Global Investing

Shadow over Shekel

Sujata Rao

Aug 14, 2012 14:31 UTC

Israel’s financial markets had a torrid time on Monday as swirling rumours of an imminent air strike on Iran caused investors to flee. The shekel lost 1.4 percent, the Tel Aviv stock exchange fell 1.5 percent and credit default swaps, reflecting the cost of insuring exposure to a credit, surged almost 10 percent.

There has been a modest recovery today as the rumour mills wind down. But analysts reckon more weakness lies ahead for the shekel which is not far off three-year lows.  Political risks aside, the central bank has been cutting interest rates and is widely expected to take interest rates, currently at 2.25 percent, down to 1.75 percent by year-end. Societe Generale analysts are among the many recommending short shekel positions against the dollar. They say:

Expect the dovish stance of the Bank of Israel to remain well entrenched for now.

That’s not all. Investors have been pulling cash out of Israel’s financial markets for some time (Citi analysts estimate $1.6 billion fled in the first quarter of the year). After running current account surpluses for more than 8 years, Israel now has a deficit (the gap was $1.7 billion in the first three months of this year, double the previous quarter) .

Looking behind the scenes, a key factor behind shekel performance is the relative performance of Tel Aviv stocks versus the U.S. market, says Citi analyst Neil Corney.  Last year, Tel Aviv fell more than 20 percent and it hasnt recovered this year. New York’s S&P500 on the other hand has rallied 12 percent so far in 2012 and outperformed last year as well. Corney tells clients:

Local investors in Israel always have a massive home bias but have been investing abroad for a number of years now. However, whilst the local market was outperforming the U.S. markets, they generally would hedge their exposure back to shekels. The inflows into the local real money accounts are strong and growing and the recent underperformance of the local market has led us to a ….phenomena of investing abroad but without the currency hedge. The general rule of thumb that I followed was at least one quarter of underperformance would cause local real money to increase their offshore investments and increase their short shekel position.

Quite simply, these outbound investors are betting the shekel will at best not strengthen much  in the short-term, so it makes sense for them to stay unhedged.

Put down and Fed up

Mike Dolan

Aug 14, 2012 12:46 UTC

Given almost biblical gloom about the world economy at the moment, you really have to do a double take looking at Wall Street’s so-called “Fear Index”. The ViX , which is essentially the cost of options on S&P500 equities, acts as a geiger counter for both U.S. and global financial markets.  Measuring implied volatility in the market, the index surges when the demand for options protection against sharp moves in stock prices is high and falls back when investors are sufficiently comfortable with prevailing trends to feel little need to hedge portfolios. In practice — at least over the past 10 years — high volatility typically means sharp market falls and so the ViX goes up when the market is falling and vice versa. And because it’s used in risk models the world over as a proxy for global financial risk, a rising ViX tends to shoo investors away from risky assets while a falling ViX pulls them in — feeding the metronomic risk on/risk off behaviour in world markets and, arguably, exaggerating dangerously pro-cyclical trading and investment strategies.

Well, the “Fear Index” last night hit its lowest level since the global credit crisis erupted five-years ago to the month.  Can that picture of an anxiety-free investment world really be accurate? It’s easy to dismiss it and blame a thousand “technical factors” for its recent precipitous decline.  On the other hand,  it’s also easy to forget the performance of the underlying market has been remarkable too. Year-to-date gains on Wall St this year have been the second best since 1998. And while the U.S. and world economies hit another rough patch over the second quarter, the incoming U.S. economic data is far from universally poor and many economists see activity stabilising again.

But is all that enough for the lowest level of “fear” since the fateful August of 2007? The answer is likely rooted in another sort of “put” outside the options market — the policy “put”, essentially the implied insurance the Fed has offered investors by saying it will act again to print money and buy bonds in a third round of quantitative easing (QE3) if the economy or financial market conditions deteriorate sharply again. Reflecting this “best of both worlds” thinking, the latest monthly survey of fund managers by Bank of America Merrill Lynch says a net 15% more respondents expect the world economy to improve by the end of the year than those who expect it to deteriorate but almost 50 percent still believe the Fed will deliver QE3 before 2012 is out.  In other words, things will likely improve gradually in the months ahead and if they don’t the Fed will be there to catch us.

