Month: October 2018

What is it that the foreign press doesn’t get about Brazil’s Bolsonaro?

If Jair Bolsonaro wins the election in Brazil this coming Sunday (October 28) one of the obstacles he will face is the severe skepticism of the international press. Important publications around the world have been nearly unanimous in their repudiation of the candidate, branding him as an uncouth, right-wing radical with authoritarian tendencies.

Typical of the onslaught against Bolsonaro was the article published by the Editorial Board of the New York Times this week. According to the NYT, Bolsonaro is an “offensive, crude and thuggish populist” who holds “gross and repulsive views” and ”is nostalgic for the generals and torturers” of the past…His election is a “frightening prospect.” The NYT also published an article by the well-known Brazilian musician, Caetano Veloso, warning that “dark times” are coming to Brazil. In a similar vein, The Economist Magazine recently wrote that Bolsonaro is a “dangerous politician… with an admiration for dictatorships,” and a “menace to Brazil and Latin America.”

There is a large disconnect between this furious criticism expressed by the foreign press (generally echoed by the progressive Brazilian media) and the reaction of the Brazilian stock market, which has rallied strongly in recent weeks as the polls have shown Bolsonaro surging ahead, and the large crowds expressing their enthusiastic support for him this past weekend in rallies held in major cities around Brazil. Part of this chasm can be explained by the high esteem which the international press still holds for former President Lula, despite his incarceration. For example, The Economist describes Lula “as a president who brought “prosperity to many poor Brazilians.” Lula’s hand-picked heir-apparent, Fernando Haddad, is said to be a “temperate moderate.”

So, what is going on with the Brazilian electorate?

The basic divergence can be explained by the almost exclusive focus of the foreign press on public persona. Lula is remembered as an endearing and charismatic crusader for the poor, and Haddad is seen as a boring moderate with good intentions. On the other hand, Bolsonaro is taken to task for a history or rude and politically incorrect statements on socially sensitive issues. Bolsonaro’s loose lip has resulted in comparisons with President Trump. However, the stock market and Bolsonaro’s supporters in Brazil, have been willing to overlook the candidate’s faux pas. They have preferred to focus on the almost diametrically opposed views that the two candidates have on society and the economy.

Brazil is a country that for the past four decades has favored a large and very interventionist government, with a dominant role for the state in economic planning and investment. After a brief period of economic liberalism in the late 1960s and early 1970s, which led to Brazil’s so-called “economic miracle,” the country changed direction. First under the military regime (until 1985) and then under a succession of elected presidents, entrepreneurial activity was squashed by a very interventionist and bureaucratic state. This reached its apogee during the Lula years, and was made even worse by a rapacious takeover of the state bureaucracy and state-run companies by corrupt politicians.  The result of this is that for the past four decades Brazil has become a major economic laggard, growing its per capita GDP at nearly half the OECD average. With its extremely protectionist policies, Brazil entirely missed out on the globalization boom of the past three decades. The country also provides a particularly hostile environment for business. For example, it ranks 125th in the World Bank’s 2018 “Ease of Doing Business” rankings, the worst of any significant emerging market.

The economic policies presented by the two candidates could not be more different. Simply put, Haddad offers a continuation of the failed policies of the past without any explanation for why they would now work, while Bolsonaro hopes to bring about a complete break. The differences in the economic agendas proposed by the two campaigns are at opposite sides of the ideological spectrum. A  cursory glance at the two candidates’ official websites makes this abundantly clear.

Haddad’s Plan (Link )

Haddad proposes a carbon copy of the policies followed during the Lula/Rousseff years. He offers:

  • A “developmentalist” agenda grounded in the state as the motor of the economy, through the actions of state companies and state banks. Privatizations are unacceptable. Foreign investments in the “pre-salt’ off-shore oil fields are to be unwound.
  • A trade and foreign policy focused on south-to-south initiatives, with a focus on regional integration and Africa.
  • Centralized power in the federal government, with a strongly activist role in social policy.
  • Repeal of the recently approved labor flexibilization law and a change in the mandate of the Central Bank to include employment targets.
  • The government will promote plebiscites and referendums to engage citizens in democracy.

