’s breadth of knocking through 5% today and has made new post-bailout lows. And yet Greek debt, as we have seen, has sold off – while the Athens Stock Exchange has outperformed all major markets, currently standing a little higher on the year to date.
In the US, stock market weakness has been accompanied by earnings reports which have surprised to the upside 72% of the time. As of this afternoon 250 of the member companies of the S&P 500 index have reported EPS for Q4 and have managed a +10.5% share-weighted change on the year since Q4 2012. Both of these percentages compare favourably with the picture at the end of January 2013, a month which saw the S&P rise by more than 5%.
There is more that could be said along these lines but the picture is clear – which is to say, not very clear at all, and subjected to interpretations which barely convince even at a superficial level.
What can perhaps be observed is that 2013 saw some unequivocal behaviour from asset classes and that uncertainty has reasserted itself since. We should not expect markets to move in straight lines. Sometimes this sets them against the grain of the fundamentals – and that, of course, can present opportunities.
The US shutdown is over. Japanese inflation for the year to September reached its highest level for nearly 5 years. And UK GDP data showed signs of a strengthening recovery. The S&P 500 has risen 4% since the beginning of the month, the FTSE 100 has done likewise and the Euro Stoxx 50 is up by a little more.
At the same time, the Norwegian sovereign wealth fund – the world’s largest with $810bn under management – announced that it is waiting for a correction before increasing its equity exposure. (See the widely-read Bloomberg story here.)
Developed-world equity markets have had a strong 2013, to the point where it is difficult to argue on some measures, such as p/e ratios, that they offer value. Are we entering the territory of over-exuberance?
As a starting point let’s have a look at what the CEO of that Norwegian fund actually said:
Our share in the stock market has been stable or falling even though markets are rising, and that means in practice that we’re not using inflows to buy stocks … In general, we see market corrections more as opportunities than as threats, so it’s not something that worries us. If they come, that’s just a positive sign for us as an investor.
According to the interview he did say the fund was “preparing for a correction”. But this is a fund whose rapid growth is underpinned by sizeable petrodollar inflows. They are not selling the market, and in the event of a correction – should it come – they intend to start buying again. In fact this sounds like the Norwegian central bank is offering the market a put!
In addition it is always worth looking at what reported earnings are doing. US news has been dominated by political and monetary goings-on, but the S&P is almost half way through the latest quarterly earnings season: 243 companies have reported an overall EPS increase of 8.4% on the previous year so far, significantly ahead of expectations. If that growth rate can be sustained as predicted the current price level would soon look much easier to bear.
Finally, the rally in risk pricing has not been universal. We took a look at India a few weeks back when the rupee was coming under heavy pressure for instance. Indeed, emerging market equity in general has underperformed its developed-world equivalent by a margin of 23% over the year to date. Selective exuberance may be irrational in some ways but it is not so terrifying as indiscriminate (and price insensitive) optimism.
The Norwegian view looks sensible: no panic, nor any excitement over the major markets at current valuation levels, and a preparedness to buy again should prices come down.
The markets which have performed the most strongly – as ever – may not be offering the most obvious opportunities. But the steady stream of positive data on earnings and economies is encouraging for their investors nonetheless.
One of the effects of the market’s recent taper tantrum has been to depreciate developing-world currencies, provoking fears in some quarters that we are on the cusp of a re-run of the events of 1997 which saw various tiger-shaped dominos tumble across the Asian part of the emerging market landscape. Particularly badly hit has been India. At one point on Wednesday the rupee stood 31% weaker against the dollar than it had done at the beginning of May, when the panic kicked off. Despite a muted recovery it is still down about 25% at present. Is the writing on the wall for the BRICs? Is it the Asian crisis all over again?
The short answers are “no”, and “no”.
It is true that Indian GDP has slowed and that today’s release for the year to Q2 came in below expectations. On the other hand, 4.4% annual growth in real terms doesn’t look so bad from a developed-world perspective, disappointing though it is set against an average rate for India over the last ten years of 8%.
It is also true that the Indian balance sheet is not as strong as some of its EM peers, with IMF putting its gross government debt to GDP ratio for 2012 at 67%. And India is running a budget deficit of about 5% of GDP at the same time – though again, these figures look downright enviable if you’re the US, Eurozone, UK or Japan.
So far, so worrying. But we are still some distance from 1997 and here’s why.
Going into the ’90s collapse the Asian tigers had been over-hyped and over-invested in by exuberant developed-world investors drunk on low inflationary growth and technological advancement. At the same time they had begun to have the rug pulled under them in certain industries by lower-wage China through an insistent combination of economic liberalisation and currency devaluation. (When Thailand, first casualty of the 1997 collapse, stood on the brink of annihilation in June of that year its economy was already in recession.)
Furthermore, the level of foreign currency debt at the time was huge, and countries including Thailand were trying to maintain currency pegs against the dollar with derisory levels of foreign exchange reserves to back them. On the way into the crisis, external debt to GDP in Thailand and elsewhere in the region was running at over 60%.
