Investment research is ill equipped to deal with the present macro themes as most research is Fed, ECB, BOE and BOJ centric. We live in a world where 60% of all growth comes from Asia, but very people research or even travel to Asia or Latin America, but that never stops anyone from having a view J - A view which is in my opinion often superficial and ignores the big fundamental changes going on with the business models all over Asia. There is now in Asia a need for "a mini crisis" to create a mandate for changing things around. In China it's about the shadow economy, the bubble in the housing market and pollution. In rest of Asia it's about financing current account deficits, the needs for new reform to reach next level in the economic evolution, and finally its election year in many populous countries (India, Indonesia, South Africa, Brazil=???)
I noticed on my last trip November 2013 to Singapore, Hong Kong and Indonesia that something significantly had changed: There was a sense of urgency, a realization and finally an embracement of the fact that the Asian business model of being production hub to the world was under pressure. Salary increase, lower export volume, rising import costs, and falling producer prices have tested margins at companies and as seen in the recent flurry of "bad deals" in China managed products the credit cycle have turned into the nasty mode where failures, intervention and crisis management are a every exercise.
This crisis runs considerably deeper and have bigger impact than most people realize. Asia slowing down means 60% of world growth is under pressure. (China: 36%, Asia excl. Japan & China: 24% in 2012 data). Asia continues to export deflation, and the export companies in Europe and the US will soon find that not only is their margins coming down, but so is their volume. Asia overinvestment had high degree of OECD countries products in them, now…….less is coming through as Asia and China readjust their model towards what will be the next leg, where the next 5-10 years sees Asia growing 3-5% from 7-10% and China moves to 5% sustainable growth from 10% few years ago.
This crisis started with the Fragile Five, got more momentum from Argentina and Latam, and now it also includes Eastern Europe. Rubble is almost as weak as during the financial crisis:
Source: Bloomberg LLP
Russia which have gotten use to do "things their own way" is increasingly getting to a point where the dependence on the rest of world, and certainly global growth is more and more important. Energy is 50% of Russian revenue and 25-30% of GDP. Growth in Russia is almost perfectly correlated with the development of the oil prices:
Meanwhile rumors persist about a potential devaluation of the Rubble, which is denied by Putin and the central bank: Putin denies devaluation and Russian PMI have entered contraction:
The point is that this "Argentinian story" is really most of the growth engines in the world, less than one week ago you couldn't open a newspaper or tv without getting told that market was great, recovery, higher growth, IMF and World Bank even increased their growth forecasts, all ignoring probably the most central catalyst there is in any markets: The FX rate.
Currencies are always leading not lagging in reaction, this due to higher liquidity and 24 hours trading, and more to the point in EMG. Let's face it EMG returns are almost exclusively driven by FX rates adjustments. Several studies point out that EMG FX translates to more than 100% of performance, meaning investing in stocks and bonds have NET negative accumulated return. Or put more directly: EMG as a theme is not about the local economies, or even investors believe in the countries, no, it's about FX rates reflecting interest rate and inflation differentials, and now these same indicators are telling you: No excess return here – go somewhere else. We have gone full circle. Chasing the yields, will change to capital preservation if this continues. That however is good news. Imagine we start trading on fundamentals and not expected printing of money?
For investors interested in correlations, volatility and EMG Robco Fund Management in April 2013 did great white paper called: The volatility effect in emerging markets The conclusion reads: Specifically, a monthly rebalanced top-minus-bottom quintile hedge portfolio based on the past three years volatility exhibits a negative raw return spread of -4.4 percent per annum over our 1989-2010 sample period. Adjusted for differences in market beta, this amounts to a statistically significant negative alpha spread of -8.8 percent. The alpha spread remains large and significant after also controlling for size, value and momentum effects. In line with other studies on the volatility effect, we observe that the negative alpha of the most volatile stocks is greater than the positive alpha of the least volatile stocks.
We started the year with markets being priced to perfection. Perfection does not happen very often unfortunately, what 2014 will be however, is a year where volatility will increase across the board, the world economy, its capital flow and investors are looking for a new equilibrium – as George Soros says in his book on reflextivity: The market is never in a static equilibrium, it always going to a new clearing price. The illusion we had over the last three to four years was that we indeed had found a static not dynamic equilibrium – meaning finding the next better eqiulibrium will take a lot of trial and error's but like in Asia crisis in late part 1980s, the ERM crisis in 1992 and financial crisis 2008, it will be worth it as we need to find new model for world growth otherwise we doomed to fail in creating enough growth to keep everyone happy, at the end of the day the closest thing we get to perfection when we deal with crisis'.
MARKET POSITIONS:
Fixed Income
My models still very skeptical of higher fixed income prices (lower yield). The move is extended and I'm still looking to sell. My good friend Mr. E points out we have some seasonal weakness in US fixed income over the next month, but I am flat from long in fixed income, but looking for the sell.
Commodities
Natural gas: bought some deep of the money puts. Weather continues to indicate "deep freeze" but this move is now overdone even under present forecasts: Another Artic blast on the way & next 10 days for Washington(-6/+7 Celsium from Friday…)
Brent: Went long this morning @ 107.50 (stop: 105.00). WTI and Brent trades in very clear mean-reversion channel right now:
Gold: Still long some of the money Gold Puts (based on the higher yield my models indicate)
Stock market:
IBEX50 still short…
S&P: Short one unit on model
FX:
GBPUSD: Sold option this week. Neutral
EURUSD: Still long….
AUDUSD: Took big profit on multi-week play.
USDMXN: Took profit – neutral
USDTRY: Sold option back.
Performance Index: 105.00
Safe travels,
Steen
Med venlig hilsen | Best regards
Steen Jakobsen | Chief Investment Officer
Saxo Bank A/S | Philip Heymans Allé 15 | DK-2900 Hellerup
Phone: +45 39 77 40 00 | Direct: +45 39 77 62 23 | Mobile: +45 51 54 50 00
Research: http://www.tradingfloor.com/traders/steen-jakobsen
Please visit our website at www.saxobank.com
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