Bolsonaro’s Plan (Link)

Bolsonaro offers a plan to unleash private entrepreneurial activity.

  • Private initiative is the principal motor to overcome poverty and develop the country. “We need free citizens, an efficient government with limited responsibilities, decentralized power, greater autonomy for municipalities and the engagement of civil society.” It is expected that Bolsonaro will announce a massive privatization effort.
  • Free Markets: Limited government and deregulation so that individuals and firms can act freely.
  • Decentralization: Private initiative come first. Activities best conducted by the public sector should be the responsibility of the municipality, the states and the federal government, in that order.
  • Social services provided by the state for the most needy, and reliance on private initiative to complement the role of the state.
  • A trade and foreign policy based on interaction with the most successful economies in the world, which can invest and provide technology for Brazilian development.
  • Representative democracy with the separation of powers is the best option for Brazil.

Anyone can agree or disagree with each one of the principles forwarded either by Haddad or Bolsonaro, but it is impossible to argue that the policy differences between the candidates are not profound. Haddad believes in state-driven development while Bolsonaro wants to unleash the “animal spirits” of Brazil’s entrepreneurs. For the first time in its democratic history, Brazilians are being offered the choice of taking the path of economic liberalism. In Brazil, as elsewhere, there is huge rejection of the political class and appetite for change, and this is driving the electorate to Bolsonaro.

Brazil’s task is not easy. The country has dug a deep fiscal hole for itself through bad policies, reckless spending and the world’s highest interest rates. But, we should all root for Bolsonaro to get this great nation back on the right track.

Macro Watch:

India Watch

  • India partners with Russia in energy deals (Lowy)
  • Golden opportunities in Indian agriculture (Mckinsey)
  • India’s auto sector (Mckinsey)
  • India PM performance (SPIVA)
  • India’s Russia arm deal (WSJ)
  • India’s game-changing healthcare plan (Lowy)

China Watch:

  • The world’s longest sea-bridge opens (CNN) (QZ)
  • China provinces compete for talent (EIU)
  • China’s influence on global tourism is growing (SCMP)
  • China,US, miscalculation, war (Axios)
  • Apple denies China hacking story (Buzzfeed)
  • US pork hit hard by China tariffs (WSJ)
  • China faces a debt iceberg (FT)
  • Hainan free trade zone to boost international tourism (Caixing )
  • Is there a new “cold war” (WIC)
  • China middle-class desperate to get money overseas (SCMP)
  • Yan Lianke’s forbidden satire of China (New Yorker)
  • Chinese actress to pay $129 million tax-evasion fine (WIC)

China Technology Watch

  • China’s smart-phone offerings (The Verge)
  • The battle for 5G (SCMP)
  • Dutch battery firm to build plant in China (FT)
  • Hacking accusations against China seek to undermine China tech (Lowy)
  • Big tech in China moving closer to Party (Lowy)

Brazil Watch

  • Dark times coming to Brazil (NYT)
  • Brazil’s Bolsonaro (New Yorker)
  • In Brazil, campaign promises but no money (WSJ)
  • Emerging markets’ lost decade (Blackrock)
  • Brazil’s gene-edited angus cow (WSJ)

EM Investor Watch

  • Are developing countries converging (PIIE)
  • Turkey, the 1994 crisis (Seeking Alpha)
  • What next for Turkish-American relations (GMFUS)
  • The Global Competitiveness Report  2018 (WEFORUM)
  • The World Bank’s Human Capital Report (World Bank)
  • Indonesia’s bullet-train is stalled (Caixing)
  • Russia’s missed tech opportunity (Hoover)

Tech Watch

  • The plan to end malaria with CRSPR (Wired)

Investing

  • KKR white paper on asset allocation (KKR)
  • Hedge funds fleecing investors (SL advisors)
  • Monish Pabrai’s ten commandments (Youtube)
  • SPIVA’s mid-year assessment of mutual fund performance (SPIVA)
  • Update on the Buffett indicator (Advisor Perspectives)
  • Factor investing in emerging markets (http://ETF.com)
  • Challenging the conventional wisdom on asset managers (SSRN)
  • What does an EV/EBITDA multiple mean? (Blue Mountain)
  • Joel Greenblatt’s talk at Google (Youtube)
  • Consequences of current account imbalances (Private Debt Project)

