EUROPE: MIND ON THE MARKET WHILE CHARTING A BETTER WAY FORWARD
In the immediate aftermath, by agreeing to buy Euro 60 billion worth of public and private securities on a monthly basis until September 2016, under its recently launched quantitative easing ( QE ) program, the European central bank (ECB) has quite clearly distorted the market. Also the initiative has given once in a life time type opportunity to Euro area countries to get their fiscal house in order by borrowing for longer duration and at a record low cost without being able to provide or required to provide any fundamental justification to the market. And also by showing a willingness to buy European governments debt as low as minus 20 basis points, the ECB is probably attempting to harmonise the cost of borrowing of the EU states. So as a consequence, we are now living in a reality, where Portuguese and Spanish 10 years sovereign bond has a lower yield than a U.S. Treasury of the same duration.
While the benefits of the QE to the European governments can’t be understated, European financial institutions from the likes of an insurance companies or a pension fund etc, who rely on investment returns to keep their business model sustainable will most likely have to reassess, or redesign their investment model factoring the new reality of low and negative yielding sovereign debt.
The ECB is clearly aiming to push investors out of what is considered safe haven assets, but investors could also opt to very well sell the Euro denominated European sovereign bonds, and instead buy US treasuries as ECB has very limited control over how investors will allocate capital, and the overall directional flow of the capital. Non European companies with stronger balance sheet could also benefit immensely by borrowing at very low rates in Euros, and there are ample evidence of that happening already as more and more companies flock to Euro to raise capital. So there remains an inherent risk with the approach, and capital will likely flow into various asset class outside of the Euro area.
Also in the last couple of years, a sizeable portion of the profits made by euro area based banks came from their sovereign debt holdings, and in the current environment, it will be interesting to see what sort of impact the change in dynamics will have on banks profitability. Although the banks are comparatively in a much better shape than few years ago, they are still struggling to make good money from their traditional day-to-day business.
Going forward, the QE initiative of European Central Bank (ECB) should improve the overall economic dynamics of the Euro Zone, and the signs are that it is in some way or the other heading in that direction. But a QE coupled with ultra low interest rate environment over a longer than desired period isn’t all NET positive for the general well-being of the economy. A sustained ultra low interest rate environment over a long period of time can cause misallocation of capital, mis-pricing of risks, and can also easily become addictive without really creating a big jump in the overall economic activity of the real economy. And here is an interesting data that I believe provides an interesting perspective. Based on various reliable estimates, Japanese savers have over US$ 7.1 trillion stashed in cash, and roughly around US $ 300 billion of cash is believed to be literally stashed under the carpet across Japanese households creating a situation where excessive savings is not being utilised by the real economy as average household aren’t able to get the return they would expect from traditional channels of investments.
There are still a large number of savers who believe in the good old savings model, where a bank provides an attractive return to its clients on deposits. Also more than half of the population of the developed as well as developing world does not actively invests on a regular basis in stocks or bonds so therefore they are unable to reap the benefits of a record high stock market. And their savings get eroded over time through low to almost negligible return on their deposits while a small percentage of sophisticated institutional investors make good money from record high stock markets mostly driven by the easy QE money, which distorts the connection between the financial markets and the real economy.
And even in an economy where a large percentage of the savings comes from the higher valuation of the house prices, if through traditional channels, a saver is not getting decent enough return from the banks, the overall confidence in the economy suffers, and it is one of the reason why the economic data remains somewhat confusion creating volatility in the financial markets.
There are limitations to what a central bank and monetary policy can deliver or achieve on their own without a sound business and investment friendly economic environment. And this is where Europe continues to struggle. Euro zone economy is showing some signs of improvement but it still has a long away to go.
A Europe where an entrepreneur as a value creator with credible ideas or project is able to access right capital and start the journey without getting stuck in bureaucratic red tape is still a bit far from becoming a reality. In general, the market is turning optimistic on Europe’s prospect, but the EU leaders as well as the bureaucrats will need to be focused on delivering the essential reforms in order to make sure Euro Zone as an economic growth engine starts to fire, to ensure it stays relevant and competes better. So the European policy makers will need to keep their mind on the market while charting a better way forward for Europe.
Talking About The All Scary Emerging Market, Market Perception and Investing in General
The markets are once again busy with chatter about Emerging Market ( EM ) and the sound of CHOAS seems to be re-emerging and many in the market are starting to wonder, what’s next ? A number of analysts have gone on record suggesting in their daily market commentary that emerging markets could now be a danger to global financial stability. No doubt, these are strong statements so it begs the obvious question, are we looking at another financial crisis, this time coming from the emerging markets ? And I do wonder if the fundamentals of EM have changed so dramatically leading some commentators to believe that a crisis is somehow imminent as evident from the way markets have reacted last week? Well, unlike our friends in the financial world, we ( I am referring to our group ) like many others who operate on a daily basis in the real economy can see and feel that the global economy is shaping up nicely and the IMF’s latest revised up global growth projection of 3.7% for 2014 and it’s growth expectation of around 5.1% for emerging markets from an earlier 4.7% GDP growth rate guidance, more or less reflects the ground the reality of the day. So the obvious question, why this panic and uncertainty ?
