Emerging markets local debt trended higher in April in spite of struggling commodity prices and a poor outlook for developed markets. Concerns about Chinese demand for key inputs like copper and iron ore have added to the general malaise about global growth prospects but for the month, emerging markets tended to perform in line with domestic issues.

In Latin America, the Brazilian real underperformed significantly as consensus forecasts for the SELIC rate moved lower. The central bank and government are committed to moving rates to a lower neutral level; an agenda which at the moment, is being supported by a weak economy. High rates in Brazil relative to most of the rest of emerging markets is a function of low savings and investment rates, so it remains to be seen if reforms in these areas are sufficient to change the status quo. Recently announced changes to tax exempt savings accounts are a step in the right direction, but it will take significant fiscal reform to really have a long term impact.

Meanwhile the April performance in Hungary reinforced some of the analytical difficulty faced by fundamental active managers stemming from government intervention. The florint had a 6% rally in the last week of the month, in addition to strong performance in bonds, as the market perceived a softening in the stance taken towards the country by the European Commission (EC). We believe that there hasn’t been a substantial change in the requirements set by the EC and International Monetary Fund (IMF) for continued funding and the rally was driven by short covering. Subsequent poor performance thus far in May seems to confirm this view.

Market outlook

A number of Purchasing Managers Index (PMI) releases in April confirmed the view that global growth, while fairly anemic, is ticking along slowly. We believe that Chinese GDP growth is close to bottoming and should pick up in the second half of the year as policy easing measures begin to take hold. In the meantime however, very poor April figures for industrial production, trade and credit have added to investor unease which can be seen in the strong performance of the US dollar and treasuries. Going forward, it remains to be seen how the government’s attempts to rebalance the economy in the face of weak external demand will impact the country’s demand for raw materials. While we don’t expect a large fiscal stimulus package to be forthcoming, it seems likely that infrastructure spending in the rural west of the country will be a priority, which in turn lowers the likelihood of a ‘hard landing’ scenario spreading to commodity exporters in Latin America and elsewhere.

The divergence of economic performance between Europe and the US continues to widen in spite of strong European Central Bank (ECB) support for the banking sector. Liquidity alone will not be able to overcome the political and economic turmoil present throughout the Mediterranean member countries. There is still a fairly good chance that voter rejection of austerity measures could force Greece’s exit from the euro later this year, but our base case scenario is that the costs of such a move to the core euro block exceed the cost of continued financial support. The outlook for emerging markets seems better, but the asset class could suffer substantially under some of the more negative scenarios for developed markets.

Strategy

Rexiter’s strategy continues to favour Latin America and Asia over Emerging Europe. After a bout of recent underperformance, the Brazilian real is beginning to look more attractive and we believe the probability of the government unwinding the IOF tax is growing. Their goal of sustainably lowering the SELIC rate becomes much more difficult to achieve with the currency hovering around 2 real to the dollar. Our overweight to the long end of the curve along with a hedged exposure to the currency has added to the strategy’s alpha, but is reaching the end of its usefulness. Similarly our underweight to the Indonesian rupiah has done well and the currency has returned to a much more favourable valuation. Going forward we continue to focus on the outlook for developed markets and the impact sovereign and banking sector problems will have on our markets. 

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

The modest fall of 1.2% in April was the second consecutive down month and the momentum of the first quarter rally has clearly stalled. Nevertheless, the falls were not sharp or widespread. China started the month depressed by continued worries about the sustainability of growth, but enjoyed a late rally when news was published suggesting a quite sharp expansion in lending. The Chinese market ended up over 3%, second only to Colombia’s 8% gain. At the other end of the league table languished Brazil and India. Brazil suffered from declines in two important sectors – banks, on worries about margin pressures following a poor trading update from Itau and energy companies on some disappointing output figures from Petrobras. 

Market outlook

Is the glass half full, or half empty? Optimists will quote the growing confidence that the worst of the slowdown in China is out of the way, the historically high divergence in prospective valuations between emerging markets (10x next year’s earnings) and developed markets (12x), the strong balance sheets of both corporate and sovereign emerging entities and the oft repeated structural positives of the asset class. In the “half empty” camp worries about further instability in Greece, the lurch to the left in Europe more widely and nervousness about the ability of developed economies to grow their way out of the current problems all raise the hurdle required to invest in “risky” assets such as emerging equities.  Even the optimists will concede that the high beta nature of these markets has not changed.

Strategy

The strategy is overweight Russia, Turkey and Thailand, funded by underweights in South Africa, China, Mexico and Taiwan. There are more significant divergences at the sector level. The strategy is overweight the consumer discretionary and technology sectors and underweight consumer staples and telecoms. 

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

MSCI Asia ex-Japan fell 1.6% in GBP terms (though was flat in US dollar terms). Investor’s attentions returned to Europe and its commitment to the austerity ‘medicine’ as elections in France look likely to deliver a change in government while the Dutch government collapsed as the coalition members pulled out of budget cut talks. Across the pond, the US also delivered weaker than expected 1Q GDP.

China (1.9%) however brought more cheer towards the end of the month as surprisingly strong loan growth suggest the end of its tight monetary conditions and hope for sequential improvements to growth (following slowdown in 1Q12). The smaller Asean markets of the Philippines (1.1%) and Thailand (1.8%) continued to do well, being less affected by the global issues.

India (-6.3%) continued to struggle this month and was the worst performer. A 50 bps rate cut in response to weakening growth, currency weakness and disappointing earnings all contributed. 

Taiwan (-5.7%) was also weak on much the same themes (weak earnings and poor economic data). Adding to these woes were proposals for capital gains tax on financial transactions and a large hike in electricity tariffs.

Market outlook

Is the glass half full, or half empty?  Optimists will quote the growing confidence that the worst of the slowdown in China is out of the way, the historically high divergence in prospective valuations between emerging markets (10x next year’s earnings) and developed markets (12x), the strong balance sheets of both corporate and sovereign emerging entities and the oft repeated structural positives of the asset class. In the “half empty” camp worries about further instability in Greece, the lurch to the left in Europe more widely and nervousness about the ability of developed economies to grow their way out of the current problems all raise the hurdle required to invest in “risky” assets such as emerging equities. Even the optimists will concede that the high beta nature of these markets has not changed.

Strategy

The strategy is a little overweight China, Hong Kong, Indonesia, Singapore and Thailand funded by underweights in India, Malaysia and largely Taiwan. There are more significant divergences at the sector level. The strategy is overweight the capital goods, consumer discretionary and staples and technology sectors and underweight energy, chemicals, banks and real estate.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

Source: Wikipedia.com

“I am a head of state, not a hoodlum” Cristina Fernandez de Kirchner, President of Argentina, April 16th 2012.

Spanish oil company Repsol no doubt think “hoodlum” following the announcement that Argentina was nationalising Repsol YPF, Argentina’s largest oil and gas company, by expropriating 51% of the company from Repsol of Spain whilst at first glance leaving local investors untouched. Prior to the move, Repsol owned 57% of YPF, local group Petersen (the Ezkenazi family) owned 25% with the remaining 18% owned by local and foreign investors via listings on the Buenos Aires and New York Stock Exchange.  Post the move, Repsol will be left with just 6%, and facing a long battle to agree on a price and payment time scale. Investors left in YPF will likely see a company that is run increasingly for the benefit of consumers and the state. In an ironic twist, the locally based Petersen group, whom were supported by the Kirchners to buy the 25% stake in YPF, face possible default - Petersen group borrowed $1.9bn from Repsol and $680m from banks to acquire the stake and relied on the dividends from YPF to pay the debt.  The government is likely to cut YPF’s dividends. Repsol end up in protracted arbitration and a once-favoured local group may end up with nothing.