What could possibly go wrong?? Well, lots — obviously. As Vanguard’s European CIO Jeff Molitor told us here this week: “No one can see around corners.” And the euro crisis of course remains top of the list of bogeymen. But here too the ECB has constructed its own “policy put” of sorts as ECB chief Draghi has pledged to bolster euro sovereign debt markets via the banks’ first ever bout of QE in the event of a request for a support progamme from ailing giants such as Spain and Italy.  What else? Hard landing signs in China? Fresh banking stress globally? All possible. But — all likely to be met with substantial policy reaction from the Fed at least if they hit the US economy badly again and threaten to  push already-high unemployment back up.

So calm is justified then?

Enter November’s U.S. Presidential election. The “Bernanke put”, as with the “Greenspan put” before it,  is rooted in the Fed’s dual mandate to pursue both full employment as well as price stability — a critical post-Depression orientation of the country’s entire macroeconomic policy approach that many economists insist has served the United States well over the past half century but which also riles many others, not least Paul Ryan, Republican presidential candidate Mitt Romney’s newly-appointed running mate for the position of Vice President.

Ryan, chair of the House Budget Committee, has many criticisms of the Fed, feels QE is storing up inflation for the future and is a supporter of some form of congressional oversight of audit of Fed policymaking. But, crucially, he’s also in favour of removing the full employment part of the Fed’s dual mandate — leaving it with a sole focus on price stability and inflation.

Norwegians piling into Korean bonds

Sujata Rao

Aug 14, 2012 10:31 UTC

One of the stories of this year has been the stupendous rally on emerging local currency debt, fuelled in part by inflows from institutional investors tired of their zero or negative-return investments in Western debt.  Norway’s sovereign wealth fund said last week for instance that it was dumping some European bonds and spending more of its $600 billion war chest in emerging markets.

Quite a bit of that cash is going to South Korea. Regulators in Seoul recently reported a hefty rise in foreigners’ bond holdings (see here for the Reuters story) and  Societe Generale has a note out dissecting the data, which shows that total foreign holdings of Korean bonds are now worth around $79 billion — back at levels seen last July.  Norwegians emerged as the biggest buyers last month,  picking up bonds worth 1.5 trillion won ($1.3 billion) , almost double what they purchased in the entire first half of 2012. Norway’s holdings of Korean Treasuries now total 2.29 trillion won, up from just 190 billion won at the end of 2011.

The growing interest from overseas investors would seem logical — South Korea stands on the cusp between emerging and developed markets, with sound policies, a current account surplus and huge currency reserves. And Socgen analyst Wee-Khoon Chong says the Norwegian crown’s recent strength against other currencies makes such overseas trades more attractive (the crown is up 6 percent versus the euro this year and has gained 5.3 percent to the Korean won). “Norwegians are the newbies into the KTB market,” Chong says. “They are probably recycling their FX reserves.”

All the interest from overseas (along with the central bank’s switch to monetary easing)  have pushed yields on benchmark 5-year Korean bonds to record lows under 3 percent, after starting the year at 3.4 percent. Yet that is significantly higher than what’s available in the “safe” Western markets such as Germany, United States and Britain — 5-year bonds in these countries offer 0.5-0.7 percent.

Emerging corporate debt tips the scales

Sujata Rao

Aug 13, 2012 14:53 UTC

Time was when investing in emerging markets meant buying dollar bonds issued by developing countries’ governments.

How old fashioned. These days it’s more about emerging corporate bonds, if the emerging market gurus at JP Morgan are to be believed. According to them, the stock of debt from emerging market companies now exceeds that of dollar bonds issued by emerging governments for the first time ever.

JP Morgan, which runs the most widely used emerging debt indices, says its main EM corporate bond benchmark, the CEMBI Broad, now lists $469 billion in corporate bonds.  That compares to $463 billion benchmarked to its main sovereign dollar bond index, the EMBI Global. In fact, the entire corporate debt market (if one also considers debt that is not eligible for the CEMBI) is now worth $974 billion, very close to the magic $1 trillion mark. Back in 2006, the figure was at$340 billion.  JPM says:

The international primary market for EM has transformed into a corporate debt market, with sovereign issuance now less than one-third of total EM external issuance.   