Now one could rightly argue that the revised up guidance are just projections and the risks both known and unknown still remains. Also the recent volatility in the markets to a large extent has been driven by downward pressure on the Turkish LIRA as well as Argentine PESOS devaluation and the South African RAND, which is also come under a bit of pressure. And then there are obvious chatters around how good or bad China is doing and how will the leadership manage the US 4.8 trillion dollar worth ( estimated ) shadow banking system along with a relatively high local government debts, and then there are concerns about India as well as Brazil’s fundamentals. These are real and genuine concerns but having said that, I can’t help but wonder, how is all this a SURPRISE to anyone in the market ? For example most of us are aware of the ongoing political uncertainty in Turkey and based on our own common sense, we could safely conclude that if the political turmoil drags on then there will be consequences to the economy.
And also assuming the worst case scenario, one needs to ask and know, did the previous crises in Turkish and Argentine economy kill the overall emerging markets across the board ? the clear answer is NO, so in short it will be unwise to assume that Turkey will some how bring down the emerging markets of Asia, Africa or Latin America, the reality is a potential crisis in Turkey may be more damaging to developed European economies then China or India for that matter. Also it is important to emphasise that there is a crisis of leadership in Turkey today which is weighing down on the economy and a positive resolution could very easily change the overall dynamics of the economy. Now with regards to China, a US 9.4 trillion dollar economy growing at around 7.7% isn’t just going to fall off the cliff under the weight of its shadow banking system and the local government debt. Yes, there are real concerns about how the government may go about handling the whole situation but it will be unwise to assume that somehow the economy will implode bringing down the global economy. There are simply too many opinions on China both bearish and bullish but understanding the structure and behaviour of the overall Chinese economy is an extremely complex task and betting against the government’s ability to deliver on its set forth agenda never really works and this may be one of the reasons why foreign investors tend to struggle in China. And with regards to India, the Indian economy today is in a much better shape fundamentally than last year also the overall investors sentiment around India has improved significantly, the country’s real problem today is a lack of decisive leadership which will hopefully get resolved after the upcoming general election and also most CEOs representing both local and overseas companies are quite upbeat about India’s medium and long term growth prospect. The current government has also made a series of reform announcements aimed at opening up various parts of the economy to overseas investors.
So why then the market is projecting a risk of contagion and giving a sense that somehow an imminent crisis is brewing up in the Emerging market ? I must say, I do wonder if by holding an emerging market stock or bonds or taking up speculative positions in local currency an overseas investor is ever able to get the full picture and flavour of the overall economy ? And the answer is, most likely not because in reality most emerging markets are layered and quite different to each other and also it must be said that there is a reason why they come under the category of being classified as ” emerging markets ” but this is not to say that developed markets are somehow immune to crisis as evident from the financial crisis of 07/08.
In the big picture scenario understanding a market or an asset class isn’t just about reading opinions from various experts of the subject and one must not forget that even in good times people and companies do fail so yes some emerging markets may struggle but today the global economy is in a much better shape than it was few years ago and it is quite unlikely that from here on we are looking at an imminent collapse. However, the inherent risk in the global economic system as well as the financial markets by design still remains so the system isn’t CRISIS proof and never was. Also opinions and projections are part and parcel of how a markets operate but people do need to be rationale and honest because clearly there are those in the market who may prefer a free ride and to keep making money on the back of easy money printed by the central bankers. This is not to suggest that the global economy has now reached a stage when all the loose monetary policy stimulus should be withdrawn right away, the tapering and tightening of traditional monetary policy tools will most likely be gradual.
But having said that the market will continue to make tapering related bets. Vanguard, PIMCO and BLACKROCK lost roughly over 35% in value on their investment in the last 6 months of 2013 by getting their inflation bet wrong on Treasury Inflation Protection Securities (TIPS ). These firms made bets on the assumption that Quantitative easing (QE ) will deliver inflation down the road and although it is quite evident that they got their bet wrong but we mustn’t forget the fact that QE did in fact create Inflation in ASSET PRICING and also across various Emerging Markets, but obviously not where it was expected so clearly those who held a view that QE will create inflationary mayhem in the economy killing the dollar down road most likely didn’t incorporate the fact that the economy of today works and behaves a bit differently. There needs to be a realisation that too much money in the system and ultra lose monetary policy will not necessarily create an immediate spectacular growth trajectory especially when the economy is coming out of a MASSIVE HEART ATTACK. And there are clear evidence that QE has created ASSET pricing inflation through misallocation of capital and this may be what is eating up growth ( growth rate below market expectation ). Also while some managers did get their inflationary bet wrong they should also realise that central bank’s ability to create or control inflation in a 2014 world isn’t always guaranteed or straight forward but having said that inflation will slowly but surely show up in the real economy but most probably not tomorrow.
