Michael Hartnett at Merrill Lynch is a great guy and a great
strategist. He manages to distill his thought clearly and concisely, and is
able to look at problems from a variety of angles.
One of the indicators he uses is to look at how much money
is flowing into or out of the markets. If an abnormally large amount of many
has flooded into a market it becomes harder to argue that the story is
undiscovered. A big sell off suggest a bottom has ben reached, at least
temporarily, and now is a likely to buy.
Like a lot of managers, I have been waiting to see a big
final sell off in Emerging Markets to put an end to the long slow
“death-by-a-thousand cuts” we have had for 20 weeks now.
The logic is pretty simple. What we are looking for is the
last hold-outs to capitulate and to dump their last holdings in one big flush;
After the Mexican devaluation in ‘94 I advised my Global colleagues for weeks
to get rid of their Mexican holdings. They, however, insisted they were not
material and that they should hold them for recovery. Eventually they got so
frustrated with the constant slow declines that one day they demanded we just
dump the positions – “Get this crap out of my portfolio NOW!” was how they put
it. They pretty much hit the bottom of the market.
In recent weeks we have seen a lot of turbulence in the
markets, but no big cathartic sell off. I wait anxiously for Michael’s analysis
ever Friday in his “Flow Show” report, only to be disappointed that we remain
stuck in neutral.
At the same time I have looked at the various drawdowns we
have had and I can hints of that final flush out, so I looked at what the
“Fragile 5” have been up to in recent weeks, and was surprised by what I saw.
Just to recap, the “Fragile 5” are Brazil, India, Indonesia,
South Africa, and Turkey. They are the five countries that analysts are most
worried about because of their anticipated financing needs for 2014 whilst Fed
tapering means it will be hard for them to raise the money.
By the end of February, bond issuance by Emerging Market
Countries was up 40% year over year, at just under $30BN. JP Morgan estimated
that was equivalent to about 1/3 of this year’s needs.
Here are links to the price charts of the various Exchange Traded
Funds for the Fragile 5 stock markets. Only Brazil and Turkey are below their
50 and 200 day moving averages, and even Turkey looks like it has broken out of
its down trend. Indonesia looks to have broken out upwards, and India looks
like it could follow suite.
When Indonesia started to rally, my initial reaction was
“Dead Cat Bounce”, but it has gone on so long and been so sustained, that I
have to seriously rethink my position. Investors clearly believe the
improvements to the current account are permanent and that vulnerability has
materially decreased.
India is getting a lot of support ahead of the elections, as
Narendra Modi of the BJP appears likely to be the next Prime Minister, the
prospects of meaningful reforms grow.
In Turkey, markets appear to have
taken far more courage from the central bank’s interest rate hike in January
than I had expected.
Although it is still early days, I
hear the hedge funds have stopped shorting Russia, with several already closing
out their shorts as long-only investors start to throw the towel in. Tomorrow’s
reaction to today’s Crimean vote will be interesting.
In China this week, Haixin Steel
looks like it will be the next company to default on its debts, sending the
iron ore market, global suppliers, and global steel companies into free fall,
despite this being a relatively unknown company outside the top 30 Chinese
producers. Its problems were well know and well flagged as Rio stopped
supplying it in 2012. Iron ore in China fell 10% during the week, hitting
levels not seen since 2009.
I had closed a short on Brazilian
steel maker CSN a couple of weeks ago during a previous period of turbulence at
$4.51 and I was thing in I was pretty smart. The Haixin news drove it down to a
low of $3.64! That is just background, what is really interesting is that talk
of a share buyback drove the price on Friday up 13%. To my way of thinking, the
huge final sell off had been a “Get this
crap out of my portfolio NOW!” moment.
Like most men of my age, certain
phrases are guaranteed to scare the living daylights out of me: “Dad, can I
borrow the car”, “Daddy, this is my Boyfriend”, and that great broker quote “This time it’s different”
will all push my buttons the wrong way.
So I need to square this circle; is
there something in the recent market action that can confirm for me that we are
broadly speaking at the bottom, without there being a cathartic capitulation,
and with out it being “different this time.”
Turkey was unquestionably the
weakest of the Fragile 5 and the market everyone loved to hate. Instead of
pouring out platitudes about the market not giving them credit, they doubled
interest rates from 4.5% to 10%.
Brazil was to my mind the least
vulnerable of the group given its huge FX reserves, and although they did not
act decisively, they did act early. They have been raising interest rates for
nearly a year now even as the economy sinks into a recession. Their
“normalization” of fuel prices was somewhat half-hearted, but from a Government
that was firmly behind the curve, it was a significant volte-face.
Meanwhile, in specific area, such
as CSN, there are individual signs of that BIG cathartic selling pressure, but
it is very concentrated. We are not seeing contagion.
And finally, as shown by the ease
with which all these countries have been able raise funds so far this year,
tapering has NOT been the beast everyone expected. Like the Hound of the
Baskerville’s, it has not barked.
So what has changed is the Global
backdrop. Fears of a credit crunch for Emerging Markets were overblown, and the
measures put in place have proven sufficient to counter the real rather than
perceived risks. The long slow shedding of EM assets over a record period of
time has shaken out many of the non-believers, and those that are left seem
more likely to add to positions on weakness rather that throw their towels in.
It’s been starring me in the
face.
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