Source: business.financialpost.com

This move represents the latest but most serious in a series of policy missteps by an increasingly desperate looking President – She has attempted to involve other South American nations in renewed fervour over the spat with the UK over the Falkland Islands/Malvinas, increased currency controls to stem capital flight, meddled with inflation statistics and attempted to control the country’s media. So why this dramatic latest move? 

Argentina’s complaint against Repsol is that the Spanish company has failed to invest in boosting production in Argentina, instead opting to pay big dividends to shareholders.  The government claim this policy action has led Argentina from being an exporter of energy to a net importer with an oil import bill of some $7bn.  In the mid 90s Argentina produced around 900,000 barrels of oil per day – now that figure is closer to 700,000.  However the real source of the problem lies with the Kirchner administration’s own energy policies.  In a country that has never really  fully embraced the idea of free market prices, the government of Nestor Kirchner (Fernandez de Kirchner’s late husband) imposed caps on energy prices, effectively regulating prices far below market oil and gas prices.  Little wonder then that Repsol and others were less than keen to invest heavily to boost production.

Slumping production is the “official line” for this move but a more powerful driver is shale oil - specifically aggressive resource nationalisation of that shale.  YPF owns significant acreage in the recently discovered Vaca Muerte shale oil and gas field, estimated to contain 23 billion barrels of oil equivalent. Who could resist this potential? However this is where the administration has really shot themselves in the foot – Argentina’s shale oil potential is huge but it will require enormous capital expenditure to develop. The state has no access to international capital markets and is running out of domestic piggy banks to raid (central bank reserves and Argentine citizen’s domestic pension funds are being used to finance the state). To develop the shale is likely to require massive foreign investment.  Having just witnessed how Argentina treats one of it largest foreign investors, international oil executives will hardly be clamouring to get on the next flight to Buenos Aires.  Argentina will thus need to take on a lot more debt (which it can ill afford) or find a “friendly” government, possibly China, to help develop the shale.  If the government hopes that its stewardship of the company will be any better than the private sector in boosting existing production, it should take a hard look at the woeful production track record of other nationalised oil companies in Latin America and its own nationalised industries. (Aerolineas Argentinas springs immediately to the Author’s mind!)

It is clear that the government is becoming increasingly interventionist as the strains of running an economic model that has exceeded its useful lifespan increasingly come to the fore. With this administration it is impossible to rule anything out, but nationalisations in other sectors of the economy looks unlikely.  However, overall business confidence in the economy will be dented, let alone the negative signal that is being sent to foreign investors. Borrowing costs will rise alongside country risk. The author was expecting Argentina to begin reconciliatory moves to allow it to borrow again in the international bond markets (it has not done so since the sovereign default in 2001).  Expropriation of the assets of a fellow G20 member (Spain owns a stake in Repsol) makes any move towards rehabilitation unlikely. It will be diplomatically isolated from Europe.

Argentina is a member of the G20, but is not behaving like one.  It is increasingly joining the small group of Latin American nations that are mired in the failed populism of the 1970s – Venezuela, Bolivia and Ecuador.  Investors should differentiate this group from the majority of progressive, reform-minded Latin countries that openly encourage and welcome foreign investment.

Mauricio Macri, mayor of Buenos Aires, put it best…”this decision will get us billions of pesos into debt and distance us from the world. We are all going to pay for this in Argentina”.

NB: Rexiter does not own shares in Repsol YPF in any client portfolios.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

Local currency emerging market debt has had a strong start to the year returning over 8% in dollar terms. This strong performance has been in line with a general pick up in risk appetite this year as the liquidity benefits of “operation twist” in the United States and the long-term refinancing operations (LTRO) in Europe feed through into higher global asset prices.

A large percentage of the strong returns from this asset class have been generated by foreign exchange appreciation. We believe that this is going to be an ongoing theme throughout 2012 as we feel many emerging market currencies remain undervalued. By contrast bond yields, although still generous in comparison with developed markets, are historically low on both a real and absolute basis. At these levels we feel that yields are particularly vulnerable to any upward surprise to growth and inflation forecasts in a number of markets.

Correlations have been fairly high year to date but we expect these to break down as the year progresses and investors more closely differentiate between country specific stories and fundamentals. We continue to prefer Latin America and Asia over Eastern Europe on a regional basis.

Market outlook

Although returns were disappointing in March we remain positive on the outlook for the asset class over the remainder of this year. We believe that with a few exceptions in peripheral Europe, artificial stimulus in the Western world will continue to place downward pressure on long dated bonds yields. This ongoing state of excessive liquidity will ensure that emerging market debt yields remain attractive. We caution that in some emerging markets bond yields are low on a historical basis in both real and absolute terms and could be subject to a heavy sell-off if global liquidity conditions change. It therefore remains crucial to invest only in those markets that offer value relative to the underlying fundamentals of each specific country.

We remain generally bullish on emerging market FX. Unlike some of the bond markets we feel that currencies do not yet fully reflect the advancement that emerging economies have made relative to their developed counterparties. In addition, we feel that the currency markets are under-estimating the level of quantitative easing that developed market central banks will need to undertake in order to stabilise both financial markets and economies over the coming years. Although this environment is likely to create volatile trading sessions on a week by week or even month by month basis it is likely to ensure that emerging market FX continue to appreciate as a basket with Asian and Latin American currencies the largest beneficiaries.

Strategy

Our strategy will continue to search for relative value between emerging market debt and currencies. As correlations break and country specifics become the key driver for returns the potential for alpha generation increases. To this end we continue to hold a zero weight in Indonesian bonds. Despite low levels of inflation our outlook is a lot more pessimistic than consensus that this low inflation environment will persist. At current levels the temptation to partially remove fuel subsidies must be strong and current bond yields do not reflect that risk. 

We remain very bearish on Hungary. Following a recent trip to Eastern Europe our conviction that the government is moving the country in the wrong direction, fiscally and politically has strengthened. We believe that there is little evidence to suggest that Hungary will secure a much needed bail out facility from the International Monetary Fund and European Union in the near future and that asset prices remain vulnerable to a large-scale sell-off if risk appetite reverses.

Our largest overweight markets remain the Philippines and Mexico and we continue to have a strong regional bias in favour of Asia and Latin America over Eastern Europe.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

A strong start to 2012 saw the MSCI EM index gain 14.14% over the first quarter.  Much of this gain was made in January and February as March saw a small pullback as investors drew breath.  Better global economic data combined with a belated response to the positive impact of the LTRO funding programme from the European central bank, saw investors become more positive about taking risk, in turn sparking a rally in EM equities as investors reappraised decent underlying fundamentals and cheap valuations  in EM equity markets.

Smaller markets led the top performers of the quarter – Egypt (+41%), Turkey (+27%) and Hungary (+23%).  Information Technology was the best performing sector in Q1 (+21%) likely led by the recovery in the US economy.  Industrials (+17.8%) were also strong as the market anticipated recovery in global industrial production.

EM currencies also contributed positively to returns, with the overall EM FX index gaining 3.1% against the US Dollar. Brent Crude (+15%) was strong, likely driven by a combination of economic recovery and rising supply risk from Iranian geopolitics. Better economic sentiment saw Industrial metals gain 7%.