Investment is about taking risk by relying your own assessment of a specific risk and then taking a decision based on your own judgement. MARKETS OR COMPANIES are all run by Human ideas and thought process so the market or a company is only as good as people behind them. And without being philosophical, we all know that life comes with no guarantee so what do we do? well, we learn to take risks and the same goes for creating a business and how we invest. There are no guarantees and the guarantees you may have or seek could easily become worthless when the circumstances change. And whatever investment decision you make or take will always come with an inherent RISK so there is always a chance that it may or may not work out as planned. You can only make a decision based on what you can see and know today but there are always many unknowns that you may not be able to factor in and going forward these unknowns may very well influence the outcome.
So investing in general isn’t all about following a trend or analysts reports or getting overwhelmed by the sound bites coming from various corners of the market or committing yourself to a fancy model. In most cases, a good investment is generally about following your own intuition or in other words your own inner radar just like many decisions we make or take in our lives and you can always use the information available in the market to make up your own mind in a similar way as you would seek advice from friends or family when taking an important decision in your life but always remember you will have to live with outcome and blaming others for an undesired outcome never helps although it might be quite tempting to play the game but if you do then you are denying yourself an IMPORTANT OPPORTUNITY TO LEARN and there is nothing scary about learning. So the all scary emerging market as projected by some in the market today in fact may not be that scary after all and remember a perception doesn’t always equal reality.
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The Need For India and other Emerging Market Economies to Stay Ahead of the Game
During the recent G20 meeting, the Indian and the Japanese government announced to boost their bilateral currency SWAP agreement from US 15 billion to US 50 billion. This measure is most certainly a step in the right direction and not just because I have been talking about it for months but the arrangement sends all the right signals to the market and will help to arrest the fall of Indian Rupees and other emerging market economies should follow suit to stabilise their currencies. The central bankers across the emerging markets should realise that using old tools to protect a potential run against a currency doesn’t work today and this is why it is important for the policy makers to get ahead of the curve instead of waiting for the fires to start erupting and then get into a fire fighting mode.
So the need of the hour is for emerging market economies including India to better plan the road ahead and prepare well for various possible outcome. Small measures may send a signal of intent to the market but is never enough to stop a big tidal wave and with this in mind the central bankers across emerging markets should beef up their existing firewalls to protect the economy. The fiscal situation of many emerging economies today including of Brazil, India, Indonesia and Turkey among others are somewhat stretched and its one of the reasons why they are feeling the HEAT. In a very deeply interconnected world a credit or market event in one economy could easily have a damaging impact on the other so a bilateral, regional and global cooperation will be Key to any credible long term solution and safeguarding against negative momentum.
The Indian government and RBI will do well to reach out to their counterparts in Taiwan , China, HK, Singapore among others and create a similar currency SWAP agreement agreed with Japan during the G20 summit. There is a lot of goodwill and willingness among policy makers as well as the politicians and businesses in Asia and across other emerging economies to work with each other as evident from the south to south investment boom. Any possible cooperation should address the short, medium and long term issues and not just be focused around dealing with a potential CRISIS down the road.
Reserve Bank of India (RBI) and other central bankers across emerging markets should go further and explore the possibility of settling bilateral and regional trade in their own currencies rather then using the U.S. dollar to settle bilateral trade. This will not just help them diversify but also remove pressure on the currency related to current account deficit because they won’t be required to settle trades in US dollar.
By all accounts, the currency market in its current shape and form is inefficient and unless the world finds a uniform single trading currency unit (USTC) and decides to use IMF style Special Drawing Rights ( SDRs) to settle bilateral and global trades , using a third party currency to settle trades will come with serious forex risk leading to volatility and also added layer of costs. Developing a globally accepted Uniform Single Trading Currency Unit (USTC) to settle trades will make trade easy and also help solve many existing problems but getting all the major trading nations behind the idea may not be that easy.
This is why there is a clear and compelling case for RBI and other central bankers across emerging markets (EM) to look ahead and use the existing volatility as an opportunity to reach out to their counter parts across the world including of other emerging nations and work out the framework and infrastructure that will facilitate the settlement of trades in regional or bilateral currencies. India’s biggest trading partner is ASIA and based on EXIM Bank’s data for the financial year 2011-12, India’s overall export to ASIA makes up around 51.6% of the country’s total EXPORT. For the financial year 2012, India’s total exports stood at US 142 billion and its total IMPORT bill for crude petroleum alone was US 155 billion which is around 65.9% of its overall imports of US 235 billion for the same year. The current account deficit and the requirement for a high level of US dollar reserve to keep paying the import bills has obviously put a lot of pressure on the Indian rupee.
