More on Latin America's protests

Following last week’s comments about protests in Venezuela, I got an email from Christian Novak chiding me for not taking my analysis farther and discussing whether the eventual collapse of the Maduro regime will have a knock on effect on other Latin American countries, such as Argentina, Bolivia, or Peru.

Guilty as charged.

President Christina Fernandez in Argentina is already on her way out. Last October’s elections did not give her the mandate she needed to change the constitution and run for a third term. Fernandez never militarized the economy the way Chavez did, whilst all her mistakes are homegrown; there are no foreign advisors, Cuban or otherwise. Neither the IMF approved reforms to the national inflation indices nor the settlement with Repsol over YPF would not be possible without her approval, stated or otherwise.

Collapsing foreign exchange reserves seem to have done an excellent job of concentrating Fernandez’s mind. Neither the IMF backed reforms to the national inflation indices nor the settlement with Repsol over YPF would not be possible without her approval, stated or otherwise, and she would only do so if she had no other choices. Argentina’s lack of a developed Energy industry to underwrite her excesses meant she was never able to push her nationalism as far as Chavez did, despite all the rhetoric and joint issuance of bonds.

Peruvians have been much harder on President Humala than Venezuelans were on Chavez. Lacking Chavez’s charisma, his popularity slumped as the economy slowed last year. Chavez was able to put many of his cronies into positions of authority where they could seek rents unopposed, whilst Humala’s attempts to do likewise were immediately met by street protests, forcing him into a humiliating climb down.

Unlike in Venezuela, Bolivia’s Evo Morales has used the commodities boom to accumulate Foreign Exchange reserves to insulate the economy from the inevitable fall in prices, so reserves/ GDP are now amongst the highest in the world. Whereas debt/ GDP is at record levels in Venezuela (when you factor in the Chinese Oil loan and the Government’s unpaid bills), it has fallen dramatically in Bolivia. Where he has nationalized an industry, Morales has ensured that they continue to invest back into the business and remain competitive.

None of these three countries are dependent on Venezuela in any form, so a change in Government in Venezuela is not going to cause them any hardship. Despite all their fraternal leftist rhetoric, what they have actually done in practice is qualitatively different to what Venezuela has done. Any future policy changes will be independent of any changes in Venezuela.

The one country where a material change in Venezuelan policy will impact them is Cuba. The presence of so many Cuban “advisors” in the country is being increasingly questioned, and is a source of tension. This video posted to Youtube shows the arrival of another planeload of Cubans at Caracas airport being told to “Get lost!”

Currently the island receives an unknown but significant amount of cheap oil. As Venezuela’s oil revenues shrink, it will be harder and harder to maintain these subsidies, and a less accommodative government in Caracas could be as disruptive to Havana as the fall of the Berlin wall.

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Over the weekend, some of Venezuela’s protestors tried to link what they are doing to events in the Ukraine, but the differences are probably greater that the similarities; the demonstrations in Ukraine appear to be more broadly based than in Venezuela, with a more focused leadership. The protestors in Venezuela are still seen as being predominantly Middle-Class, without clearly defined goals. Having said that, the numbers attending the anti-Maduro marches are impressive - see the picture at the top.

Finally, Colgate Palmolive announced that they would take a one-off loss of $180-200M on Venezuela’s latest devaluation. I include this little tidbit not because it refers to Venezuela, but to emphasize the increasing role Emerging Markets play in the profitability of global multinationals.

Protests in Latin America.

This week saw three major developments in Latin America; in alphabetical order, Argentina finally produced a meaningful inflation index, Brazil officially slipped into a recession, and at least two people were killed in student protests against the Government in Venezuela.

There is a tragic inevitability about the protests in Venezuela; as the Government has radicalized and demonized any who don’t support it, they have left those who have genuine grievances nowhere to express their views in a peaceful manner. At the same time, the continued and extensive shortages of basic goods, from foodstuffs like flour to necessities like toilet paper are leaving people increasingly frustrated and disenchanted.