Market outlook

In February’s outlook we wrote that “Given the extent of the rise and the speed and volume of capital inflows a bout of profit taking would not be a surprise”. It seems that process began in March and has continued into the early days of April. Realisation that recovering economic data cannot keep positively surprising investors forever and the strong rally in prices has left the market more circumspect.  Alongside recovery in industrial production and employment data in the USA will come a lower likelihood of The Federal Reserve having to employ further quantitative easing.  Markets could well consolidate if we enter a period where the momentum of recovery stalls enough to prevent a meaningful drop in developed world unemployment yet is not so weak as to force the Fed into another round of monetary stimulation (the latter has generally been positive for assets perceived to carry greater risk like Emerging market equities) A fine tightrope to walk.

Within EM, we retain a positive view on economic growth in China as we believe visibility on growth is close to a trough and that trough is not as deep as the market feared.  Russia is a market we continue to like as we think that politics can settle down after Putin’s election victory and we could see an acceleration in the pace of reforms. Overall, economic growth in the emerging world continues to look sound and inflation in most countries looks better behaved than in 2011. Flows into EM equity have been supportive so far in 2012 with $22.7bn on inflows into EM equity funds.

We retain our positive outlook, but our thinking is that risks look more balanced going forward rather than the very positive skew we argued for over the previous six months. 

Strategy

The portfolio is overweight Russia, Turkey and Thailand, funded by underweights in South Africa, China, Mexico and Taiwan.  There are more significant divergences at the sector level.  The portfolio is overweight the consumer discretionary and technology sectors and underweight consumer staples and telecoms. 

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

MSCI Asia ex Japan started the year on a roll, up 13.7% for the first quarter but all and more of that gain came in January and February.  Positive sentiment was coming from all corners of the world with China easing and hard landing fears dissipating, a positive response to the ECBs LTRO and second Greece bailout as well as broadly more positive data (especially out of the US).  By March however, some of the excitement was deemed over done and markets retreated led by commodities and China.

Once again the Asean markets were the strongest led by The Philippines (17.9%) and Thailand (17.8%).

Following last year’s annus horribilis, India (16.8%) recovered strongly at the start of the year but was one of the weakest markets in March on weak politics, policy (in particular a retrospective and anti foreign tax legislation) and disappointing budget.

China (6.9%) underperformed as hopes for more policy led growth faded while more recent economic data showed weakness on both the domestic and exporting fronts, bringing back the bears.

Market outlook

On balance, we retain our positive outlook, but with rather less conviction than before as markets have moved close to 20% from their recent November trough and are more ‘up to speed’ with our earlier positive stance.

China continues to occupy the investors’ minds and earlier confidence in a soft landing has somewhat dissipated.  In particular that China’s policy makers will ramp up (strong) growth for the second half of the year is looking less likely.  It appears to us that the China bears are back following the recent spate of weak data.  On this we are probably more optimistic than the market as we believe the first quarter represented the trough for economic growth and while we remain very cautious about real estate sector, we think domestic consumption and exporters can do better from here.

But there are many other risks to the fragile investor confidence on which we are less qualified to opine.  These would include volatile situations in Syria and Iran that add an extra layer of risk to the oil price that could easily result in a very damaging spike in oil prices.  Europe remains high on the agenda, in particular with French elections looming and a potential reversal of capital flows (“risk off”).

Fundamentally though, Asia ex Japan remains attractively valued at 11.8x 2012 PE and 1.7x trailing P/B. At these levels, our markets remain comfortably below 5 year averages yet sustaining high ROE levels of around 19%.  We also note that negative earnings revisions have stabilised since the downward trend started last summer.

Strategy

The portfolio is overweight China, Singapore and Thailand, funded by an underweight in Taiwan, India and Korea. At the sector level, the portfolio is overweight the capital goods, materials, utilities, consumer discretionary , technology (particularly software) and consumer staples sectors, whilst underweight telecoms, real estate, banks and energy. 

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class. This does not mean we are looking to take risk out of the portfolio, rather that we are trying to diversify that risk by country and sector.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

… Anything you kim do I kim do better,

I kim do anything better than you

Chey you can’t, Chey I can, Chey you can’t …

I kim drink my liquor faster than a flicker

I kim do it quicker and get even sicker

I kim open a safe.  Without being caught?

That’s what I thought – you crook!

Almost from Irving PyongYang’s “Anniyo, Get Your Unha-3 Rocket” inspired in equal turn by Pawnee Bill Jong-Eun’s “Great Far East Show” and Buffalo Bill Obama’s “Wild West Show”. 

Premier due on or around 15^th April 2012 from a peninsula near you – watch out, it could go anywhere from there!

Introduction

2012, the year of the Black Dragon according to the Chinese calendar, is of course a year of great provenance …

… and democratically speaking it is a double whammy election year in the Republic of Korea (RoK)!  Spoilt for choice!  First off are the National Assembly (Gukhoe) elections on 11^th April (it was a 299 seat unicameral legislature; 245 decided by first past the post ballots, and 54 allocated proportionally, it now has 300 seats with the extra on the elected side), and second up the grandstand finale on 19^th December, the Presidential election!

We can’t wait… but we just do not yet know who will be running for President, but never mind, the National Assembly election will serve as a pointer!  Alarms were set off by the October 2011 result of the Seoul mayor election convincingly won by a progressive independent, Park Won-Soon.  The ruling party has shuffled and the opposition parties have coalesced in the hope of making it one-versus-one.  Something rarely achieved before.

The key party candidate lists for the National Assembly are drawn up with the beginnings of rumblings of discontent and factional repositioning in the playground… some toys are flying around. Perhaps we can now expect a slew of independents to run as well.  It was ever thus, and may set up yet more post-election positioning!  The National Assembly is on a four year cycle and the Presidents run on fives meaning that every 20 years there is this voting frenzy!  Stuff the ballot boxes.  Aaiigou! 

The right wing business friendly ruling party, the party formerly known as Hanaradang (Grand National Party) with 59.0% or 174 seats in the National Assembly and the incumbent President Lee Myung-Bak to boot (a questionable benefit at present) is battered in the opinion polls.  Something needed to be done. 

In distancing desperation, the party is recast as Saenuridang (New Frontier Party), a facile ploy which should fool no-one, but a ploy nonetheless tried with monotonous regularity, like for almost every election, politics in the RoK being more about regions, factions and fractions, than substance and policy!  The party has also ditched its traditional conservative blue colour for a more provocative red!

The Lady in Red… dressing to the left… for now?  Park Geun-Hye, Saenuridang Emergency Committee Chairwoman, de facto Party Chairwoman and aspiring Presidential candidate (second time around).

Getting up an unprecedented head of left-leaning steam, Saenuridang’s newly-branded policy reaction to submerged poll rankings has been to roll out the “red” barrels of tueji kalbi (pork ribs) on a near weekly basis, and proclaim pump priming “initiatives”.  And the policy initiatives have been suggestions that merchant credit card fees should be cut, auto insurance premia should be cut, mobile phone charges should be cut, modern format discount stores (hypermarkets) should close one or two days a month to ensure that traditional mom-and-pops continue to trade, teenagers should be restricted in their internet gaming, banks should provision more and pay less dividends, increase the debt to income (DTI) ratio for household loans… we also expect petrol prices could be cut.  Madam Chairwoman appears to dress to the left, to be the Lady in Red!  Not yet cheek to cheek… but who knows.  If nothing else she is long on nostalgia, but her father’s legacy cuts both ways.  She is anti Lee Myung-Bak, has easily topped Presidential polls for months, and works an election well.  But those presidential polls have been slipping.  She must display substance and overcome her reticence. Fate has dealt her quite a hand. 