So there is a need for India to explore the possibility of settling trades in other currencies and it makes all the sense in the world for RBI and the Indian government to propose their counter parts in China to settle at least 20% of CHINA- INDIA trade flow of US 36.4 billion ( of which US 26 billion is import from China and US 6.4 billion in export to CHINA) in RMB and Rupees, India should also work with UAE Government and explore the possibility of settling around 15% of its overall trade flow of US 38 billion ( of which US 19.6 billion in imports and US 18 billion in export) in Rupees as well as Dirham. And also further explore settling around 15% of INDIA- RUSSIA trade flow in Roubles ,18% of INDIA – MALAYSIA trade flow in ringgit or rupees and 75% of all SAARC area trade flow in Indian Rupees. This measure will most likely relieve any immediate pressure on the Indian Rupee and also help the trading partners to diversify. The idea enables the policy makers to use simple yet innovative tools to Outthink the speculators and hopefully get them out of the game. The initiative is also in the benefit of most ASIAN and other emerging market economies as their currencies have come under serious pressure this year due to concern over the stretched fiscal situation of some of the economies including of India, Indonesia, Brazil among others as well as FED’s planned tapering in the level of quantitative easing (QE), all this has created a degree of uncertainty over emerging markets and there are already talks of a possible Asian crisis looming in some corners of the financial markets.
There are no solid evidence to suggest that there is an imminent ASIAN crisis brewing or on the cards and the latest China’s trade data seems to suggest that the global demand is in fact improving and gathering momentum but having said that the policy makers across emerging markets will need to have a proactive approach and willingness to work together to stay ahead of the game. The governments of the day will also need to do what is necessary to get the fiscal house in shape and fast track all the critical and essential reforms focused on growing the economy. These measures will not only send the right signals to the markets but also relieve any existing concern and anxiety over the direction of the economy especially in the current circumstances.
The overall macro picture of Asia today looks very different and most Asian economies are generally in a better shape then they were going into the ASIAN crisis of 1997. Also the JAPANESE economy is gathering momentum and feels more confident then ever and the government of the day in Japan will most likely be willing to support any regional cooperation aimed at stabilising the financial markets if and when required as evident from the recent currency SWAP agreement agreed between India and Japan. A growing and confident Japanese economy is good for ASIA and the government of Japan understands the importance of a vibrant and growing Asia as its economy is very closely tied to the region and the same goes for Australia. The INTRA-ASIAN trade flow is now over US$ 63 trillion dollar mark and is projected to be around US$ 109 trillion by 2020 so ASIA will continue to grow and this growth story has still got legs.
The world has changed and this is why I keep saying to my friends and colleagues, if you are Investing in the year 2013 then you should first start with developing a better understanding of the world today, the current world order and the society of the day and here is why, the information drivers of today make a MARKET EVENT instantly available to a global audience in seconds and at the same time so any event that has occurred or may occur is open to a number of possible interpretation from various parts of the financial market with instant analysis. In short, there is never a shortage of OPINION or commentary and these opinion derived from many different OPINIONS floating around at the same time creates more uncertainty leading and adding to more volatility. So the volatility related SWINGS in the market now tends to be bigger and higher then seen historically mostly because our world today is more interconnected than ever before and also the global economy is very different to what it was in let’s say 1993 or 1997 and it also behaves differently. This is why using past comparisons and old tools to make projections comes with a serious risk and it may not accurately reflect the ground reality.
Also any analysis or projection is generally a best guess and not something that is SET in stone so in order to get better at assessing a situation one needs does need to look at the Big Picture and also develop a 360 degrees vantage point. This is why I believe following a fixed strategy when you are getting shot at from so many different angle is for brave hearted and the only thing I have learnt so far is that I KNOW NOTHING and everyday is a new DAY at school. Learning never stops and when there are many factors at play making projection or forecasting a specific outcome is extremely difficult and prone to errors so those who are brave enough to suggest that a possible carnage in Emerging markets is on the card or more or less imminent have most likely misjudged the whole situation and not looking at the complete picture. No doubt that emerging market economies are stretched and struggling somewhat but the current situation also makes them quite attractive for value investors and it will be unwise to assume that by taking out the HOT money supply as a result of QE tapering, the emerging markets are going to start faltering by dozens. Going forward there will be no shortage in supply of various projections or commentaries suggesting many possible outcomes but through a collaborative, proactive and innovative approach the policy makers should look to get ahead of the curve and quell any potential reckless speculative bet or bets that could drive the economy into another CRISIS.
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