Toyota recently joined the long list of those cutting back on their Venezuelan operation when they announced that they would no longer be assembling vehicles in the country. The lack of dollars means that their just-in-time inventory management simply does not work, and even old-fashioned stock management is problematic because there is no way to plan stocks since there is no way of knowing when dollars will be available. In the unlikely event dollars do become available, there is no way of knowing at what exchange rate they can be bought, and at what exchange rate the finished product can be sold. Meanwhile, official waiting lists at car dealerships are apparently years long.

Unfortunately Maduro’s position is too weak for him to compromise. There are many within his own party, such as Diosdado Cabello, who are waiting for the right time to push him aside His weakness is forcing him to be “more Chavez than Chavez”. When faced with the withdrawal of firms like Toyota or the increasing shortages of basic goods, President Maduro has fallen back on increasingly bellicose rhetoric, but without the humility shown by the late President; when 20 000 tons of food rotted in Government run warehouses during the early days of the food shortages, Chavez was at least able recognized this as a Government problem and to promised to do better. As power cuts have spread into Caracas, Maduro has increasingly railed against “sabotage” by “Fascists” and “Antigovernment interests”.

The events of this week were truly tragic, and probably only the beginning. Please may I be wrong.

Brazil’s recession was equally inevitable. I believe I have nagged you enough about the failure of the current Government to enact any meaningful reforms, whilst they remain transfixed by next October’s presidential elections. There is so much that Finance Minister Mantega could have done to avoid the slowdown, but instead he fell back on the usual tried and failed policies of the past.

The ongoing protest against the World Cup are also directly linked to the weakness in the economy; many of the protestors have made it clear they want to see an improvement in Government services, from education to healthcare, whilst Inflation, although low by historic standards, is seen as a problem.

I believe, and I hope I am not being naïve in this, that the protests in Brazil are about as bad they are going to get. All sides recognized the tragic death of TV cameraman Santiago Andrade as unacceptable, whilst the Government has enlisted Pele to be their PR spokesman for why the World Cup should still take place. The fact that they are even launching such a PR campaign shows that they realize how big their problems really are. Once the games start, Brazil’s love of the beautiful game will replace any resentment over Government policies. It will then be up to the Government to build on that peace rather than squander it like they have squandered so much in recent years.

Argentina has not, as far as I am aware, suffered from the same level of street protests in recent weeks as either Brazil or Venezuela, but I think they are coming.

As I mentioned in the introduction, the Argentine Government has stopped lying about inflation. They have just announced a new index that more accurately tracks price changes, and it even appears to give a higher reading than previous private estimates. The January reading was 3.7% that annualizes out at 50%. Other private estimates were in the range of 25-30%, whilst official numbers were only 10.9% for 2013. They did not, however, rework previous numbers.

The recent devaluation of the peso will cause inflation to accelerate farther just as the Government tries to bring public spending under control. This in turn is likely to lead to conflict between the Government and unions as the Government is forced to backtrack on its “Social Justice” commitments; they have run out of their own money, and their inability to tap international capital markets means they do not have access to other people’s.

There are early signs that the economy is going into recession, if it is not already there – shorter work hours, holidays being brought forwards, possible rising unemployment.

Taking these together, and Argentina’s history of protests, it is highly likely that the erosion of purchasing power and the Government’s inability to fund its programs will bring Argentines out onto the streets in a rerun of the Cacarolazos protests that followed the 2001 financial crisis.

2014 is shaping up to be a noisy year in Latin America.

Show me the Money!

For a great many investors, perhaps “You had me at Emerging Markets!” would have been more appropriate, but the truth for so many is that profits and market performance have too often lagged economic growth.

As I have commented in previous posts, Governments have interfered with markets to create national champions that are spectacularly inefficient, at the same time they have often turned a blind eye to corruption that has drained profits into offshore banks, or the property markets of London, Dubai, and Miami.