This is the sixth assembly election witnessed by your correspondent and he has neither seen nor heard anything like this.  Traditionally conservative and pro-business, the party appears absolutely not to be flinching from the challenge of jerking-knee populist pronouncements and apologies to compete with the more left-inclined opposition block led by the Democratic United Party (89 seats or 30.2%) …

And the opposition block?  It was Uridang, then Minjudang and as of December is merged with the minor Citizens Unity Party and is the Democratic United Party (Minju Tonghapdang).  This “unification” could benefit Moon Jae-In who has been on a rising wave of popularity over the last 12 months.  The new block is led by Chairwoman Han Myeong-Sook, Korea’s first female Prime Minister (an office that rotates regularly and means less than it sounds) under President Roh Moo-Hyun.  A former party Chairman Sohn Hak-Kyu harbours his own Presidential ambitions and there are others.  The party has had its own candidate nomination issues, and seems to have performed a policy volte face, opposing the Free Trade Agreements (FTAs) initiated by their spiritual leader former President Roh Moo-Hyun.  There is a flipflop on a Naval base on Cheju-do, the Sejong Administrative city, four rivers etc etc.

Han Myeong-Sook, Chairwoman, Democratic United Party and Moon Jae-In, rising star?  Roh’s return?

So who is for what and what is for who?  In Saenuridang it is Park Geun-Hye supporters versus Lee Myung-Bak’s and in Minju Tonghapdang it is Roh Moo-Hyun’s versus Kim Dae-Jung’s.  For now Park-Roh in the ascendant.  Call for the independents!

And the chaebol (corporates) perhaps sense a shift to the left, an out-going government attempting to rush through a privatization agenda and as ever the chaebol wrestle with their own generational transfers and disputes. 

Mergers and acquisitions… and restructurings - Korea is generally known for its government largesse, and corporate intransigence.  The M&A market is typically characterized by terminally distressed sellers in the “pass the sell by date, do not collect 200, and DO GO to jail … but not for long anyway,” category.  On the buy side it is frantic “high as you can” merchants, particularly those on the genetically addictive but potentially toxic cocktail of me-too chaebolic steroids and financial painkillers!  Never mind the quality of the debt, feel the width…and the ratios!

This often precipitates obscene proportions of leverage, special purpose vehicles and future obligations to IPO, shrouded loosely in put options and deadlines encouraged by local institutions.  An unerringly remorseless path to high-yielding disaster, as all is laid bare in the absence of on-going shareholder returns.  A common Chairmanic upshot is the sanctuary of a hospital stay/wheelchair court appearance for the afflicted/offending executive, a mumbled apology in the national interest, and assumption of control by creditor banks, whereupon the banking sell-side approach is… sell high… and the cycle continues…

… and as the divided peninsula is in a double election year, with the prospect of regime change, the last few months have seen an explosion in corporate super-action (chaebol of the peninsula unite - get it in while you can).  Some of these super-actions break the mold, and others are fully hallmarked and firmly stuck therein.  Where to start …

Prologue

Presidents in Korea can only serve one constitutionally decreed five year term of office.  Post installation it takes a little while for them to get settled and organized and blow their popularity ratings (100 days), they then have around 3 years of potential impact and supporter reward, and for the last 12-18 months of their term, they enter the “lame duck” phase when all and sundry, including they themselves, have their eyes on the possible successors, and the necessary positioning in eager anticipation.  The incumbent President may be planning evasive action if precedent is to be followed….

Act 1 Scene 1 Take 1 - Electioneering

An incumbent President is almost always unpopular in his lame duck – he is probably faced with not knowing who will be his successor candidate from within his party, or just as bad a possible backlash opposition victory.  What post-election preparations to make?  Ex-President and Presidential loser have not always enhanced the resume.  Predecessors have been shot on the job, fled the country, been belatedly incarcerated, and in the most recent tragic case seen the solution in suicide! 

Park Geun-Hye, nick-named suchop kongju (note book princess, she is famously taciturn, speaks from notes and enjoyed a gilded childhood), Presidential hopeful, is in charge of candidate selection and the campaign for Saenuridang.  She lost the ruling party presidential nomination last time around to Lee Myung-Bak, the incumbent president, and her faction was purged/temporarily left the party at the last National Assembly election.  She is the daughter of President Park Chung-Hee (hard man Korean President-general who took power in a coup in 1961, “elected” 1963, reelected, then suspended the constitution in 1972 replacing it with a state of emergency and the Yushin Constitution - his dictatorship).  Her mother was assassinated in 1974 by a North Korean agent, and she acted as de facto first lady until her father’s assassination in 1979 by his own intelligence chief.  She is identified with Korean economic progress and the cost to personal freedoms.  Is she to blame for any of this?

The DPRK now refers to her disparagingly as yushin kongju (the Yushin Princess after her father’s Yushin dictatorship).  Yet in a 2002 visit to the DPRK, if official reports in the Beijing Times are to be believed, the atmosphere at a dinner in her honour was “overflowing with compatriotic feelings”.  Ahem.

Park Geun-Hye meeting Kim Jong-Il in PyongYang, May 2002; spot the “amicable atmosphere overflowing with compatriotic feelings”. They killed her mother!  Mind the gap….

Park’s candidate selection committee has embarked on a factional purge of Lee Myung-Bak supporters.  42% of 144 incumbent Hanara/Saenuridang Assembly members were either not selected or chose not to seek re-election.  32 sitting Lee Myung-Bak faction members were dropped, and only 15 Park Geun-Hye supporters missed the cut.  The committee had pledged to oust members embroiled in “unsavoury scandals”.  Pretty clear what that means…  Chung Mong-Joon, a long time presidential hopeful in his own right, weighed by lots of baggage, and a former Hanaradang Chairman and ally of Lee Myung-Bak made it onto the proportional list, but his key aide failed.  He is not happy with the “lurch” and the absence of his bag carrier! 

Act 1 Scene 2 Take 1 – Opposition bock!

So the rising opposition star could be Moon Jae-In … who is he?  Chairwoman Han was a Prime Minister under Roh Moo-Hyun, and Moon Jae-In was Roh Moo-Hyun’s Chief of Staff and an architect of the Sunshine Policy towards DPRK.  He is the head of the Roh Moo-Hyun Foundation.  But there is rather more to him than may first be apparent … he was born in 1953 in Koje-do, his father, having fled North Korea, was working at the prisoner of war camp (remnants now constitute a museum).  He went to Kyongnam High School, was expelled from Kyunghee University for involvement in student protests against the Yushin Constitution, and was forcibly conscripted into the paratroops for three years – a tough assignment and a not uncommon fate for student protesters.  On coming out of the army he qualified as a top lawyer but because of his past was prevented from becoming a judge.  He joined Roh Moo-Hyun establishing a law firm in Pusan.  In 1988 he was a founder member of the progressive Hankyoreh newspaper, he masterminded Roh Moo-Hyun’s successful presidential campaign in 2001, and organized his funeral in 2009.  Last year he published a book, Unmyung  “Moon Jae-In’s Destiny”, an instant best-seller about his time with Roh Moo-Hyun.  