 

 

 

 

 

Xi Returns to Shenzhen

Shenzhen is where China’s “economic miracle” started four decades ago. In 1980, Deng Xiaoping gave the sleepy fishing village which lies north of Hong Kong the status of “Special Economic Zone,” embracing market mechanisms and the process of integrating China into the world economy.  After the political turmoil and the events of Tiananmen Square in 1992, Deng returned to Shenzhen where he reaffirmed China’s commitment to “modernization… through reform and opening.”

In China, symbolism and slogans carry great weight, so the visit of President Xi Xinping to Shenzhen this week should be seen as highly significant. Xi has been repeatedly accused by critics both inside and outside of China of returning China increasingly towards the state-controlled dirigisme of the past, and his visit to Shenzhen aimed to reaffirm support for the private sector entrepreneurialism which has made Shenzhen into the world’s only rival to Silicon Valley.

In Shenzhen, Xi made comments aimed at bolstering confidence in China’s economic prospects. He paid tribute to Deng and vowed to continue China’s reform and opening up.

The road of “reform and opening up” was the “correct path” and China could create “bigger miracles” by sticking to it, Xi was quoted as saying by the official Xinhua news agency.

Xi added:

“I come to Shenzhen again … so that we can declare to the world: China’s reform and opening up will never stop.”

“We will continue down this path, unswervingly continue down the path of enriching the country and the people, and will break new ground.”

“This year marked the 40th anniversary of China’s reform and opening up. In the last 40 years, China’s development achievements have impressed the world…“So, since we are getting better and better, then why don’t we continue along the chosen path? Although we have some difficulties and problems, we have to solve and overcome them by going along the chosen road. We must firmly walk down the road of reform and opening up.”

 

Macro Watch:

India Watch

  • Golden opportunities in Indian agriculture (Mckinsey)
  • India’s auto sector (Mckinsey)
  • India PM performance (SPIVA)
  • India’s Russia arm deal (WSJ)
  • India’s game-changing healthcare plan (Lowy)

China Watch:

  • The world’s longest sea-bridge opens (CNN) (QZ)
  • China’s influence on global tourism is growing (SCMP)
  • China,US, miscalculation, war (Axios)
  • Apple denies China hacking story (Buzzfeed)
  • US pork hit hard by China tariffs (WSJ)
  • China faces a debt iceberg (FT)
  • Hainan free trade zone to boost international tourism (Caixing )
  • Is there a new “cold war” (WIC)
  • China middle-class desperate to get money overseas (SCMP)
  • Yan Lianke’s forbidden satire of China (New Yorker)
  • Chinese actress to pay $129 million tax-evasion fine (WIC)

China Technology Watch

  • China’s smart-phone offerings (The Verge)
  • The battle for 5G (SCMP)
  • Dutch battery firm to build plant in China (FT)
  • Hacking accusations against China seek to undermine China tech (Lowy)
  • Big tech in China moving closer to Party (Lowy)

Brazil Watch

  • Dark times coming to Brazil (NYT)
  • Brazil’s Bolsonaro (New Yorker)
  • In Brazil, campaign promises but no money (WSJ)
  • Emerging markets’ lost decade (Blackrock)
  • Brazil’s gene-edited angus cow (WSJ)

EM Investor Watch

  • Are developing countries converging (PIIE)
  • Turkey, the 1994 crisis (Seeking Alpha)
  • What next for Turkish-American relations (GMFUS)
  • The Global Competitiveness Report  2018 (WEFORUM)
  • The World Bank’s Human Capital Report (World Bank)
  • Indonesia’s bullet-train is stalled (Caixing)
  • Russia’s missed tech opportunity (Hoover)

Tech Watch

  • The plan to end malaria with CRSPR (Wired)

