Currencies -- The macro case for Euro 1.30?
The currency wars that led to 1.37 Euro dollar and 1.28 Euro yen now have the potential to abort the EU's economic growth momentum. While it is premature to expect a ECB rate cut, Mario Draghi will be tempted to jawbone the Euro lower (Trichet's style?) to slash recession risk. In any case, the Banca Monte dei Pachi Siena scandal is a disaster for Draghi since it happened on his watch as Governor of the Banca d'Italia.
The Euro's 12 per cent rise in its trade weighted index since last summer is entirely logical given the shrinkage of the ECB balance sheet below 2.8 trillion Euro at a time of central bank money printing in Washington, Tokyo and London. Yet the uber-Euro has the potential to spawn a political crisis between Paris and Berlin, particularly if French dirigisme assault against the Euro, the Bundesbank and ECB could well slash their growth projections. Then and only then will a ECB Draghi rate cut become inevitable and take the Euro lower to 1.30.
Italy is a source of risk in global markets. The Italian 10 year bond yield is now 4.58%, a full 50 basis points above January's low. The election outcome could well take Italian debt above 5%, a scenario that could well take the Euro down to 1.30 and trigger a safe haven rally in German Bunds and US Treasuries. If Luigi Bersani, a former Marxist, becomes Prime Minister in a fragile centre-left coalition, he could well abandon Mario Monti's reforms and trigger a bloodbath in the BTP debt market, with ten year yields having the potential to spike to 5.60% or higher. This would be the worst possible moment for Mario Draghi to present the ECB's OMT for the verdict of the capital markets in a desperate attempt to avert a spike in sovereign debt. After all, OMT financing has to be approved by the Bundesbank and is thus hostage to the vagaries of German politics in an election year.
The political scandal in Spain now has a tangible impact on the capital markets. Even though Chancellor Merkel has backed PM Rajoy in the illegal cash payment probe, Spanish debt yields have now begun to creep higher. While the ten year Spanish-German debt spread does not suggest imminent crisis, (last summer the 10 year Spanish debt yield spiked to 7.78%), the last thing a nation in economic distress needs is a sleazy political scandal with the potential to gut the Partido Popular's senior most leadership. In any case, Rajoy will be less able to railroad structural reforms on an electorate or slash public spending at a time of increasing Catalan/Basque secessionist sentiment. The political risk on Spanish debt can only rise another black cloud for the Euro.
Macro Ideas - Magic realism and Latin American finance!
The macro/currency trade that gave me most pride last year was the early summer call to aggressively buy the Mexican peso against the dollar at 14, a level that made the currency of the world's largest Spanish speaking society absurdly undervalued. The Mexican peso soared to 12.50 in the subsequent six months and is 12.80 now. With 600 million people, a GDP of $5.6 trillion, Latin America should be a key investment focus for Gulf investors. Sadly, it is not.
Latin America is on the brink of epic political and economic change as the Castro era ends in Cuba and the Chavez era ends in Venezuela. I desperately hope for soft landings in Havana and Caracas for the sake of their long suffering people. An Argentine friend, a former Chase debt trader whose uncle was a roommate with Che in Buenos Aires, was horrified by the squalor, human degradation and five decades of Marxist Leninist socialism wrought in Cuba during a recent visit.
After more than a century of the Monroe Doctrine, CIA financed military coups, gunboat diplomacy and Marine invasions, Latin America no longer defers to the US and the Monroe Doctrine is a geopolitical anachronism. The passing of Hugo Chavez and Fidel Castro will not mean Cuba and Venezuela enthusiastically embrace Coca Cola, the IMF, Wall Street and the Washington Consensus (surely an oxymoron in a time when the GOP veers to the right and the Dems go left under Obama!).
Yet I can easily envisage huge money making opportunities in the debt/loans of both countries. Strange. JFK was assassinated fifty years ago in Dallas but the hirsute El Commandante who stationed Soviet missiles on the island and sent his armies to fight for Lenin (actually the Brezhnev gerontocracy in the Kremlin), in Angola, Mozambique and Ethiopia is still alive.