Moon Jae-In’s Destiny – a best seller; and Moon in the paratroops

Moon Jae-In has declared his candidacy for the National Assembly running in the Pusan constituency of Sasang.  In a fascinating twist, Saenuridang has chosen a 27 year old novice to oppose him, Sohn Soo-Jo, the youngest of all candidates carries no traditional ruling party baggage.  Saenuridang has nothing to lose.  If she beats Moon Jae-In she delivers a body blow to any Presidential aspirations.

Moon Jae-In and Sohn Soo-Jo, 27 year old novice running against Moon in the Sasang district of Pusan

There are two other potential opposition candidates for president.  One is Ahn Cheol-Soo, an independent software magnate and University professor, and the other is Sohn Hak-Kyu, a candidate with ambition, but one with the baggage of having failed and crossed over from Hanaradang.  The wind is different this time!  For now Moon is right up there in the polls, Ahn has yet to declare his Presidential hand, and Sohn is slipping.  Others have faded.  If successful, will the Roh Moo-Hyun faction be better prepared and make a better government second time around?

Act 2 Scene 1 Take 1 – Corporate super action

There has been a very noticeable increase in Corporate Action activity amongst the listed and soon-to-be listed peninsula over the last 6-12 months, some of which can be interpreted as governance progress, and the rest of which serve as timely reminders that things do not always change as fast as they may seem. 

In a potentially ground breaking deal, belatedly, Hana Financial Group has completed the acquisition of Korea Exchange Bank (KEB) buying out the stakes held by Lonestar, the US private equity fund, and KEXIM Bank.  Amazingly this is a 57% controlling stake bought at a 20% discount to the book value with the prospect of the residual holding also being taken out at an even greater discount.  This deal is actually accretive to Hana FG’s earnings and return on equity, even if the minority shareholders in KEB see little added value.  Wow and relief that this saga is coming to an end. 

There was then the acquisition by SK Telecom of Hynix!  By the end of the process SKT was the only bidder for the 15% creditor bank stake having submitted an initial LoI for W1.5tr, STX having pulled out. Korea’s leading mobile phone network operator took over the world’s number two semiconductor maker – a cash injection and share acquisition totaling W3.43tr for a 21.5% stake at W23,099/share!  Figure that one out.  And “Flash” Chey Tae-Won, SK Group Chairman will be patting himself on the back for once after Hynix’s share price has leapt from his agreed acquisition price to above W30,000 as the DRAM outlook has dramatically improved with Elpida’s bankruptcy.  “Flash” Chey was indicted by prosecutors on 5^th January on charges of embezzlement to hide losses on certain foreign currency transactions ….

On the embezzlement theme, on 3^rd February after market hours Hanwha Corporation disclosed to the Korea Stock Exchange (KSE) an embezzlement of W90bn.  This particular rumble in the corporate jungle has been going on for a year or so with prosecutor investigations etc, but critically for a listed company without any formal disclosure to the exchange until now.  At issue was the late disclosure and the bending or otherwise of exchange rules; should any embezzlement be for more than 2.5% of paid in capital without timely disclosure, suspension and possibly de-listing should follow.  The embezzlement was equivalent to 3.9% of paid-in capital, but the exchange decided not to impose any punishment, suspending the stock for just one day.  Chairman Kim Seung-Youn is facing the prospect of a fine and prison.

These two are serial offenders!  I kim do anything better than you. Chey you can’t, chey I can!

Two other notable corporate actions concern recent IPO Hi-Mart – a complete fiasco amidst ownership disputes and allegations of embezzlement, and Woongjin Coway where the controlling shareholder seems to be selling his cash cow!  Samsung Electronics continues to treat minority shareholders in Samsung SDI with disdain and the Samsung Group Chairman is being sued by his elder brother and his elder sister over misplaced inheritance.  The Hyundai Motor Group may feel that they are running out of time under the current pro-Hyundai President to reorganize into a holding company structure … there is so much more!

Act 3 Scene 1 – A long range rocket to strength and prosperity

On 29^th February the Democratic People’s Republic of Korea (DPRK) agreed a moratorium on long range missile tests and to suspend uranium enrichment in return for 240,000 tonnes of food aid from the United States. Within days the DPRK announced that they were preparing to launch an Eunha-3 rocket carrying an “observation satellite”, Kwangmyongsong-3, sometime between 12^th-16^th April to commemorate the 15^th April centenary of the birth of Kim Il-Sung.  The main body of a rocket has been moved to the launch site.  They failed in 1998, in 2006, and 2009 with the Taepodong-2 splashing down in the Pacific Ocean 3,200kms from its launch site.  The first stage of the rocket would be scheduled to fall into the West Sea, but if things go wrong it could fall on South Korea and the rest could go anywhere.  This rocket could serve as a delivery vehicle for a nuclear warhead.  Strength and prosperity?  Food parcels are off.

Launch site for Kim Jong-Eun’s pocket rocket? Hyun Song-Wol performing at International Women’s Day Concert 8^th March Pyongyang

Kim Jong-Eun is allegedly maintaining a relationship with a married singer if claims by a DPRK defector Kim Yeon-Ju, a former member of a DPRK art troupe, are to be believed.  Hyun Song-Wol (aka Han Song-Wol) is a former singer with the Bocheonbo Electronic Music Band.  A relationship started in the early 2000’s after Kim Jong-Eun returned from Switzerland.  On his father’s orders he broke up with her, she married a military officer, but the relationship has restarted.  She is famous for hits such as “Excellent Horse-Like Lady” in 2005, and “Future is Beautiful” and “Whistling Bachelor” in 2006.  She performed at a concert in Pyongyang on 8^th March to commemorate International Women’s Day which was attended by Kim Jong-Eun.

Conclusion

And so it goes on, who is or will be in control either side of freedom’s frontier? … Watch 11^th April, and on or around 15^th April for the next instalment!

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.

Myanmar (source: UNdata)

A radical transition is underway both politically, from a military to a civilian led government, and economically, from an isolated to an open economy. Political change looks irreversible and economic change genuine. Although it is much too early for portfolio investors to consider Myanmar’s metamorphosis, it will have profound implications for the Asian region, particularly Thailand, China and India, due to its strategic geographical position, large resources and abundance of cheap labour.

Key benefits include:

• A new energy and food source for Asia
• A new shipping route from Asia to the Middle East, India and Europe
• Major foreign direct investment to build key infrastructure

Those who remember Cyclone Nargis in May 2008 will probably not be thinking that this is the kind of country in which they should invest. The worst natural disaster in Burmese history which left approximately 200,000 dead and over 1 million homeless, will also be remembered for the isolationist government’s recovery efforts... which included delaying the entry of UN planes delivering medicine and food. The World Health Organisation rank Myanmar’s health care system 190th out of 190. The UN have reported human rights violations including the use of child labour and lack of freedom of speech. Transparency International publishes the Corruption Perceptions Index (CPI) which in 2010 ranked 178 countries on a scale of 0 to 10. Myanmar was ranked 176th with a score of 1.4 out of 10.

