I didn’t intend to maintain such a long break between posts,
but the cold weather here in North America caused a few unexpected problems.
Meanwhile, the world seems to have decided to go into panic
mode, triggered by a fall in the Argentine Peso.
Obviously the situation really has nothing to do with
Argentina and its currency mismanagement. Devaluations in Argentina are a bit
like eruptions of “Old Faithful” in Yellowstone National Park; if you missed
the last one; it’s never too long to wait for the next one.
In
Davos this week, David Rubenstein (Carlyle Group) and Larry Fink (Blackrock)
both made comments about people being too optimistic and not worried enough. I
have no doubt they were including Emerging Markets in that, but EM problems
have been very widely flagged since last summer, whilst the S&P has gone on
to reach new highs.
From
the attached Economist data table, one can see that the “Fragile Five” do
indeed have week external balances. Looking at
Brazil, we see a Current Account deficit of 3.7% of GDP and a Budget deficit of
2.7%, almost as bad as the UK’s numbers (3.7 and 6.7), and only slightly worse
than Canada’s (3.0% and 3.0%). Most of the famous “PIIGS” have at least one measure
significantly worse than the “Fragile Five”, whilst PIIGS Gross Public Debt
numbers are all worse than those for the Fragile Five.
I have
also attached the Economist‘s Sinodependency index, an attempt to show how
dependent large US companies are on China. It would be interesting to see the
concept expanded to Emerging Markets in general, and across countries other than the US;
Germany’s Volkswagen is the number 1 brand in China currently. The original interactive version is available here.
I am
not trying to divert attention away from the significant problems that exist in
Emerging Markets; they would not be Emerging Markets if they didn’t have
problems. One of the lessons, however, that should have been learned from the
Global Financial Crisis was that the differences in risks between Developed
Markets and Emerging are less than popularly perceived, not because Emerging
risks are lower, but because Developed risks are higher, even if only because
of their increased Emerging Markets exposure.
I still
remain deeply skeptical of the Euro project; despite all the talk of the
various PIIGS being saved, they are still massively in debt, with at least one
of their major balances – usually the Budget deficit – still very ugly. The
overall Euro area may be in balance but that still cleaves between an almost
predatory Northern group, and the moribund Southern group; the
“failure-to-launch” of the French Economy puts them firmly in the Southern
group. Comments out of the UK about France being the real weak link in the Euro are probably more about British Schadenfreude for all things French, but they do serve to highlight the extent of France's problems.
The
Basel III leverage requirements were recently watered down at the insistence of
the German and the French Governments because it would have forced their banks
to shrink their balance sheets more aggressively than is currently happening;
in short, their banks still require massive regulatory forbearance because they
have not been cleaned up to the extent of the US and UK banks.
The UK is expected to be the fastest growing major economies
in 2014, and should be the first to raise interest rates, but that has come at
the expense of a re-inflated housing bubble. It’s only a matter of time before
UK TV is again dominated by shows telling everyone how easy it is to make money
by flipping properties.
Shadow banking, not just in China, is going to be a major
issue this year. As the
FT recently reported, “Shadow banking worries
extend far beyond China. Paul Tucker, a former Bank of England deputy governor,
claimed on Thursday that regulators around the world were struggling to keep up
with the pace of change in the “shape-shifting” non-bank sector. He warned of
“faltering vigour” in official oversight of global markets.
In a paper published by the
US think-tank, Brookings Institution, Mr Tucker said regulators around the
world needed to display greater flexibility to cope with “endemic regulatory
arbitrage and the shape-shifting dynamic of finance”, pointing to problems in
both advanced and emerging market economies.’
So I have to agree with Messrs. Rubenstein and Fink, there
is a lot to be worried about, but where can we look for relief?
I actually take comfort from the reduction of QE by the Fed.
US house prices have clearly bottomed, and as I mentioned in a previous post,
US economic growth is gaining traction. Even if that does not justify the
current valuations of the S&P, a stronger US economy can only be a good
thing.
Despite my fears of a UK housing bubble, their economy unquestionably
has momentum, and, having used unemployment as an early indicator to raise
rates, failing to follow through would undermine BoE credibility. I think even
a symbolic increase of 1/8th accompanied by the message that the
Bank was actively monitoring the effects of the increase on the economy, which
they would be doing anyway, would send a very positive message.
The fact the Brazil’s President, Dilma Rousseff, went to
Davos on a charm offensive, rather than trying to polish her socialist
credentials as in previous years, suggests she at least recognizes the
magnitude of her problems. A swift readjustment to imported diesel prices to
compensate for the weaker exchange rate would also suggest she is prepared to
act. Unfortunately, the World Cup followed by Presidential elections in October
mean we are unlikely to see anything more decisive than that. IF, however, she
replaces Guido Mantega as Finance Minister in her second term that would really
set the markets racing.
Chinese New Year is early this year, starting January 31st.
Given that it is always a confusing period for Western observers that is
probably a good thing. We have already seen signs of seasonal disruption to
Steel inventories, Iron ore shipments, and possibly even the PMI. Currently the
prevailing attitude seems to be all news is bad news, so the sooner we can get
past these distortions, the better we can understand the real situation,
whatever that might be.
Turkey will get a pass. Unless PM Erdogan does something
really stupid, he will ultimately enjoy the backing of the US, the EU, and the
IMF, despite all the sturm and drange
in the meantime. Turkey is too important an ally, and despite Erdogan’s
increasingly authoritarian tendencies, the country is firmly on the democratic
track. Even 10 years ago the army would have been on the streets by now. I have
known Mehmet Simsek, Turkey’s Minister of Finance, for years and he is a VERY
safe pair of hands.
Elsewhere, the $7 billion in investments that Enrique Peña
Nieto of Mexico managed to secure at Davos shows the benefits of his reform
program. I am under no illusions as to the enormity of the task ahead of him in
actually implement his program, but he has already made more progress than
either Presidents Fox or Calderon, and he seems to be able to forge alliances
with the other parties to produce some kind of result.
Sub-Saharan Africa has seen a renaissance in recent years.
The commodities boom may have triggered it but it has gained a momentum of its
own as local firms, such as Dangote in Nigeria, as well multinationals such as
Nestlé and South Africa’s Tiger Brands look to expand. Some of the initiatives,
like Kenya’s Mpesa, are truly world class and will continue to drive growth
forwards.
Currently I am working on the premise that the first half of 2014 is going to be highly volatile, with at least a major correction across all markets, but I see that correction as being highly cathartic. The kind of correction that would give Merrill's Michael Hartnett his major buy signal, so I am also putting in place my strategies for that spike down.