Investing

  • KKR white paper on asset allocation (KKR)
  • Monish Pabrai’s ten commandments (Youtube)
  • SPIVA’s mid-year assessment of mutual fund performance (SPIVA)
  • Update on the Buffett indicator (Advisor Perspectives)
  • Factor investing in emerging markets (http://ETF.com)
  • Challenging the conventional wisdom on asset managers (SSRN)
  • What does an EV/EBITDA multiple mean? (Blue Mountain)
  • Joel Greenblatt’s talk at Google (Youtube)
  • Consequences of current account imbalances (Private Debt Project)

 

 

 

 

 

 

 

Emerging Markets Have a Human Capital Problem

Countries develop economically and allow their citizens to prosper when they provide basic public goods and services with reasonably low taxes.  The responsibility of government is to promote a healthy environment  for the development of human capital, which entails the provision of  an efficient legal system, public security and basic social and physical infrastructure. Once these are present, the conditions may be propitious to unleash entrepreneurial activity and innovation.

Most governments in developing countries do not achieve the good standards of governance that deliver sustained improvements in prosperity. After an initial wave of productivity growth driven by urbanization and technology transfer, growth stalls for most countries. Latin America, with its low productivity and GDP growth over the past three decades, typifies this process, while the Asian tigers (Hong Kong, Korea, Singapore, Taiwan) provide rare exceptions. The reasons for growth stagnation are many but one stands out:  rent-seeking, extractive agents are allowed to flourish at the expense of society as a whole, until eventually the capacity of the state to provide basic public goods is exhausted.

Two separate annual surveys – one by the World Bank (Doing Business)  and the other by the World Economic Forum (WEF 2018)  – describe in detail the burdens on growth imposed by extractive forces on countries, making difficult the activities of citizens and enterprises.  These surveys rank countries in terms of “the ease of doing business.”  Because they have been conducted for many years, they allow us to evaluate how countries evolve over time.  A new survey launched this week by the World Bank, which focuses exclusively on the quality of human capital, is an important addition to the understanding of the growth challenges faced by developing countries.

The measure of a country’s human capital is probably the most important indicator of whether a government is providing basic education and health services to its people.  A citizenry that is unhealthy and uneducated will not be productive in its own country and will not compete successfully in the world. The importance of human capital has never been greater than today as technology (robotics, 3D printing, etc…) increasingly poses a threat to menial labor around the world.

The World Bank Human Capital Index (HCI)  tabulates health and education indicators to measure the relative development of human capital in 157 countries. In this report, Singapore is ranked the country with the highest level of human capital while Chad has the lowest rank. The chart below shows a sample of the ranking, focusing on important countries for emerging markets investors.

 

The high rankings of the Asian tigers go a long way towards explaining their remarkable economic success (Taiwan is not included in the HCI, but it would also rank near the top). These countries have a high capacity for investing in public goods and do an exceptional job at providing the basic public services that their citizens need to prosper. China ranks relatively well in the context of emerging economies and appears to be moving in the direction of the Asian tigers, with already high levels of HCI in major cities like Shanghai and Beijing. Vietnam also shows positive signs that it may follow in the path of the Asian tigers.

The remainder of Asia is a mixed bag. Thailand and Malaysia are much less effective in providing public goods and services to their citizens. This likely will stifle their growth, and they may increasingly be squeezed between new low-labor-cost competitors and highly productive developed economies. Indonesia, Philippines and especially India all do a very poor job for their citizens. However, unlike Thailand and Malaysia, they have large markets and still have high, early-stage development growth potential.

Eastern European countries formerly of the Soviet bloc score well in the World Bank HIC rankings. With high-quality human capital and accelerated integration into the very large western European market, these countries are well positioned to prosper.  Russia less so; though HCI is good, the country has not chosen integration with Europe, preferring instead to pursue costly geopolitical ambitions.

Latin America, by-and-large, has low rankings which will compromise its future performance in the global economy.  Only Chile appears on the right track towards improving human capital. Most of Latin America consist of  middle-income countries with poor human capital and seems badly equipped to face the future. For small economies the best path must be to seek full integration with the global economy but distance is a problem. Brazil, with its large market and huge potential to improve the business environment, and Mexico with its proximity to the U.S. and trade integration,  have the best prospects.