JP Morgan expects the $1 trillion milestone to be hit by year-end, when the total stock of sovereign dollar bonds will stand at $700 billion.

There are many reasons for this explosive growth. First, sovereigns are issuing less dollar debt, resorting instead to local bond markets where they can raise funds in their own currencies. Last year, governments raised $566 billion at home, compared to just $70 billion on dollar bond markets.  Their space has been filled by companies which have been emboldened by investors’ enthusiasm for emerging markets and the prospect of cheaper capital than at home. And most recently, the syndicated loan market, previously the main funding source for corporates, has dried up — JPM says loan volumes are down 90 percent from 2011.

Olympic medal winners — and economies — dissected

Sujata Rao

Aug 13, 2012 11:21 UTC

The Olympic medals have all been handed out and the athletes are on their way home.  Which countries surpassed expectations and which ones did worse than expected? And did this have anything to do with the state of their economies?

An extensive Goldman Sachs report entitled Olympics and Economics  (a regular feature before each Olympic Games) predicted before the Games kicked off that the United States would top the tally with 36 gold medals. It also said the top 10 would include five G7 countries (the United States, Great Britain, France, Germany and Italy), two BRICs (China and Russia), one of the developing countries it dubs Next-11  (South Korea), and one additional developed and emerging market. These would be Australia and Ukraine, it said.

Close enough, except that Hungary took the place of Ukraine as the emerging economy in the Top 10 and the United States actually took 46 gold medals — more than Goldman had predicted.

Goldman Sachs quite rightly pointed out in its report that progress and improvement in economic growth have historically equaled progress in sport  –check out South Korea’s 13 golds in London compared with none in Munich 40 years ago; its per capita income is now $23,000 compared with $2,300  back then.  Clearly wealth is key: hence 9 of the top 20 medal winning nations also have among the highest per capita incomes.

Second, countries with a socialist past (or present) also usually put up a strong showing even if the people are poorer — 8 of the top 20 from London are either communist (China, Cuba and North Korea)  or ex-Soviet bloc (Russia, Hungary, Kazakhstan, Ukraine and the Czech Republic).

Now for the euro zone. There has been some hand-wringing in Germany, France  and Austria about their relative performances. The first two received 11 golds each (compared to the 14-plus that were targeted) while Austria go home with no medals at all, gold or otherwise, for the first time in 50 years. (Lets wait until 2014 to see how the Austrians do at the Winter Olympics).

In the euro zone periphery, Italy fared best, landing 8 gold medals for 8th place, though less than the 10 that Goldman had predicted.  Spain failed to break the top 20, with just 3 golds (it took 5 in Beijing and Goldman  had forecast it would get 6 this time).

Aussie: reserve managers’ new favourite

Sujata Rao

Aug 10, 2012 14:29 UTC

Lucky Australia. In a world of slowing economic growth its central bank today raised forecasts for 2012 GDP growth by a half point to 3.5 percent. That’s down to a mining boom, driven of course by China. But there’s a downside. Australia’s currency, the dollar (or affectionately, the Aussie), has steadily risen in recent years, and is up 3 percent versus the U.S. dollar this year. Unsurprisingly, the Reserve Bank of Australia tempered its good news on growth with a warning over the Aussie’s gains.

Analysts at Credit Agricole note that the Aussie’s gains this year have come in tandem with a rise in Japan’s yen. That in itself would have been highly unusual in the past: the yen is a so-called safe haven, the currency investors run to when all else is selling off, while the Aussie is a commodity currency, one that does well when world growth is looking good and risk appetite is high. CA analysts explain thus:

The role of the (Aussie) is probably changing from a traditional commodity currency to an increasingly attractive reserve currency.

There is only anecdotal evidence central banks are actually buying the Aussie in large quantities. The German, Swiss and Russian central banks are among those that have indicated an interest. But a recent IMF report put the share of ‘other’ currencies (that includes the Aussie and the New Zealand dollar) in world FX reserves at $295 billion in the second 2012 quarter.  And that’s quite a jump from $87 billion in three years ago. The graphic below shows that the share of the “others” in central bank reserves now exceeds the sterling or the yen.