Latin America was once afflicted by military dictatorship that abused human rights, notably Argentina under Generals Viola, Videla and Galtieri and Chile under Augusto Pinochet. Yet Argentina's defeat and surrender in the Falklands war and Pinochet's death spawned democracies in Santiago and Buenos Aires. Yet the Honduran military's overthrow of President Zelaya demonstrates political/coup risk still exists.
Mexico, Brazil, Colombia and Chile are some of the most exciting emerging markets I know in the world. There was an old saying when I lived in Colonia Polanco, near Chapultepec Park in Mexico City DF, Poor Mexico, so far from God, so close to the United States. Not true any longer. Lucky Mexico, so close to the US Southwest that has become a crucible of its high tech, networked, cheap energy manufacturing renaissance. The US trades five times more with Colombia than Russia and Bogota is now a petrocurrency power and as the FARC rebels are doomed.
The surreal continent that first bewitched me via the books of Gabriel Garcia Marquez, Octavio Paz, Carlos Fuentes and Jorge Luis Borges is now dominated by mature, vibrant, pro market democracies. The Lula decade in Brazil changed the course of history. Lula lifted forty million people out of poverty. Fairy tales sometimes happen in real life. Not often but sometimes. Magic realism is as vibrant in Latin American finance as in its literature.
Market View - Can India's Sensex drop to 15000?
My bullishness on the Indian rupee at 55 - 56 was based on the sheer scale of offshore fund buying on Dalal Street after Dr. Manmohan Singh unveiled his "shock and awe" reforms last September and Finance Minister Chidambaram spoke forcefully about a commitment to cut a fiscal deficit that coupled with dependence on crude oil imports and supply side wholesale inflation, is the Achilles heel of the Indian economy. However, the epic fall in ten year Indian government bond yields below 7.8% and the consequent rise in the rupee to 53 did not surprise me. The valuation rerating on Sensex since September and the fall in rupee G-Sec debt yields is entirely due to offshore fund (FII) buying, since Indian life insurers and mutual funds were net sellers.
2012 was an annus mirabilis for Indian equities, with a 26% rise in the Sensex though the rupee had a midyear plunge to 57.30 on fears of sovereign government's September reform policy bombshells. However, I now believe that the Sensex at 20,000 discounts a far too optimistic scenario on the economy, reforms, fiscal consolidation and even global risk appetites. Why?
One, Indian GDP growth will not rise suddenly to 8.5% just because Chidambaram waves his magic wand. Indian GDP growth in 2013-14 will be in the 5 - 6% range since the investment cycle just does not have ballast. In the mid to late 1990's, Indian shares traded at 8 - 10 times forward earnings, other than in the euphoria of the 1999 - 2000 tech bubble. Sensex valuations are correlated to Indian GDP growth momentum. So I believe valuations on the Sensex could well derate from the current 13.8 times forward earnings this summer, a 20% premium to the Morgan Stanley emerging markets index.
Two, no less than 12 Indian states will hold elections this year and the UPA faces a general election under the untested leadership of Congress scion Rahul Gandhi in 2014. There is no way valuation metrics in India can rerate at a time of protracted political risk, particularly since state elections in Rajasthan, Andra Pradesh, Mizoram, Sikkim etc. will be toxic.
Three, Brent has reached $117 and no less than 70% of the Indian current account deficit derives from crude oil imports. This is another headwind that will inhibit RBI monetary easing or any sustainable improvements in WPI inflation or the current account deficit (taxes on gold imports mean squat!).
Four, the EU is Indian's largest trading partner and the EU is headed for recession. The political scandal in Spain and the losses at an Italian private bank (founded during the Florentine High Renaissance five centuries ago!) led to frantic foreign selling of Indian equities for four consecutive sessions last week. What happens in the next round of Club Med debt crisis? What happens if Washington's political charades trigger a US government shutdown or a budget deal dissed by Wall Street? The pendulum of greed and fear, as expressed in the Chicago Volatility Index (VIX) screams out complacency. In any case, China at 10X earnings and Thailand at 12X offer better value in Asia.