The major African economies are very poorly positioned, with very poor HCI rankings. This bad situation is worsened by extensive “brain drain,” as educated people leave these countries for better opportunities elsewhere.

 

Macro Watch:

India Watch

  • India’s Russia arm deal (WSJ)
  • India’s game-changing healthcare plan (Lowy)

China Watch:

  • US pork hit hard by China tariffs (WSJ)
  • China faces a debt iceberg (FT)
  • Hainan free trade zone to boost international tourism (Caixing )
  • Is there a new “cold war” (WIC)
  • China middle-class desperate to get money overseas (SCMP)
  • Yan Lianke’s forbidden satire of China (New Yorker)
  • Chinese actress to pay $129 million tax-evasion fine (WIC)
  • A strategy for dealing with China (PIIE)
  • China and Islam ( Hoover)
  • Gloves off in China-US conflict (Axios)
  • The garlic war (AXIOS)

China Technology Watch

  • China’s smart-phone offerings (The Verge)
  • The battle for 5G (SCMP)
  • Dutch battery firm to build plant in China (FT)
  • Hacking accusations against China seek to undermine China tech (Lowy)
  • Big tech in China moving closer to Party (Lowy)
  • BMW takes control of China venture (WSJ
  • China aircraft sector slow take-off (SCMP)

Brazil Watch

  • Brazil’s Bolsonaro (New Yorker)
  • In Brazil, campaign promises but no money (WSJ)
  • Emerging markets’ lost decade (Blackrock)
  • Brazil’s gene-edited angus cow (WSJ)
  • Brazil’s social media election (FT)
  • How to fix Brazil’s economy (Project Syndicate)

EM Investor Watch

  • Turkey, the 1994 crisis (Seeking Alpha)
  • What next for Turkish-American relations (GMFUS)
  • The Global Competitiveness Report  2018 (WEFORUM)
  • The World Bank’s Human Capital Report (World Bank)
  • Indonesia’s bullet-train is stalled (Caixing)
  • Russia’s missed tech opportunity (Hoover)

Tech Watch

  • The plan to end malaria with CRSPR (Wired)

Investing

 

 

 

 

 

 

The U.S.-China “Cold War”

 

Until recently, China and the United States had a convenient symbiotic relationship whereby China supplied cheap consumer goods to the U.S. consumer in exchange for dollars which it then invested in U.S. treasury bills. The relationship was perceived to be largely benign and mutually beneficial. For China, access to the U.S. market allowed it to follow the path followed in the past by its Northeast Asia neighbors (Japan, Korea and Taiwan), gradually moving up the value chain from toys, to textiles to electronics…etc. For the U.S., cheap Chinese goods increased consumer purchasing power at a time of stagnant wages. Geo-political strategists in Washington imagined that as China prospered it would start to act more like a Western liberal democracy.

However, since the arrival of Trump the relationship has frayed, and the two countries are now on the verge of a full-fledged “cold war.” Though Trump’s  anti-globalization and protectionist rhetoric may have galvanized opposition to China, the change in Washington is deep-rooted and largely consensual. Today, China-bashing is one of the few things that unite republicans and democrats, and the Washington establishment has made a remarkable about-face and now actively demonizes China. What was once seen as a “win-win” relationship is now perceived to be heavily skewed in favor of Beijing.

The current line of thinking in Washington is that China has abused American goodwill. While the U.S. opened its markets for Chinese exports and investments, China gamed WTO rules, restricted access to its market for trade and investments and sponsored the theft of intellectual property. Moreover, it has suddenly dawned on the Washington intelligentsia that China does not intend to become a liberal democracy. This makes China very different from previous beneficiaries of the “Pax Americana,” such as Germany, Japan and the Asian tigers. China is also different because of its huge scale and a growing economy that may, if it follows its current growth path, surpass the U.S. economy over the next decade. For the first time ever, China is now seen as a potential hegemonic rival that must be thwarted.

