With global markets in turmoil and investors running very scared, we give a list of our biggest investment recommendations for the rest of 2008.
By Jonathan Anderson, Caijing Magazine 5 November 2008
1. Stay in cash
Global stock markets are starting to look very cheap, and we’re starting to see some of the more intrepid funds start to take on exposures at these levels – but for most investors our best advice is: don’t try to “catch a falling knife”. The global slowdown is still very much underway, and the trough of the cycle is at least another two quarters ahead. Even then most of the risks are skewed to the downside and there’s no guarantee that we don’t wake up in 2009 with a much longer recession. So while there are good potential returns to be made by “timing the trough” of the market, there are also strong risks that the market keeps on falling into next year.
Another hallmark of the current environment is how few safe global assets are really left in the world. Many of the “usual” instruments such as developed country money market funds, high-quality corporate paper, quasi-government agencies and even US Treasuries now look much more questionable. Even a traditional financial hedge like gold looks fairly expensive and is not immune to the recent volatility on commodity markets. For Chinese investors, the best answer may well be to stay in renminbi deposits in a large local bank for now.
2. Don’t try to play the euro-dollar trade
In today’s environment, there is a large group of people who believe that the US dollar will rebound as the rest of the world “catches up” with the US slowdown, and in particular as the European economy weakens and as the European Central Bank is forced to cut interest rates. There is also an equally large group of people who believe that the dollar will continue to fall, as the costs of the US bailout become more evident and the US government is forced to issue more debt. Some even talk of a “dollar crisis” as emerging market investors finally give up support for the currency.
Who should you believe? No one. There may be good arguments on both sides of the trade, but neither is particularly convincing – which means that there are no guaranteed gains to be made by buying or selling the dollar right now, and the dollar could easily move in either direction against the euro. The one story that makes no sense at all, incidentally, is the “dollar crisis” one; there’s no evidence that global central banks or petrodollar funds have been particularly biased towards the US dollar in the first place, and our best estimates show that they actually hold relatively balanced portfolios among the various global markets.
3. Buy the yen
Instead, think about the Japanese yen. The Japanese economy is not growing very rapidly at the moment – but this is the one large global economy without big structural deleveraging pressures at the moment; it does not have a housing or construction bubble, has not seen excessive credit growth in the past five years and thus is not facing a sharp downturn in growth prospects for 2009 and 2010. Japanese interest rates are already close to zero, and in an environment where the market is already starting to price in significant further central bank easing by both the US and Europe, the yen has been a good outperformer in the past few months. In our view, this situation should continue for the next few quarters as the problems in the US and EU become more evident and both economies enter recession.
To some extent this is true for the Japanese equity market as well. Since the beginning of the year, Nikkei index has fallen by more than the S&P 500 or the FTSE 100 index in local currency terms – again, despite the fact that most of the bad news is coming from the US and European economies. In fact, the Nikkei has fallen by more than the average emerging market equity index. At some point, it starts to make sense to look at the Japanese market with different eyes.
4. Be very careful of emerging markets
Stock markets in the emerging world have fallen by a good bit more than their developed counterparts, and some markets, for example Russia, are trading at all-time low levels. In valuation terms alone, these are very attractive markets indeed for global investors. Should you be rushing to buy now?
Our best answer would be “not just yet”. The first problem is that we simply don’t see any good news on the horizon that would help reverse today’s cheap valuations. Every emerging country we cover is now slowing, and with a US and EU recession looming on the horizon this process will become more painful in the next three to six months. Large “core” emerging countries have their own problems; India is in the midst of a relative credit crunch at home, and China is going through an outright construction recession which will last through the end of the year at very least. So again, the next three or four months are unlikely to bring great macro catalysts from the emerging world.
The second problem is that corporate earnings estimates are still far too optimistic. Today’s consensus forecasts for emerging markets put 12-month forward earnings growth at around 16% y/y for 2008 and 10% y/y for 2009 – numbers that are way above what we would normally associate with an economic downturn. In fact, earnings growth is likely to be zero or negative next year in much of the emerging world, not only because of headline growth deceleration but also due to rising cost pressures in a significant number of countries, which will push down markets even further.
Third, emerging market currencies normally weaken in a slowdown cycle – and we’re only beginning to see this process occur over the last month or so. Since September the Brazilian real, the Mexican peso, the South African rand and a few other currencies have dropped sharply, but most emerging countries still have remarkably stable exchange rates to date, and this is likely to change in the months ahead. For investors looking to buy inexpensive assets in emerging markets, it may be best to wait until we see a more widespread currency depreciation.
5. Avoid Eastern Europe
The final point is that of all the emerging regions we cover, by far the most fragile and dangerous is Eastern Europe. Whether we look at the amount of overall debt and leverage created in the economy, the size of external deficits, dependence on overseas finance or the level of indebtedness in domestic banking systems, countries like Estonia, Latvia, Lithuania, Romania, Ukraine, Bulgaria, Kazakhstan and Hungary show up at the top of the list in every case. Russia also looks relatively exposed in terms of the domestic leverage created in the banking system – and it should come as no surprise that Russia was one of the first emerging markets to see a banking system crisis at home, or that currencies in Romania, Hungary and Ukraine have been among the worst affected across the world. Growth in all of these countries has been very imbalanced, and in many cases highly dependent on foreign capital from Austrian, Scandinavian, or Italian banks, and the main risk going forward is that we see a repeat of the 1997 Asian financial crisis – but this time we will be calling it the 2008 Eastern European crisis.