Credit Agricole adds:

Although the breakdown is unknown, such a big jump indicates at least part of diversification flows moving into Aussie.

Risk spills over in Middle East

Carolyn Cohn

Aug 10, 2012 13:44 UTC

There’s little or nothing to put your money into in Iran or Syria, and countries like Egypt and Tunisia are struggling to win investors back after their Arab Spring uprisings last year. But geopolitical risk is also seeping into other countries in the Middle East.

Lebanon is looking a tricky bet, as the country has seen clashes between supporters and opponents of the uprising against Syrian President Bashar al-Assad and the border region has been used by rebels to smuggle arms into Syria and take refuge from Syrian troops.

Farouk Soussa, Middle East economist at Citi in Dubai, says:

Syria is having a very big impact on people’s perceptions of risk in Lebanon. There is an increasing risk that if we do have regime change in Syria, it could mean change in Lebanon.

Yields on Lebanese debt, which appears in flagship bond indices tracked by many investors, have hit their highest in more than a year, at a time when most emerging market debt has rallied.

Meanwhile, Aberdeen Asset Management Israel fund manager Susan McDonald says she is underweight Israeli industrial companies, in part because of rising gas prices after Egypt in April terminated its agreement to supply gas to Israel.

The 20-year deal was signed in the era of toppled President Hosni Mubarak and ties between the two countries have been strained since his February 2011 overthrow in a popular revolt.

Belize’s bond: not so super after all

Sujata Rao

Aug 10, 2012 11:37 UTC

Belize’s so-called superbond has not proved to be a super investment proposition.

The country has set out proposals on how it might restructure the bond, which bundled together several old debts (hence its name) and the ideas have been greeted with horror by investors. Essentially, the government wants to reduce the principal of the bond by almost half while extending the maturity by 13 years, according to one of the proposals.  Interest rates on the issue, at 8.5 percent this year, could be cut to a flat 3.5 percent. Or investors could accept a 1 percent rate that steps up to 4 percent after 2019.

Markets had been expecting a restructuring ever since Prime Minister Dean Barrow said in February the country could not afford to keep up debt repayments. The bond duly fell after his comments but picked up a bit in recent months after Barrow assured investors the restructuring would be amicable.  Investors holding the bond are now nursing year-to-date losses of 24 percent, according to JP Morgan.

There’s worse. If the government sticks to its original proposals, says Stuart Culverhouse, head of research at brokerage Exotix, the principal of the bond, currently at $544 million, could fall under $500 million. That will push it out of the main bond benchmark for emerging markets, JP Morgan’s EMBI Global, and would trigger automatic selling by funds benchmarked to the index.  Culverhouse predicts that the bond, now trading at 42 cents on the dollar, will fall eventually to the low-20s. It started the year just over 60 cents.

JP Morgan which had been advising an overweight position on Belize relative to the EMBIG index, cut its recommendation to marketweight on Thursday. It tells clients:

Next Week: “Put” in place?

Mike Dolan

Aug 8, 2012 17:00 UTC

Following are notes from our weekly editorial planner:

Oh the irony. Perhaps the best illustration of how things have changed over the past few weeks is that risk markets now fall when Spain is NOT seeking a sovereign bailout rather than when it is! The 180 degree turn in logic in just two weeks is of course thanks to the “Draghi put” – which, if you believe the ECB chief last week, means open-ended, spread-squeezing bond-buying/QE will be unleashed as soon as countries request support and sign up to a budget monitoring programme. The fact that both Italy and Spain are to a large extent implementing these plans already means the request is more about political humble pie – in Spain’s case at least.  In Italy, Monti most likely would like to bind Italy formally into the current stance. So the upshot is that – assuming the ECB is true to Draghi’s word – any deterioration will be met by unsterilized bond buying – or effectively QE in the euro zone for the first time. That’s not to mention the likelihood of another ECB rate cut and possibility of further LTROs etc. With the FOMC also effectively offering QE3 last week on a further deterioration of economic data stateside, the twin Draghi/Bernanke “put” has placed a safety net under risk markets for now. And it was badly needed as the traditional August political vacuum threatened to leave equally seasonal thin market in sporadic paroxysms. There are dozens of questions and issues and things that can go bump in the night as we get into September, but that’s been the basic cue taken for now.  The  backup in Treasury and bund yields shows this was not all day trading by the number jockeys.  The 5 year bund yield has almost doubled in a fortnight – ok, ok, so it’s still only 0.45%, but the damage that does to you total returns can be huge.