Five, the Indian government must announce a credible fiscal deficit program at the next Union Budget. The Finance Minister's long term 3% target fiscal deficit is just not credible to the financial markets. Any reduction in government spending could well earnings risks not factored into current Sensex valuations. The Insurance Bill might pass in the winter session of the Lok Sabha, though not the GST, so reform disappointment is another risk. Net net, if the world turns ugly in New Delhi and Dalal Street Indian valuations rerate and the Sensex falls to 15000. New highs? Sure, though caveat emptor!
Stock Pick - Hunting for value in Asian equities
Asia is on fire, thanks to the spectacular bull market in Japan's Nikkei Dow/TOPIX, triggered by PM Shinzo Abe's determination to force the Bank of Japan to embrace a 2% inflation target and the subsequent precipitous depreciation of the yen. Stellar Chinese GDP growth data and the pro-market, anti-corruption drive of incoming President Xi Jinping, anointed with the mandate of heaven by China's Politburo in November, has triggered a fabulous bull market in Shanghai. The Thailand SET index has reached 1500 and the Philippine's Manila Comp index is above 6400 as Southeast Asia's twin equity tigers have roared with a vengeance since late 2011, up 40% for dollar investors.
South Korea's KOSPI has fallen on foreign fund selling and the spike in the won/yen trade. Singapore's Straits Times index looks pricey at 3275 now that DBS has missed earnings and the property curbs hit the REITs/developers even as the Sing dollar falls to 1.24. Political malaise has hit the stock markets of Malaysia and Pakistan. Hong Kong is still a magnet for global liquidity/China flows, as the 12 - 15% rise in the shares of Wharf Holdings, China Sands and Tencent alone demonstrates. As the Year of Dragon surrenders to the Year of the Snake, Asia feels, acts and trades like a growth warrant on the global economy, a cliche from Wall Street in the 1990's.
It makes sense for cyclicals to outperform when the US and China lead an acceleration in the global growth cycle. However, apart from Japan, I believe cyclical Asian markets have rerated since last summer and Morgan Stanley MX APJ at 12.4 times earnings is no longer compellingly cheap, though I see a risk/reward calculus in niche companies, sectors, even countries. I would refocus on Asian energy (CNOOC, Keppel), PBOC easing and reform beneficiaries (The Big Three Chinese banks), domestic growth banks (Siam Commercial/Krung Thai Bank in the Kingdom of smiles), Asian commodities (who could be nobler than Noble, though I do not mean Scottish taipans who once triggered the Victorian era's Opium Wars and now own Cathay!).
Take the Noble Group (NOBL SP), a clear laggard since the Asian dragon roared last summer even though it is one of the world's most successful commodities firms. Noble trades at a mere book value and offers a 3% dividend yield, trades at 10 times earnings even though EPS could rise 30 - 34% now. True, Noble missed 3Q earnings, thanks to low soybean crush margins and a fall in corn prices. Yet Noble's Energy and Sugar business is on a roll, though iron ore is not. The latest spat from Argentina's grain regulator has also hit sentiment, creating a valuation Cinderella for longer term investors. Or a classic value trap?
Can Asia's raging bull markets remain immune from the darkening clouds in Madrid, Rome, Paris - and Berlin? No. The dramatic fall in risk premium is not a permanent feature of the human condition and Club med's protracted recession could well deepen even as the Elysee Palace is hit by a French sovereign downgrade.
The primary reason to own Asia in 2013 is that it is both the epicenter of global growth and a sustained rise in profitability/margins as operating leverage works its magic. This means valuations can well rise as Asia's downgrade cycle finally ends. Earnings growth alone makes me bullish on Thailand, Hong Kong and China. Yet Mr. Market Asia ex Japan has revalued Asia by a full 2 points since last July.
There is not much deep value left in Asia except Chosun/Hermit Kingdom. South Korea now trades at 8 times forward earnings, though won/yen will hit EPS growth in the chaebol's auto/electronic growth franchises. Still, South Korean banks are deep value.
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|Date:||Feb 12, 2013|
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