Myanmar (formerly Burma) key facts

• Population approx 60m – last partial census in 1983, last official one in 1931
• GDP approx USD50bn or USD800 per head
• 90% Buddhist
• Bordered by India and Bangladesh to the west, China to the north, Thailand and Laos to the east
• The old capital was Rangoon (which became Yangon), but is now Naypyidaw, situated between Mandalay and Yangon
• Member of ASEAN since 1997. Chair in 2014
• Military Forces 488,000 (12th in world size)
• Used to be world's largest exporter of rice
• Used to produce 75% of the world’s teak
• World’s 2nd largest producer of opium
• 90% of the world’s rubies come from Myanmar
• National currency is the kyat

Background

Burma was the richest country in Asia prior to the military coup in 1962 (along with Vietnam and the Philippines which only goes to show that governments do have influence). There has been significant political change and it looks like this is only the beginning. The US Secretary of State, Hilary Clinton, visited Myanmar in December 2011 and became the most senior US diplomat to visit Myanmar in more than 50 years. The US upgraded its mission to Myanmar to full embassy status in January 2012. Norway has also said despite current EU and US sanctions it will now encourage companies to put money into Myanmar. So what changed in Myanmar to pre-empt this massive change of heart? Well, despite allegations of vote rigging in the general elections in 2010, which was won by the military backed Union Solidarity and Development Party (with 80% of the votes) and much initial western scepticism, the government has embarked on a series of reforms including the release of pro democracy leader Aung San Suu Kyi from house arrest, amnesty for 200 political prisoners, new labour laws which allow strikes and relaxation of press censorship. There are by elections on April 1st in which Aung San Suu Kyi has been allowed to stand.

Aung San Suu Kyi (source: BBC.co.uk)

Aung San Suu Kyi is the daughter of Aung San, who formed the Burmese Independence Army in WWII which initially fought alongside the Imperial Japanese Army before changing sides to fight alongside the allies. Burma came under British rule in 1885 and became a separately administered colony in 1937, with Ba Maw the first Prime Minister who then wanted self rule. When Japan entered Rangoon in 1942, Ba Maw headed an executive administration. After the war, Aung San negotiated the Panglong agreement which guaranteed the independence of Burma as a unified state and he became Deputy Chairman of the transitional government. However, in July 1947 he and several cabinet members were assassinated by political rivals. It became an independent state in 1948, named the Union of Burma, with Sao Shwe Thaik as its first President and unlike other former British colonies, did not become a member of the Commonwealth. In 1961 their UN representative, U Thant, was elected Secretary General of the UN. A young Aung San Suu Kyi worked there for some of this time.

In 1962 there was a military coup led by General Ne Win and the military has been in charge from then until 2010. General Win’s government nationalised everything in similar Socialist style to the Soviets and until 1988, ruled as a one party system, which duly impoverished the nation and where all protest was violently oppressed. However, this led to the 8888 uprising (8th August 1988) by the pro democracy movement which ended with security forces killing thousands and General Saw Maung staging another coup and forming the State Law and Order Council (SLORC). The SLORC changed the country’s name to Myanmar in 1989 and in May 1990 the government held free elections for the first time in 30 years. Aung Sang Suu Kyi’s National League for Democracy won 392 of the 489 seats (80%) but the military refused to cede power and remained in power as SLORC, then the State Peace and Development Council, until its dissolution in March 2011. There were elections in 2010, but the military backed Union Solidarity and Development party declared victory stating that it had won 80% of the vote. Although this election result was considered fraudulent, what has surprised is the implementation of the reforms described above since then. The consequences could be far reaching.

Summary of reforms and infrastructure investment issues

The general elections held in 2010 were the first for 20 years (without the National League for Democracy). In April 2012, Aung Sang Suu Kyi and her National League for Democracy (NLD) will compete in by-elections. There are 48 seats available out of the national Parliaments’ 664 members, of which 25% are military appointments. The current government is headed by President Thein Sein (since April 2011). The cabinet comprises the President, 2 Vice Presidents and 30 ministers. Anyone serving in the cabinet surrenders their seat. Aung San Suu Kyi may be offered a cabinet post, but the NLD is likely to want to ensure that political reform is irreversible before accepting. If the answer is yes then this will be a watershed moment for Myanmar and will likely lead to the removal of sanctions by the EU, US and Switzerland. Removal of sanctions would require a fully inclusive political system, release of political prisoners and an end to the attacks on ethnic groups. There has been progress on all 3 of these issues.

Other major changes are that the Central bank has said they will move to a managed float exchange rate system, also on April 1st 2012, with a starting rate of 800 Kyat to the USD. The IMF has said they will provide technical assistance.

Source: Myanmar Central Statistical Office, UBS

The Government has amended the foreign investment law (FIL) to make it easier for foreign companies to invest. FDI has actually risen sharply in the last 2 years primarily in oil and gas projects and power generation. Greater China represents 75% of foreign investment since 2007.

Myanmar passed the Special Economic Zone Law in January 2011. The law envisages several types of SEZs – high tech, telcom, export, ports and logistics.  The southern city of Dawei was designated a special economic zone with a 60 year concession granted to Ital-Thai for development of the 250km estate. It is a huge project which will require substantial funding (presumed to be from China and Japan). The focal point will be a deep sea port with a 160km 8 lane highway linking Dawei to Bangkok, a large power plant and an industrial estate. The port will be similar in capacity to Singapore. The advantage is the saving in time versus the existing route via the Malacca Strait.

Unlike many emerging or frontier markets, there is a strong environmental and heritage lobby. Two projects were halted recently due to environmental concerns (a hydo electric plant being built by a Chinese company and the power plant at Dawei). There are currently 189 buildings in Yangon listed as heritage sites which cannot be demolished. This is a key area of concern for Auug Sang Suu Kyi. Myanmar has a bright future as a tourist destination if they maintain places like Bagan, with its 2,200 temples. The country also has 2,823km of coastline and some resort hotels are starting to be built with untouched beaches (no buildings taller than coconut trees are allowed). Myanmar also extends north to the Himalayan Mountains with the highest peak being 6000m and permanently snow capped.

Aung Sang Suu Lyi key facts

• Born in Rangoon Burma in 1945
• Early education was at Methodist High School in Rangoon, but is Buddhist
• Father is Aung San, considered the father of modern day Burma (d 1947)
• Mother was Burmese ambassador to India
• Went to secondary school and university in New Delhi, India
• 2nd degree in PPE from Oxford (1969)
• Worked in New York for the UN for 3 years
• In 1972 married Michael Aris, an expert on Tibetan culture (d 1995)
• Earned a PhD from SOAS (School of Oriental and African Studies) in 1985
• In 1988 she returned to Burma to look after her ill mother
• Founded the NLD in September 1988 after the 8888 rising
• Was first placed under house arrest in July 1989
• 1990 won general election with 80% of the votes
• 1991 Nobel Peace prize
• Under house arrest for 15 out of the 21 years since 1989, until her release in Nov 2010

Myanmar securities exchange

There is a local stock market of a kind. It was established in 1996 through a joint venture between the central bank (Myanmar Economic Bank) and Daiwa Securities of Japan. There is no trading floor or electronic screens… there is a large whiteboard and employees write on it with marker pens. However, there are believed to be ongoing talks with the Tokyo Stock Exchange and the Korean Stock Exchange about a major upgrade by 2015. At the moment, access to Myanmar would be indirect through Asian companies with businesses in Myanmar, such as Yoma in Singapore and Siam Cement, Ital Thai, PTT and PTTEP all in Thailand to name a few. Given the large increase in various government trade lobbies and corporates who have been going to Myanmar in the last 3 months, investment opportunities may not be as far away as cynics might think.