Washington’s new-found condemnation of China grew in tandem with the ascendency of Xi Xinping, his consolidation of power and his “coronation” in October, 2017 as “leader for life.”  Prior to Xi, Chinese leaders had projected  diffidence and humility. This was best expressed by Deng Xiaoping who advised: “Observe calmly; secure our position; cope with affairs calmly; hide our capacities and bide our time; be good at maintaining a low profile; and never claim leadership.”  However, Xi has come to symbolize a new more militant, arrogant and ambitious China, with pretentions of global leadership. Most emblematic of this are Xi’s two core policy initiatives: One-Belt-One-Road, which seeks to project Chinese influence and investments outside of China, particularly along the old “Silk Road” and international shipping routes; and the “Made in China 2025” industrial planning policy which aims to move Chinese manufacturing up the value chain into frontier technologies.

The U.S. is critical of both of these initiatives because they are seen as anti-market products of a command economy, made possible by state subsidies and state companies. These policies and Xi’s stated objective of strengthening state capitalism and the role of the Communist Party are seen by Washington as indicative that China is a non-market economy that operates by different rules than Western economies. Topping off Washington’s grievances is the perception that Xi is taking China down a new path of military expansionism which threatens Asian stability.

With Trump at the helm, there is a very high probability of further deterioration in the relationship with China. As JPMorgan strategists wrote last week  “a full-blown trade war becomes our new base case scenario for 2019.” It is increasingly likely that a 25% tariff will be imposed on all Chinese goods early next year.

Currently, the two countries are at an impasse. Trump believes that the Chinese will surrender on his terms as the Chinese economy deteriorates. Xi believes the state-run Chinese economy is resilient, and China can wait patiently for changes in the U.S. political and economic cycles. China is convinced that the U.S. is now undermining the post-war economic order because it is determined to thwart China’s economic rise. Its response has been to act as a responsible member of the rules-based international community, gradually adapting to the legitimate demands of its commercial partners. An example of this is China’s recent elimination of joint-venture requirements in the auto sector (this week BMW announced it is taking full control of its JV with Brilliance China).

The two countries are probably underestimating each other’s resolve, which means that the quarrel with have long-term consequences. What may be these be?

  • Tariffs and disruption of supply chains will boost inflation in the U.S. and bring the late-cycle U.S. economy closer to recession. Over the short term, little can be done to substitute Chinese imports, and tariffs will act as a large tax on consumers. Over the medium term, countries like Vietnam, Bangladesh, and Mexico can replace China as manufacturing bases for the U.S. consumer. Over the long-term robotics may change everything and allow a contraction of manufacturing supply chains.
  • European and Asian firms will take advantage of the trade war to take market share from U.S. firms in the Chinese market.
  • As indicated by the poor performance of the stock market, the Chinese economy may become less stable. China already faces big challenges dealing with high debt levels and malinvestment, while it moves from an investment and export driven economy to one based on consumption. A trade war with the U.S. can only make this transition more difficult, and this may have significant negative consequences for the global economy. Given that EM stocks are mainly driven by events in China and the U.S., the disruption of the China-U.S. relationship will surely have very serious consequences.
  • Over the medium term, there may be a retrenchment in globalization and an acceleration of regional blocs and multipolarity. Firms will have to think about operating in increasingly separate ecosystems, each with its own supply chains and technological platforms: one supply chain will serve the U.S. market; another will be structured for the Chinese market. This process is in full acceleration: Huawei and ZTE have been banned from the U.S.; the U.S. is accusing China of hacking supply-chain components sourced in China; China is determined to become self-reliant in key components for the high-tech sector.
  • Initially, one of the few clear winners of this “Cold War” may be Mexico. The Mexican government smartly outmaneuvered Trump and secured the basics of NAFTA in exchange for a new name (USMCA). The deal allowed Trump to say that “the worst trade deal ever” has now become “a great deal, the most important trade deal we have ever made.” The new deal may make Mexico the manufacturing base of choice for firms seeking the combination of easy access to the U.S. market and cheap labor.