Where does that leave us markets-wise? Let’s stick with the pre-Bumblebee speech benchmark of July 25. Since then,  2-year nominal Spanish government yields have been crushed by more than 300bps… as have spreads over bunds given the latter’s equivalent yields remain slightly negative.  Ten-year Spain is a different story – but even here nominal yields have shed 85bp and the bund spread has shrunk by 100bp.  The Italy story is broadly similar.  Euro stocks are up a whopping 12.5%, global stocks are up almost 7 percent, Wall St has hit its highest since May 1, just a whisker from 2012 highs.  Whatever the long game, the impact has and still is hugely significant. An upturn in global econ data relative to recently lowered expectations – as per Citi’s G10 econ surprise index — has added a minor tailwind but this is a policy play first and foremost.

So, climate change in seasonal flows? Well, it was certainly “sell in May” again this year – but it would have been pretty wise to “buy back in June”. Staying away til St Ledgers day would – assuming we hold current levels til then – left us no better off had we just snoozed through the summer.

What can ruffle the feathers from here? We still have to see the China data dump this week, so fasten your seatbelts. But whatever the outcome there, the bounceback in oil prices of late may start to become a big drag for those hoping for a global energy boost. With Brent back to within 5 euros per barrel of its all time high, it’s about as welcome as kick in the teeth — even if it’s partly a price to pay for rekindled risk appetite.

There’s not a great deal to hang on next week as the August political/event lull sets in, which means the oil spike could grab more attention than otherwise and temper the bulls. Data watchers will home in on slowing euro area and Japan Q2 GDP numbers – the euro zone likely contracted during the quarter — even if the numbers are to some extent history already. The US housing starts/permits are one to watch given all the recent focus on a bottoming real estate market there. The Philly Fed will also update us on its bellwether gauge of business activity.  The rest of the data set is interesting only on surprise.  BoAMerrill releases its monthly fund manager survey. Turkey decides on interest rates.

South African equities hit record highs, doomsayers left waiting

Earlier this year it seemed that an increase in global bullishness meant the end of the road for risk-off investment strategies and, by extension, the rise in South African equities. However, 6 months later, the band is still playing, and the ship is refusing to go down.

South African equities have flourished in the face of the doomsayers, with returns this year doubling the emerging market benchmark equity performance. Both the all-shares index and the top-40 share have hit fresh all time highs this week, and prophecies of gloom for South African stocks appear to have missed the mark somewhat.

Part of the reason for this is that, when it comes to risk attitudes, much of the song remains the same. South Africa has certainly benefitted from its continued attractiveness to risk-off investors, as global bullishness has receded from whence it came. For instance, as it is relatively well sheltered from euro zone turmoil, and as major gold exporter, firms based in the gold sector are ostensibly an attractive investment for the globally cautious.

However, while ongoing uncertainty in the euro zone has meant that global sentiment has not recovered to a consistently risk-on position, there is more to South Africa’s performance than just a reliance on safe-haven gold. This is demonstrated by the highly fluctuating performance of gold during 2012, adding 3 percent to its value in total in 2012 and dropping in value over the second quarter. By contrast, South African equities have grown in value consistently over the year, adding ten percent thus far.

Indeed, according to John Paul Smith of Deutsche Bank, it’s not because of the country’s natural resources but despite them that equities have hit fresh highs. Resources have notably underperformed in South Africa this year, and other sectors such as financials, consumer stocks and telecommunications have been supporting the rise.

“The banks have always been considered relatively dull, which I think is to their advantage,” he said.

The market also draws strength from its diversity of investors as well as companies. “It has a very broad local investor base, including local pension funds,” said Dominik Garcia, a strategist at Credit Suisse, who added that banks and consumer discretionaries had done well, benefiting from strong local demand.