Greek Stocks Reopen with a Thud
The Greek stock market very likely represents an emerging opportunity, as many stocks are sporting extremely low valuations these days. However, when we last discussed the Greek market, we pointed out that there was probably no hurry and more importantly, that using ETFs to play the Greek market would pose a difficulty at the current juncture.
Greek ruins – emblematic for the country’s situation.
Happy Death of Chavez Day
Venezuela commemorated the late 'Commandante' Hugo Chavez on Wednesday – as is so often the case, the fact that the dear leader of the revolution is no longer among the quick probably helped with a good bit of nostalgic transmogrification.
One feels reminded of the many crying babushkas in the streets of Moscow when news of Stalin's departure from this earthly plane hit, even while his former colleagues in the party probably got ready for a week of vodka-drenched partying to celebrate the psychopathic tyrant's demise. No longer did they have to worry about who was going to be purged next.
Chavez was of course no Stalin (not by a long shot), we merely want to highlight that no matter how bad a ruler, once he goes to his eternal reward, many of those left behind begin to see him in a better light than he probably deserves. Chavez did of course shower some of Venezuela's oil riches on the poor, and they loved him for it. However, he incidentally ran the country's oil industry into the ground, so it was a decidedly mixed blessing, by dint of being completely unsustainable and leaving everybody poorer in the end.
Yuan Declines Several Days in a Row
We want to point readers to our previous article on the rout in various EM currencies, in which we opined that the dramatic weakening of the Japanese yen was likely an important trigger of these moves. We felt reminded of the Asian crisis in this context, which could ultimately be traced back to a succession of events, beginning with a massive unilateral yuan devaluation in 1994, which was soon followed by the yen weakening sharply from its 1995 blow-off top. The 'Asian Tigers' meanwhile had maintained currency pegs to the dollar, which led to large current account deficits and the build-up of credit and asset bubbles. Many companies in these countries borrowed in dollars, believing the pegs had removed currency risk. The outcome was not pretty.
In theory, there exists much greater flexibility nowadays – there are no longer any pegs, with the notable exception of the currency board arrangement of the Hong Kong Dollar, and many of the former crisis countries have used the time since the Asian crisis to build up large war chests in the form of sizable foreign exchange reserves. However, sudden capital outflows and sharply weakening exchange rates are still bound to have numerous knock-on effects.
Anyway, we were wondering for how much longer China would allow the yuan to appreciate in this environment and are therefore keeping a close eye on the currency. It may well be that the trend is about to change. In recent days, the yuan has weakened markedly, although the move is still small in a bigger picture context. Still, it is the biggest monthly downward correction in some time. If the yuan were to weaken further, we would have to conclude that China's leadership has decided that it is no longer advantageous to let the currency appreciate.
The yuan has been a one way street for so long now that we imagine all sorts of trading strategies have been implemented around this seeming one way bet. In other words, a significant weakening of the yuan may have numerous unexpected effects due to the interconnectedness of financial markets.
Economic and Political Quagmires
We want to briefly take another look at the situation in four of the emerging market countries that have recently been the focus of considerable market upheaval. The countries concerned are Turkey, Venezuela, Argentina and South Africa. There are considerable differences between these countries. The only thing that unites them is a worrisome trend in their trade and/or current account balances and the recent massive swoon in their currencies as foreign investors have exited their markets (this in turn has pressured the prices of securities). There is currently an economic and political crisis in three of the four countries, with South Africa the sole exception.
However, even South Africa is feeling the heat from the fact that it has a large current account deficit and the ongoing exodus of foreign investors from emerging markets. However, the country is actually used to experiencing vast fluctuations in foreign investment flows in short time periods and has the potential to relatively quickly turn its balance of payments position around. Of the four countries in question, it seems to us to be the most flexible one in this respect.
Rudely Interrupted Swagger
An article at Reuters on this year's Davos meeting is telling us that in spite of all the problems created by central bank policies, we shall prevail (presumably with the help of even more problems to be created by central bank policies).
Apparently there was a reasonably good mood, which the brewing EM currency crisis rudely interrupted, leading some of those present (the 'veterans' we are told) to warn of complacency:
“Just as they were getting their swagger back, the global elite stumbled last week on an emerging market sell-off that served as a reminder of the risks the global economy still faces.
Veterans of the annual World Economic Forum in Davos seized on the wobble as a warning that expectations for a smooth upswing were misplaced, and that recovery would likely be volatile and uneven.
The euro zone crisis is out of its acute phase and growth is returning across the developed world but a revival fueled largely by vast amounts of new central bank money is a capricious one.
The prospect of the U.S. Federal Reserve turning off its money taps this year, combined with political troubles in several emerging markets, drove last week's sell-off and exposed some of the unresolved problems in both developing and advanced economies.