I was reminded of this conundrum this week whilst talking to a potential client, who asked me about China, and the somewhat bearish views of Michael Pettis. The point he was taking from Mr. Pettis’s work was that mathematically Chinese growth has to slow down more than currently expected as the economy rebalances from an investment led model to a consumption led model. I think where I disagree with Mr. Pettis is probably only a matter of timing; I think it will take a few years longer to slow growth in investment, and that raises the spectre of more malinvestment accumulating that ultimately has to be written off.

I did, however, start to think a little harder about being wrong. What would it mean if investment did slow faster or consumption grew faster than expected? I kept coming back to the 3^rd Plenum last year.

Ironically, Mr. Pettis’s argument could imply a stronger case for investing in China, as it would mean that the reformers were gaining the upper hand and actually cutting the damage being done in and by the State Owned Enterprises. IF the big Chinese SOEs are forced to ration capital and raise the rates of return on investment that would have the perverse effect of raising profits as growth fell. Valuations could actually rise, given the increased transparency.  You might almost get a second wave in investment as FDI came in to take advantage of the new opportunities being opened up.

Sadly, as things stand today, this is just a pipe-dream.

China’s shadow banking system needs to be cleaned up properly first, and the authorities are still trying to hide the problems rather than deal with them.

Recently, a product sold through China’s biggest bank, ICBC, was restructured before it could go “bankrupt”.  The restructuring only involved taking a minimal haircut on interest, but left the principle intact. Given that the underlying company was entirely bankrupt, this is being interpreted as a Government bailout of some sort, even if one is not entirely sure which level of Government was involved. Needless to say, such a move is entirely at odds with the proposed reforms of the 3^rd Plenum, and raised the moral hazard within the Chinese banks significantly. Plus ça Change!

Elsewhere, I am hopeful about Mexico and their attempts to pass reforms. I got some great feed back from the presentation made by Pemex at a recent conference, and the very grounded nature of Senior Management. Everyone was contrasting them to Petrobras and how much more realistic Pemex seemed.

Mexico Sovereign Debt was recently upgraded to an A- rating by Moody’s because of the reforms passed last year that should “strengthen the country’s growth prospects and fiscal fundamentals”. The country was also a winner at the recent WEF meeting in Davos, getting material commitments for new investment.

One area where reforms are taking place, and where we are seeing earnings growth commensurate with economic growth is sub-Saharan Africa. It is an area that interests me greatly and I am looking to get more involved even though I have to eat platefuls of humble pie to say that.

I don’t wish to underplay the problems with these markets; they don’t even qualify as Emerging but are firmly in the pre-Emerging/ Frontier camp. They are often so inefficient that even a slight reform can have a huge difference.

My Nigerian friends swear about the poor service of MTN and the other cellphone providers, but they will follow that up by telling you how much better even that poor service is compared to what they had before, and how it has improved their lives. At the same time MTN has been able to realize, in hard currency, substantial profits, all because the Authorities let a South African company challenge a national monopoly.

It is not just in Nigeria that change is happening. Zambia has been creating a more business friendly environment since Kenneth Kaunda was replaced in 1991. The attached article from the Economist highlights one of the better-know success stories, Zambeef.

Renaissance Capital has just started its 5^th sub-Saharan investment conference in Lagos, and it looks to be a blowout. Merrill will shortly be holding their Sun City conference, which looks to be as popular as ever (it’s a great conference) but the side trips to Nigeria, Kenya etc. look like the real draw this year whereas they were not even available a few years ago.

When I was at business school, too many of my friends from these countries were desperate to get their money out. Now they are all talking about starting businesses and trying to get money in.

I would NOT recommend your average investor go out and fill their portfolio with Nigerian or Kenyan stocks, even if they were actually able to get access to them. I would, however, recommend following them in the newspapers rather than just skipping over them. If you look at say a Guinness or a Nestlé, don’t skip over any discussions of these Frontier markets, but read them carefully, because if you want to see the money, that’s where it is going to be.