Today the attitude towards emerging market investment is far from exuberant – indeed has been relatively gloomy since the crash of 2011. And even with debt to GDP of 67% India has gold and foreign exchange reserves of almost $300bn. That’s much less than China, or Russia, but brings the net debt position down to under 50% of GDP. In addition, with budget deficits and real GDP growth balancing each other out, that debt ratio is not increasing.
Neither is there a sudden attack on a currency peg to contend with. The rupee already devalued from 45 to 55 against the dollar in 2011-12 and inflation at that time peaked just shy of 11%. There seems little reason to expect the current devaluation to 65 to result in something much more dramatic.
At the same time, export growth has bounced: up 11.6% on the year to July, an eighteen-month high. We should expect that kind of thing in a period of material currency weakness. (This is exactly the supposed cure-all remedy some have in mind for the beleaguered members of the eurozone periphery.)
It is precisely when we come to exports and growth, however, that we stumble over the real disconnect between fantasies about a reprise of the Asian crisis and the reality of the situation today. When India was booming back in 2010 and the rupee was moving sedately sideways, US monetary policy was in very much the same position as it is today. It has not changed in the interim. Therefore, the slowdown in the Indian economy cannot reasonably be attributed to a change in American monetary tapering, tinkering or anything else. Therefore, there is no reason necessarily to expect the Indian economy either to benefit or to suffer from changes in the US monetary environment over the next few quarters.
What has changed since 2010, however, is that Europe (including the UK) re-entered recession, Japan joined them in the aftermath of a calamitous natural disaster, the US recovery slowed, Greece defaulted and confidence collapsed. If we seek the cause of strain on the economy of India as elsewhere in the developing world, it is surely here that we find it – not in the press releases of the Federal Reserve.
Which brings us back to the present. It is not 1997 which lies around the corner, but 2014. So far – further shocks permitting – the coming period looks likely to be one of continued recovery. This will make an especial change coming from Europe, though if this week’s GDP revision for Q2 is anything to go by the pace might be picking up in the US too.
Can the Indian economy benefit from stronger growth across the developed world without reacting to changes in quantitative easing by the Fed any more than it has done so already?
Now there is a question to which the answer might just be, “yes”.
Markets received a pleasant surprise this week when Q1 GDP growth for Japan came in higher than expected – 0.9% on the quarter versus an average forecast of 0.7%. Growth surprises have been mixed this quarter: GDP for the US was weaker than forecast (2.5% annualised vs. expectations of 3.0%), and before that the Chinese figure disappointed too (7.7% on the year to Q1 as against a forecast 8.0%). On the other hand, the number for the UK – +0.3% – was above a consensus expectation of +0.1% and allayed fears of a “triple dip recession”.
The differences between expected and observed outcomes for growth data have not been large, but their direction has had a material effect on markets. When quarterly data for the end of 2012 began coming through it was taken badly, with the US, Japan, eurozone and UK all falling behind forecast levels. Oil and industrial metals markets have yet to regain the February peaks they left so far behind as a result of this, and while the major developed-world markets merely paused for breath, emerging markets were knocked back and only began to recover last month.
So well done the Japanese and their not-so-new programme of Abenomics.
The market reaction to these growth numbers, however – powerful as it is – only partially captures the fundamental message of the data. Of course it is material if economic growth across the world as a whole is falling short of what is expected, with all the implications for demand, trade, earnings and so on that this entails. That is what was feared this February. The data out over the last few weeks, though, reminds us that the recovery from the Great Recession is, in aggregate, an ongoing reality – albeit a patchy and unsatisfactory one. And it is that patchiness which ought also to be of interest to markets over time.
Look again at the numbers. The differences between the forecasts and out-turns for growth rates in the various economies are pretty small. Certainly they pale in comparison to, say, the difference in growth rates between China and the US, or the US and the UK, or Asia and the rest of the world. Some of these larger differences are structural, and therefore somewhat predictable – and way more so than the precise quarterly outcomes for the individual economies themselves. And yet they are often, seemingly, ignored.
Much of this is down to confidence. Though emerging economies are growing and are forecast to grow more quickly than their developed counterparts across the geographic regions of the world, their markets, generally speaking, have lagged materially over the year to date. Investors still prefer to avoid owning a bank 100% of whose earnings derive from a fast-growing economy if they can own a confectioner which derives 10% of its earnings from selling sweets in the same place. Such is the way of things, for now.
Ultimately it is confidence that will change the picture. The historic p/e ratio of the Shanghai Composite index has averaged 22x over the past ten years. It now stands at a little over 12x, where it has been stuck for the last two. On the eve of the Great Recession it peaked just shy of 48x. To say that Chinese equity has fallen out of favour would be to make an enormous understatement. And at some point, global markets will get bored with investing via confectionery.
Furthermore, as the year progresses some signs of key threats to confidence have continued to recede. This month, ten year Greek debt stabilised below 10% for the first time since the sovereign crisis broke in 2010. Buy the 2% 2023 now and it will yield you less than 8% to maturity. The equivalent bonds for Spain and Portugal will still yield a little over 4% and 5% respectively. The economic cataclysm faced by these and other countries continues but the systemic threat from bond markets that caused so much of the trouble has lessened.
It is as always impossible to say what will happen next. But confidence can be a powerful asset: just ask the Japanese.