Myanmar economy

Myanmah is a very poor country suffering from decades of stagnation. It also lacks adequate infrastructure and goods travel primarily over the Thai border along the Irrawaddy River. Railways built by the British are old and rudimentary. Highways are unpaved except in the few key cities. Energy shortages are common throughout the country. It was admitted to Least Developed Status by the UN in 1987. Industry is limited to textiles, construction materials and some metals. They do produce precious stones such as sapphire, pearl and jade, with rubies being the biggest earner sold mostly to Thailand. There are, however, some major energy projects offshore. It is this and increased investment from China, India, Thailand and South Korea which has meant GDP has started rising in the last few years from a very low base. It is still though an agrarian society dominated by rice production which covers about 60% of the country’s land. However, when combined with the planned political reform, it is their natural resources, key strategic location, cheap labour and substantial tourist opportunity which suggests that the removal of sanctions from the US, EU, Switzerland and Canada could mean this beautiful country takes on ‘ Asian Tiger’ attributes quite quickly. It will also certainly benefit Thailand and the whole Indochina region.

Myanmar GDP

Source: IMF forecasts for 2011, UBS

Source: IMF estimates, UBS

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.

Vladimir Putin (Source: bbc.co.uk)

The Russian election cycle is over. Vladimir Putin has been officially declared the winner, achieving almost two-thirds of votes cast and with an electorate turnout of over 60%. Because of a change to the constitution in 2009, the next presidential term is extended to six years, from four previously, and Putin may stay for two terms, i.e. if he repeats his election success in March 2018.

Despite the allegations of vote-rigging from the very vocal protest organizers and generally bad press in western media, the phase of political instability in Russia is now almost over. There is simply no objective basis nor political opposition structures to sustain the protest movement. The most recent rally against Putin in central Moscow brought out a much smaller crowd than previous events. The next event, planned for close to the inauguration date, is likely to be the last and should have an even smaller volume of people, probably back to the usual numbers that have regularly protested since 2000. 

Investors have accepted that the protest movement was temporary in nature and could not survive past the presidential election. Russia’s dollar-denominated equity indices and the ruble are amongst the best performing in the world so far in 2012. Attention should now quickly shift to the structure of Putin’s next government and the policy priorities that it sets itself. There is every reason to expect positive momentum in the actions expected to be taken and proposed by the new government through this year. The catalysts to drive a new direction for the economy, in particular, have actually been building since 2009, while the protests will ensure a strong social element to the government’s programme. A positive action programme, which includes clearing the final hurdle for Russia to join the World Trade Organization (WTO) after seventeen years of negotiations, is expected and should sustain continued relative Russian equity out-performance, i.e. assuming current expectations for China and US economic growth are achieved.

It should also be remembered that a new parliament (Duma) was voted into office in early December. Allegations of vote-fraud in that election provided the direct spark that led to the anti-Putin protests. But the parliament will serve its full five year term (also upgraded from four years previously) and the government aligned party, which was at the centre of the fraud allegations, now only has a very small majority. That will make a material difference to government actions also as the (expected) more aggressive and demanding opposition parties in Duma will both sustain pressure for change and provide monitoring oversight.

2013 will likely bring a tougher post-mortem. What actual, i.e. as distinct from promised, changes are then taken will be closely scrutinized. If Putin is successful in moving ahead with the reforms that he has promised during the election campaign and economic growth can be sustained above an average 4.0% per annum, then there is no reason to expect a return of political instability during the next term. On the other hand, if he fails to deliver on promises and economic growth stalls, e.g. if Brent falls back below $80p/bbl, then we may well see a better organized political opposition taking to the streets with greater determination. But even that risk is unlikely much before three or four years into Putin’s six year term.

Political Background

Putin’s determination to return to the Kremlin was never in doubt. He, of course, confirmed this when he announced his intention to contest the recent election at the United Russia (the pro-Kremlin party) congress last September. The revelation of that deal, i.e. to reverse places with President Medvedev, was also one of the key complaints of the protestors. But even from early in his first presidential term, in 2000, Putin stated that he believed the process of transforming Russia from the chaos of the Soviet-era and the lawless 1990’s would take twenty to twenty five years. If he stays for the two full terms allowed by the constitution he will have ruled for twenty years.

Putin has also been very consistent in stating that while Russia eventually needed to create a more diversified economy with greater wealth distribution and more open political structures, this process should be achieved in slow, carefully managed steps. His nomination of Medvedev to succeed him in 2008 had therefore two main objectives; to signal the end of the eight year preparation phase and a move to the investment phase and, secondly, to allow Putin’s return to the Kremlin with greater individual power than he had in 2000-2008. During this period, groups such as the so-called Soloviki, i.e. essentially the old KGB, had a great deal of influence. Led by Igor Sechin, until recently the Chairman of Rosneft, this group were primarily interested in re-building the power of the state and don’t necessarily share Putin’s longer-term vision. Now he comes back with this group much more sidelined.

Putin sees himself as a sort of Russian Lee Kwan Yew. What drives him is not the preservation of wealth or the protection of his former KGB buddies. He seems to believe that he is the only person that can be trusted with the programme to modernize Russia. Delusional or pragmatic? That remains to be seen over the next few years. But what it does mean is that Putin absolutely pays attention when real people speak in large enough volumes. We have seen that response previously on several occasions and it is one of the reasons that support the optimistic view of positive event momentum this year.

Several catalysts

The political protests simply add an additional catalyst to a list that has been building for several years. The recession in some industrial cities, the country’s auto-industry heartland, in the summer of 2009 was first to shake the previous oil-induced complacency. Putin’s personal involvement in trying to acquire an equity stake in Opel, General Motor’s German unit, was as a reaction to the public protests in those cities over how little had been done during the boom years to help diversify single-industry cities. At that time, Putin acknowledged that the Russian industry needed strategic partnerships to improve efficiency and to grow investment. In the end, a revised deal with Renault achieved the huge growth we have seen in the industry over the past two years.

In addition, during this period the attitude toward membership in the WTO shifted from indifference to pragmatism. WTO membership, after 17 years, is also a very tangible sign of how the government’s attitude toward the business environment is changing.

The accident at the Sayano-Shushenskaya hydroelectric plant in August 2009 added a second catalyst for change. After this tragedy, it became clear that Russia cannot achieve targeted growth or even sustain existing growth without major investment in infrastructure, largely ignored since the Soviet era, and in new infrastructure to cater for the expanding economy. In addition, the August 2010 shortages in the agricultural sector added a further catalyst, as they exposed just how little has been invested in core industries since the 1980s, how dependent the country had become on imported food and how inefficient the agriculture sector was. All these catalysts are finally having an effect on government policy and will determine the key priorities for the next cabinet.

Recent elections

The official result, now confirmed by the Central Electoral Commission, shows that Putin won with 63.8% of the votes. The next placed candidate, the leader of the Communist party, reached a 17.2% share. Third was Mikhail Prokhorov with 7.8% of the vote.  So while the political opposition and monitoring groups aligned to them claim voter fraud, the scale of the victory and the gap to the 2nd place means that there is no danger of these protests being disruptive or leading to instability. President Obama’s “congratulations” on Friday basically “sealed” Putin’s legitimacy.