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 A couple of interesting videos - I'll leave it to you to decide their relative merits

Getting Lashed by the storm

So the big sell off in Emerging Markets has finally started, looking like so much of the freak weather that has lashed North America and Europe this year.

 Last week we saw redemptions from the largest funds that matched those seen during the peak of the taper scare last year, the panic over the US debt ceiling in 2011, and even the Lehman’s crisis back in 2008. A couple more weeks of this and we will be in definite oversold/ buy Emerging Markets territory.

 We also saw some strong moves by several central banks, most notable Turkey, India, and South Africa. The Turkish move, raising the benchmark rate from 4.5% to 10% and raising the top rate from 7.75% to 12% was particularly bold. Some people even suggested that they had gone too far and that such big increases were not credible; the exit of Sterling from the ERM on Black Wednesday (16 Sept 1992) despite repeatedly raising interest rates seems to the model for such thinking.

 First of all I think this sell off is very necessary and very important. Emerging Markets are not going to be able to move forwards until this correction has happened for two important reasons. One obviously is that so many people have been expecting it that no one was going to allocate any capital until it had happened. They need to know, or at least tell their bosses, they are investing nearer the bottom than the top. The second reason is that I think it will end up showing that even the “Fragile Five” are not as fragile as bears have made out, and that this is NOT going to be a rerun of the Asia crisis of the late ‘90s.

 That does not mean that this is a storm in a teacup. I think the differences from the Asia crisis are greater than the similarities, but there are problems that need to be addressed. To misquote Anna Karenina, All well managed countries are alike; each mismanaged countries are mismanaged in their own way.

 Turkey’s rate rise will cut GDP growth significantly, and thus the skepticism about the rise’s durability. Rencap have already cut their GDP estimate down to 2% for this year, and others will follow – Merrill is still at 3.5%. Last week I described Turkey’s Finance Minister, Mehmet Simsek, as a “safe pair of hands”. I believe he has the ability to make Prime Minister Erdogan understand the gravity of the situation and that any attempt to force the Central Bank into reversing policy too soon risks losing control of the situation and making the crisis worse, jeopardizing Erdogan’s reelection hopes.

 Indonesia, probably more so than any other country, needs to cut fuel subsidies. As the FT points out, the Government in Jakarta was predicting they would eat up 11% of the national budget even before the Rupiah fell 20%. In domestic currency terms, Brent is trading at or near record levels in local currency terms across several Emerging Markets, pressuring budgets.

Tackling corruption is usually a good plan; I have been highly critical of Dilma Rousseff’s handling of the economy, but she was left a huge corruption mess my Lula, and she has tried to address it.

 In short, Governments need to follow up their stabilization plans with reforms. By and large, the countries that are suffering now have done very little to make their economies more competitive, preferring to sit back and collect the rents of the recent commodities boom and easy credit from QE. This complacency is not just a trait of Emerging Markets, as citizens of several Eurozone countries can attest, but currently the urgency is.

 To present a wish list of reforms for each and every country would be pointless, instead I will comment in the future on any that actually get implemented.

 So, what to do as we wait for those reforms? First of all, even if you believe they will happen at some point, you must remember they will probably come when politicians have their backs to the wall, meaning things could well get uglier first. If your career/ life savings depend on it, you should seriously consider waiting until you actually see something concrete happening.

 The second thing to think about is at what price you are comfortable owning something. Bear in mind, if you say today “I’d fill my boots up $20 cheaper”, what is going to make it $20 cheaper? Would you be trying to catch a falling knife, or would you be buying a cheap asset? Make sure you really know why you would buy something.

 As I mentioned last week, we had positioned some trades to benefit from the spike down, and we were able to close some shorts at really good prices on that day.

 Some of our long positions also fell back to levels we were comfortable with, but we only added incrementally so that we had money left over if they continued to fall.

 At every point you should ask yourself “What if I am wrong?” to make sure you are not being complacent.

Here is a nice video from John Authers at the FT.