Macro Watch:

  • The weak fundamentals of the global economy (Project Syndicate)
  • Trump’s poison pill for China (Yardeni)
  • U.S. tariffs on China are not short term strategy (WSJ)
  • The decline of the dollar standard (Project Syndicate)
  • The U.S. will win this trade war (Gary Shilling)
  • New NAFTA is a relief (The Economist)
  • Brazilian democracy on the brink (Project)
  • The Tyranny of the US dollar (Bloomberg)
  • Trump’s rebranded NAFTA (Bloomberg
  • New NAFTA shows limits of “America First” (WSJ)
  • NAFTA to USMCA – What in a name? (Lowy)

India Watch

  • India’s Russia arm deal (WSJ)
  • India’s game-changing healthcare plan (Lowy)
  • Measuring Indian equities (S&P)
  • Modi is no populist (Foreign Policy)

 

China Watch:

  • Chinese actress to pay $129 million tax-evasion fine (WIC)
  • A strategy for dealing with China (PIIE)
  • China and Islam ( Hoover)
  • Gloves off in China-US conflict (Axios)
  • The garlic war (AXIOS)
  • Chinese U.S. investments plummet (SCMP)
  • China-U.S. ties now driven by conflict and containment (CSIS)
  • VP Pence’s cold war China speech (NYtimes)
  • U.S.-China trade relations forever broken (SCMP)
  • The U.S. will lose its trade war with China   (Project Syndicate)
  • Hong Kong mainland bullet-train link opens (WIC)
  • China’s embracement of Russia (SCMP)

China Technology Watch

  • BMW takes control of China venture (WSJ
  • China aircraft sector slow take-off (SCMP)
  • How the US halted China cyber-attacks (Wired)
  • Huawei’s new chips (WSJ) and (Tech Review)
  • Most Chinese patents are worthless (Bloomberg)
  • Chinese provinces keen to attract EV investments (Caixing)
  • How China sustematically steals technology (WSJ)

Brazil Watch

  • Brazil’s Bolsonaro (New Yorker)
  • In Brazil, campaign promises but no money (WSJ)
  • Emerging markets’ lost decade (Blackrock)
  • Brazil’s gene-edited angus cow (WSJ)
  • Brazil’s social media election (FT)
  • How to fix Brazil’s economy (Project Syndicate)

EM Investor Watch

  • Indonesia’s bullet-train is stalled (Caixing)
  • Russia’s missed tech opportunity (Hoover)
  • Emerging markets’ lost decade (Blackrock)
  • SPIVA Latin American Scorecard (S&P)

Tech Watch

  • The plan to end malaria with CRSPR (Wired)

Investing

 

 

 

 

The Outlook for Emerging Markets Stocks

 

As discussed in prior posts (stormy-waters-in-emerging-markets ), the environment for emerging markets investing has deteriorated since January of this year. We are in the midst of a typical “risk off” phase for global liquidity, which causes investors to seek the safety of dollar assets. This is happening after a period of historically low interest rates which lured many EM countries into borrowing in dollars. Turkey is the poster child for this moment, having as it has for several years funded a construction and consumption boom and large current accounts deficits with dollar-funding provided by yield-hungry foreign investors.

Poor Global Liquidity is Bad for EM Equities

The current rise in risk aversion has several explanations, all of which have led to a strengthening dollar, poor global liquidity  and pain for EM.

  • A huge, late cycle fiscal expansion has boosted U.S. GDP growth at a time when both China and Europe have experienced unexpected economic slowdowns.
  • Rising inflation expectations are leading the U.S. Fed to move forward to “normalize” monetary policy, resulting in significantly higher long-term interest rates and growing spreads between U.S. yields and those of Europe and Japan. Inflation expectations are rising because of economic overheating, rising tariffs and supply chain disruptions, and high oil prices.
  • President Trump’s anti-globalization policies and the unilateral “take it or leave it” approach to diplomacy is increasing tensions and forcing companies to reconsider investments.