"I hear way too much optimism now," Larry Fink, CEO of investment group BlackRock, told the forum. "I think the experience of the marketplace this week is going to be indicative of this entire year. We are going to be in a world of much greater volatility."
The return of growth in the United States, Japan and Europe masks festering problems from chronic youth unemployment to skills shortages and rising inequality that dampened any hubris in Davos. Tech executives were exuberant about breakthroughs that are revolutionising production, healthcare and communication but others warned those advances may kill jobs.
CEOs in Davos complained more vociferously than ever about a lack of talent for hire despite sky-high unemployment in rich and poor countries alike. In the West, too many young people are graduating from expensive colleges with high debts and the wrong skills, while in developing countries a big majority are not achieving their economic potential.”
A New Variation of the 'Cleanest Dirty Shirt' Theory
Bill Gross has for some time forwarded the theory that the US was doing better relative to other regions in the post 2008 crisis era because it was the owner of the 'cleanest dirty shirt'. This was specifically in reference to US treasury bonds, which time and again have proven to attract 'safe haven flows' when trouble erupted elsewhere.
Following the sizable decline in stocks late last week, others are now trying to expand this theory to the US stock market in the wake of the rout in emerging market currencies:
“The ongoing concerns about emerging markets could end up boosting U.S. stocks as investors look for greener pastures, BMO's Brian Belski told CNBC on Monday.
Belski, chief investment strategist at BMO Capital Markets, said the jitters that caused ripples across global stock markets last week stem from a redeployment of cash between emerging markets and the next investment opportunity. As currencies in emerging markets such as Argentina, Turkey and South Africa continue to falter, the U.S. stock market could be the next best option for investors, he said.
"That's why people are freaking out," Belski said on "Squawk Box." "When you think about asset cycles, the last cycle was driven by credit. The current investment cycle has been driven by cash. … Which companies in the world have the strongest balance sheets in cash? It's America."
Michael Purves, chief global strategist at Weeden & Co., agreed that the ongoing worries over emerging market currencies could bode well for U.S. Equities. Multinational companies that do large amounts of business in developing countries, however, could have trouble if those nations continue to appear unstable, he said.”
South American Woes
Both Venezuela (socialist worker's paradise) and Argentina (nationalist socialist paradise) have a problem with their foreign exchange reserves. In both cases it stems from trying to keep up the pretense that their currencies are worth more than they really are. The central banks of both countries are (and have been for some time) printing money like crazy, and inflation is galloping with gay abandon. Their governments publish misleading economic statistics, that inter alia attempt to hide the true extent of the monetary debasement – in short, their inflation statistics are even more bogus than those of other governments (we are leaving aside here that the mythical 'general price level' cannot really be measured anyway).
Since they have maintained artificial exchange rates – coupled with capital controls, price controls and other coercive and self-defeating economic policies – people have of course felt it necessary to get their money out any way they can. This includes making use of every loophole that presents itself, so that e.g. in Venezuela, so-called 'dollar tourism' has developed, whereby citizens travel abroad for the express purpose of using their credit cards to withdraw the allowed limit in dollars at the official exchange rate (and buy some toilet paper while they have a chance to grab a few rolls).
Now the governments of both Venezuela and Argentina have reacted – the former by introducing a 'second bolivar exchange rate' for certain types of exchanges, the latter by stopping to defend the peso's value in the markets by means of central bank interventions.
Intervention Fails to Stop The Rot
Evidently the ECB followed through on its promise to intervene in Spain's and Italy's government bond markets, as these markets saw a strong bounce on Monday. Spain's 10 year yields dropped by nearly 0.9%, Italy's 10 year yields dropped a likewise very large 0.8% to 5.29%. To be sure, a yield of 5.29% is still uncomfortably high for Italy, but obviously a far cry from the levels above 6% seen last week and the distance to the 'point of no return' level of 7% to 7.5% has now once again increased markedly. A 10 year yield above 7% is generally viewed as representing the first step to government insolvency in the euro area, based on the experience with the 'GIP' (Greece, Ireland, Portugal) trio. Since Italy needs to refinance more than € 500 billion over the next two years, a rise in yields to comparable levels would have soon posed a problem in terms of rising debt service costs.
Euro Area Sovereign Debt Keeps Plunging
The to and fro in the debate over how to proceed with Greece's rescue, now that Greece has clearly missed the fiscal target conditions set by its original bailout package, continues to bedevil the bond markets of all the de facto bankrupt peripheral euro area nations. As we noted in a recent missive, the debate in Germany over involving private creditors in the next phase of the Greek rescue has introduced considerable fresh uncertainties. It looked at first as though Germany was going to climb down from this demand and adopt the ECB line. However, the latest news is that the German governing coalition is now 'debating how to involve private creditors'.
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