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Five Tips for Surviving in 2008
With global markets in turmoil and investors running very scared, we give a list of our biggest investment recommendations for the rest of 2008.
By Jonathan Anderson, Caijing Magazine
5 November 2008
1. Stay in cash
Global stock markets are starting to look very cheap, and we’re starting to see some of the more intrepid funds start to take on exposures at these levels – but for most investors our best advice is: don’t try to “catch a falling knife”. The global slowdown is still very much underway, and the trough of the cycle is at least another two quarters ahead. Even then most of the risks are skewed to the downside and there’s no guarantee that we don’t wake up in 2009 with a much longer recession. So while there are good potential returns to be made by “timing the trough” of the market, there are also strong risks that the market keeps on falling into next year.
Another hallmark of the current environment is how few safe global assets are really left in the world. Many of the “usual” instruments such as developed country money market funds, high-quality corporate paper, quasi-government agencies and even US Treasuries now look much more questionable. Even a traditional financial hedge like gold looks fairly expensive and is not immune to the recent volatility on commodity markets. For Chinese investors, the best answer may well be to stay in renminbi deposits in a large local bank for now.
2. Don’t try to play the euro-dollar trade
In today’s environment, there is a large group of people who believe that the US dollar will rebound as the rest of the world “catches up” with the US slowdown, and in particular as the European economy weakens and as the European Central Bank is forced to cut interest rates. There is also an equally large group of people who believe that the dollar will continue to fall, as the costs of the US bailout become more evident and the US government is forced to issue more debt. Some even talk of a “dollar crisis” as emerging market investors finally give up support for the currency.
Who should you believe? No one. There may be good arguments on both sides of the trade, but neither is particularly convincing – which means that there are no guaranteed gains to be made by buying or selling the dollar right now, and the dollar could easily move in either direction against the euro. The one story that makes no sense at all, incidentally, is the “dollar crisis” one; there’s no evidence that global central banks or petrodollar funds have been particularly biased towards the US dollar in the first place, and our best estimates show that they actually hold relatively balanced portfolios among the various global markets.
3. Buy the yen
Instead, think about the Japanese yen. The Japanese economy is not growing very rapidly at the moment – but this is the one large global economy without big structural deleveraging pressures at the moment; it does not have a housing or construction bubble, has not seen excessive credit growth in the past five years and thus is not facing a sharp downturn in growth prospects for 2009 and 2010. Japanese interest rates are already close to zero, and in an environment where the market is already starting to price in significant further central bank easing by both the US and Europe, the yen has been a good outperformer in the past few months. In our view, this situation should continue for the next few quarters as the problems in the US and EU become more evident and both economies enter recession.
To some extent this is true for the Japanese equity market as well. Since the beginning of the year, Nikkei index has fallen by more than the S&P 500 or the FTSE 100 index in local currency terms – again, despite the fact that most of the bad news is coming from the US and European economies. In fact, the Nikkei has fallen by more than the average emerging market equity index. At some point, it starts to make sense to look at the Japanese market with different eyes.
4. Be very careful of emerging markets
Stock markets in the emerging world have fallen by a good bit more than their developed counterparts, and some markets, for example Russia, are trading at all-time low levels. In valuation terms alone, these are very attractive markets indeed for global investors. Should you be rushing to buy now?
Our best answer would be “not just yet”. The first problem is that we simply don’t see any good news on the horizon that would help reverse today’s cheap valuations. Every emerging country we cover is now slowing, and with a US and EU recession looming on the horizon this process will become more painful in the next three to six months. Large “core” emerging countries have their own problems; India is in the midst of a relative credit crunch at home, and China is going through an outright construction recession which will last through the end of the year at very least. So again, the next three or four months are unlikely to bring great macro catalysts from the emerging world.
The second problem is that corporate earnings estimates are still far too optimistic. Today’s consensus forecasts for emerging markets put 12-month forward earnings growth at around 16% y/y for 2008 and 10% y/y for 2009 – numbers that are way above what we would normally associate with an economic downturn. In fact, earnings growth is likely to be zero or negative next year in much of the emerging world, not only because of headline growth deceleration but also due to rising cost pressures in a significant number of countries, which will push down markets even further.
Third, emerging market currencies normally weaken in a slowdown cycle – and we’re only beginning to see this process occur over the last month or so. Since September the Brazilian real, the Mexican peso, the South African rand and a few other currencies have dropped sharply, but most emerging countries still have remarkably stable exchange rates to date, and this is likely to change in the months ahead. For investors looking to buy inexpensive assets in emerging markets, it may be best to wait until we see a more widespread currency depreciation.
5. Avoid Eastern Europe
The final point is that of all the emerging regions we cover, by far the most fragile and dangerous is Eastern Europe. Whether we look at the amount of overall debt and leverage created in the economy, the size of external deficits, dependence on overseas finance or the level of indebtedness in domestic banking systems, countries like Estonia, Latvia, Lithuania, Romania, Ukraine, Bulgaria, Kazakhstan and Hungary show up at the top of the list in every case. Russia also looks relatively exposed in terms of the domestic leverage created in the banking system – and it should come as no surprise that Russia was one of the first emerging markets to see a banking system crisis at home, or that currencies in Romania, Hungary and Ukraine have been among the worst affected across the world. Growth in all of these countries has been very imbalanced, and in many cases highly dependent on foreign capital from Austrian, Scandinavian, or Italian banks, and the main risk going forward is that we see a repeat of the 1997 Asian financial crisis – but this time we will be calling it the 2008 Eastern European crisis.
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