Global dollar liquidity is now declining. In essence, dollar supply is tightening, which makes it difficult for dollar borrowers to repay loans and for global trade to grow. Chart 1  below shows the year-on-year change in dollar liquidity, measured by combining the U.S. monetary base with Foreign Central Bank Reserves. While global GDP is growing at above 3% per year, the data shows that dollar liquidity has been growing by less than 1% this year, a steady decline from the 8% growth achieved in 2012.  Chart 2  below shows that reserves held by foreign central banks also peaked in 2012. It is not a coincidence that the dollar has persistently strengthened  against EM currencies since 2012. This rise of the dollar against EM currencies is shown in Chart 3.

Chart 1. Year-on-year increase in global liquidity (IMF,FED)

Chart2. Dollar Reserves held by Central Banks (FED)

Chart 3. EM currencies against the U.S. dollar (MSCI, Yardeni Research)

Valuations are Compelling

Though current conditions of tight global liquidity and a rising dollar are detrimental for EM equities, valuations are compelling.  When global liquidity conditions improve, EM equities can provide high returns from current levels. Valuations are now at very attractive levels,  both in absolute terms and relative to history and alternative asset classes. As shown in the table below, expected dollar real returns for the next 7 years are in the order of  9.5% annually, which compares to 6% real returns (before dividends) experienced over the past three decades. These expected returns are estimated by assuming mean reversion for both valuations and earnings to historical trend lines and assuming earnings growth to be in line with GDP growth.

Similar exercises by GMO (Link) and Research Affiliates (Link) reach slightly different conclusions but all point to significantly superior returns in EM relative to other asset classes.

 

 

Conducting a similar exercise within the EM universe, we can rank from a quantitative viewpoint the expected returns of individual markets. The first chart below shows valuation parameters for major EM markets. The final column shows the gap between the current cyclically adjusted price earnings ratios and the historical “normalized” level for each market.

Finally, the table below ranks EM countries in terms of expected future returns from current levels. Not surprisingly, recent problematic markets such as Turkey, Colombia, Indonesia and Russia appear to be priced very low compared to their histories. As always, investors tend to extrapolate the recent past and find it very difficult to imagine a return to historical trends.

India, which until very recently was the market darling, also looks very attractive again., assuming it can deliver on very high expected GDP growth (IMF estimates) and return to higher earnings multiples.

Expensive markets, such as Taiwan, Thailand, Peru and the Philippines, all trade at multiples that are above historical norms and have enjoyed powerful earnings cycles that are also well above trend.

 

Macro Watch:

  • New NAFTA shows limits of “America First” (WSJ)
  • NAFTA to USMCA – What in a name? (Lowy)
  • Market Insights for a tripolar world  (TPWIM)
  • Robert Zoellick on China (Caixing)

India Watch

  • India’s Russia arm deal (WSJ)
  • India’s game-changing healthcare plan (Lowy)
  • Measuring Indian equities (S&P)
  • Modi is no populist (Foreign Policy)

 

China Watch:

  • Chinese U.S. investments plummet (SCMP)
  • China-U.S. ties now driven by conflict and containment (CSIS)
  • VP Pence’s cold war China speech (NYtimes)
  • U.S.-China trade relations forever broken (SCMP)
  • The U.S. will lose its trade war with China   (Project Syndicate)
  • Hong Kong mainland bullet-train link opens (WIC)
  • China’s embracement of Russia (SCMP)
  • MSCI to step-up A-share inclusion (SCMP)
  • Trump prepares new China attack (Axios)

China Technology Watch

  • Most Chinese patents are worthless (Bloomberg)
  • Chinese provinces keen to attract EV investments (Caixing)
  • How China sustematically steals technology (WSJ)
  • China and India lead the surge to renewables (FT)

EM Investor Watch

  • In Brazil, campaign promises but no money (WSJ)
  • Emerging markets’ lost decade (Blackrock)
  • Brazil’s gene-edited angus cow (WSJ)
  • Brazil’s social media election (FT)
  • SPIVA Latin American Scorecard (S&P)
  • What the crisis in Venezuela reveals (Project Syndicate)
  • Brazil’s polarized election  (Lombard Odier)

Tech Watch

  • The plan to end malaria with CRSPR (Wired)

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