Tuesday, February 08, 2011

Demerging emerging, me old China

Nice to see Europe keeping things tight in the MRO/STRO allotments and nicer still to see EUR/USD rally (thank the Dark Lord's followers for their helping hands). But its really the Chinese news that has taken up today. You only need to look at Chinese forward curves (see chart below) to see how massively discounted the news was and the markets reaction, after knee-jerk reactions in the usual suspects, has been pretty muted. So far. As there is a school of thought one of us is entertaining that the news, however discounted, may be enough just to tip the western equity market over from its lofty linear climb we have been following for so long. But it’s a moot point. However it does lead us to consider our general Developed Markets vs. Emerging Markets trade we have had as one of our 2011 Non-Predictions.

A running theme of the past couple of weeks has been the stopping out of consensus trades. As mentioned, One of TMMs trades du l'annee has been the DM vs. EM out-performance trade and whilst perhaps not totally owned in the real money space, we know we are in the company of a fair chunk of fast money. As we have seen the sell-off in rates markets and general improvement to the US macro data, as well as a strong earnings season that showed a move from margin compression to sales beats has supported the foundations of the DM leg and we expect this to continue in the longer run. The EM under-performance bit has been supported by a reluctance to hike rates int he face of inflationary pressures, instead going for macro-prudential credit measures. But as food inflation and related issues have moved to the popular press, and rumours about 5.5% CPI prints out of China, higher than expected inflation prints in Indonesia etc have failed to produce any further sell-off. So just ass Asian CBs have begun to tighten, TMM wonder if we might be passing the peak of the EM inflation worries.

We are reminded of Spring/Summer 2006 when a seemingly dovish Fed and spike in inflation in EM resulted in a generalised risk aversion and EM panic which only ended when the CBs started to hike and get back ahead of the curve. As such we can't help wondering if we've reached this stage again, as the risk premia priced into these assets is ready to tighten.

But we also see that not all EM markets are made equal: India and the RBI still seem behind the curve and on a "Fed model" India still looks rich. Similarly, China does not seem to have anyone convinced at this time and a deluge of upcoming IPOs is likely to keep performance weak. Indonesia, however, is showing a lot more resistance and does look like good value in equities and not just their bonds (see chart below). The Philippines also. Brazil, much like China is suffering from political transition and a lack of muscular action on rates and has instead focused on whining about FX. While TMM supports this noble endeavor it is doing very little for risk assets.


Anonymous said...

Tend to agree DM vs EM equities. However having 10-20% retracement in china, brazil and turkey on valuation concerns. In the context of 5-10% nominal gdp growth and recovery thesis in US + selling of risk premia on europe should IMHO aime it slightly than par close yoy. DM equities - no valuation concerns here and given how bearish market still is we could have further grind probably 10-25% yoy. Think gold here is a good buy against last month lows. Metals/energy think is on instrument per instrument basis. Crude here is blown up and could be good pieces to pick-up. Just look at cracks vs flat price spreads. Something has to give for things to come back in line. In FX - maybe the year of eur crosses recovery. Just maybe. USDJPY is a whole other issue - how about US FI flatteners vs long usdjpy ?

Anonymous said...

Euro flattish, gold spiking... It's all coming together.

Leftback said...

My DM v EM Scenario involves a breakdown in EMs, a concomitant dollar rally and a necessary correction in commodities that drags down a significant part of the US market as well. Then instead of the usual reflex JBTFD in China and copper, undervalued US large caps are the beneficiaries.

I really can't see a smooth rotation small cap to large cap without the occurrence of some temporary equity flow discontinuities, formerly referred to as the market going down a bit.

FX said...

anon 2.59.....There was a certain eur\x late last year building up steam until our euro mare veered off at the corner, my guess is, that, they now know that they need to put a slug in it's ass (it bigger brother) from the grandstand whenever it starts to strengthen out.

That makes those fx yield model difficult to trust in the spot market.

I hear the Russell is bubbling at around P\E x30 , very exhausted, TMM,like yourself, but I'm out of the Dow now,I'll just kick around fxland waiting to bash Betty now.

Wish me luck.

Anish said...

After some 7 hikes, RBI behind the curve? Think not. Liquidity is tight on the ground; look at the real estate vols if you are not convinced. Inflation is driven by rising commodity prices which is more of a global issue rather than a local one. That unfortunately will solved only when the western CBs abandon their loose monetary policy.

Salman said...

Darth weber no more--- any thoughts?

my bet is that he is going to a big (non-central) bank based in Frankfurt..

Anonymous said...

indonesia stocks resistant and good value? historicalky that doesn't make sense, but if one compares to S&P forward PEs then maybe. But me thinks it just another aspect of you folks risk-on trade, commodities up with risk-on trade spilling over to Indonesia; Indenesia has been for 2 years the hedgies favorite playground (besides the field trip to bangcock) and its really amazing you folks are still sucking up for more, nothing really has changed except its more corrupt than ever and islam fundamentalism is stronger than before and suharto's chidren are in the background replaced by some others, a few million rupiahs still buy a licence to most aspects of commerce, sure commodities are 3x their old prices, but how long will this last? good like friend, see you in a year.

Anonymous said...

So the Germans get the NYSE but lose the ECB chairmanship... How about we get to keep the NYSE and export Bernanke to the ECB in exchange? Deal?