Apart from the size of Putin’s win, i.e. also expected based on opinion polls in February, the other surprise was the vote achieved by Mikhail Prokhorov. This was much better than the 2-3% expected and his vote in Moscow was close to 20%. Prokhorov is now an established force in Russian politics. That also will provide a source of pressure on Putin to deliver on promises. It is also not inconceivable that Prokhorov may be offered a position in cabinet with responsibility for investment-business developments.

Mikhail Prokhorov (Source: bbc.co.uk)

Protest movement

The opportunity for protest took the opposition parties as much by surprise as they did investors. They weren’t ready. To a large extent the protests have been organised by a loose confederation of political groups that were brought together by an opportunistic common-cause and which will not be able to sustain that cooperation. Last weekend’s protest rally already exposed the differences.

However, people, i.e. those that may be categorised as middle-class, have found that they can make a difference and have a political role to play. Opposition political parties also finally see the opportunity that has eluded them twenty years after their counterparts in Eastern Europe grabbed theirs. In the coming years, several of the current protests groups will emerge more powerfully. It is expected that these groups will now take a step back and re-group into more organised political parties and, very likely, under new leadership. We should, for example, expect to see a new socialist party emerge from a combination of the Communist Party and the new, much more aggressive Left Front. There is also a very obvious mandate to represent the middle classes

What’s next?

The next official event is the inauguration of Putin as President on May 7th. He is unlikely to name any cabinet ministers until after that event, albeit rumours will abound. Putin’s first action as President will be to send his nomination for Prime Minister to the Duma. This is the only appointment that the Duma must approve. So far, all the indications are that Putin will stick to the plan of nominating Medvedev.

In the meantime, progress is expected to continue in advancing the promised response to some of the protest movement’s demands. Principally;

Political reforms - Legislation to make it easier to register a political party is already with the Duma for debate and is expected to be passed. The government has also promised a return to directly elected governors. The draft legislation to allow this is nearly ready.

Corruption - Putin has promised to deal with corruption at management level in state enterprises and legislation to advance this is expected to be ready April 1st according to the President’s office. The basic idea is that managers with fiscal responsibilities, or other roles where they may be involved in corrupt practices, will have to disclose their individual and family wealth in a public format. In return they are promised a higher remuneration.

Political prisoners - President Medvedev has ordered the Prosecutor’s Office to review the safety of 30 convictions demanded by the protestors. On the list are former Yukos owner Khodorkovsky and his partner. The review is to be complete by April 1st and recommendations may then lead to a presidential pardon for some prisoners.

Market implications

• The expansion of the risk premium on Russian equities that resulted from the early December protests has now been completely washed out. Russian equities are, however, still trading at a sizeable discount to their global emerging market peers.
• While the global economic risk is high, a fact clearly acknowledged by Putin in his election manifesto, the domestic factors are positive.
• Russian equities trade at an average 35% discount to emerging market peers based on 2013 earnings. Excluding Oil and Gas, earnings growth is almost double the average expected for emerging market peers.
• Russian equities only represent an average of 6.8% of GEM funds compared to 12.2% in June 2008.
• The macro backdrop remains positive with GDP growth expected to be 4.0% in 2012. The initial indicators for January-February show the trend to be on course.
• Inflation which fell to 6.1% last year from almost 9% the year earlier is on course to finish this year below 5%. Lower inflation allows the Central Bank to cut its 8% benchmark rate quite soon and it also means that real wage growth should be at least 6% in 2012.
• Total foreign debt equals just about 26% of GDP. Sovereign foreign debt equals less than 3% of GDP and total government debt equals just about 10% of GDP.
• The main issue remains the budget dependency on oil revenues. If the government starts to make real changes aimed at improving the business climate and investor perception of Russian risk then the risk premium will start to fall and allow for sustained out-performance of the market.

12-month forward PE, BRIC and EM

PE discount to EM

Source for charts: UBS, Thomson DataStream

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.

Emerging markets local currency debt had another strong month of performance in February. The JP Morgan GBI EM Global Diversified Index rose 2.64% in US dollar terms. Of the four regional returns in the index, again it was emerging Europe that made the most gains over the month. Hungary by far achieved the strongest country return for the month at 7.39%.  Markets in general continued to benefit from the increased confidence over peripheral Europe’s sovereign debt crisis. Indeed, the Eurozone and IMF agreed to make a second bailout loan, after Greece agreed to implement more austerity measures. This gave investors more confidence that some of the debt problems are now behind us or, depending on how you view the situation; some of these debt sustainability problems have been at least delayed. Risk markets therefore continued to appreciate, albeit at a slower rate than in January.

The returns for emerging Asian sovereign bonds were however held back due to the sell off from Indonesia towards the end of the month, with concerns over future inflation. With these concerns, Indonesia was the only country to post a negative return in US dollar terms in February at -1.59%.

Market outlook

As mentioned last month, the euphoria we saw in January subsided over February with more modest gains being posted over the last month and we expect this to continue over the first half of the year. With the Greek insolvency issue having drawn to at least a temporary solution, we expect risk taking to increase over the course of the year.

In Asia, in particular we expect Indonesia to be weaker over at least the first quarter of 2012. Indonesia received investment grade status in January, following Moody’s upgrade to Baa3. With Indonesia’s improved debt sustainability and fiscal position the up-rating was well deserved. However, inflation continued to be below 4% in January, which drove valuations far beyond our forecasts. It seems that the market has chosen to ignore that the government will likely reduce fuel and energy subsidies this year, pushing inflation back towards its usual higher level. Surely then, Indonesia will need to price lower over the coming months. Indeed, we have already seen this dynamic come into play before the end of the month. It could be that we will start to reemploy capital to Indonesia once we have confirmation over the removal of the energy subsidies.

That all said, despite our expectation for Indonesia’s weakness, we expect Asia along with LATAM to be resilient over the course of 2012. Inflation is generally in control across both of the regions and central banks in both regions have scope to cut rates further.

Strategy

With our central case for 2012 being for slow but steady growth in all but the Eurozone, global central banks will remain supportive of growth by holding loose monetary policy. Even though we are seeing stronger economic data in the US, the Federal Reserve remains committed to keeping longer dated bond yields low, which will be supportive of risk taking. The strategy has recently increased its exposures in the Philippines and Mexico and continues to hold large overweight positions in Brazil. With the continued problems in Europe we will remain underweight Eastern Europe, in particular short Hungary which has yet to properly engage the IMF and EU to support their national debt.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

It was another good month for emerging markets in both absolute and relative terms, though in both cases the numbers were rather less dramatic than January. The benchmark MSCI index appreciated by 6%, bringing the return since the October low to over 30%. Given the strength of oil (Brent rose $12 over February) it was not unexpected that Russia (+9.6%) outperformed, but the relative weakness of Brazil (5.5%) and Indonesia (-1.3%) was more of a surprise. Most of the big sectors and countries gained ground with Egypt (+14.9%), and Thailand (12.3%) leading the way and Indonesia and Peru (-0.8%) being the only markets to fall.

Market outlook

On balance, we retain our positive outlook, but with rather less conviction than before. In particular, the volatile situations in Syria and Iran add an extra layer of risk to the oil price that could easily result in a very damaging spike in oil prices.

All the arguments we outlined in December and January with regard to the relative attractions and favourable risk/reward profile of emerging assets remain valid. However, the fact is that the 30% market rally seen since the low last fall has brought valuations back into a more normal range. Given the extent of the rise and the speed and volume of capital inflows, a bout of profit taking would not be a surprise and would not in itself cause us to reconsider the positive strategy bias.

Strategy

The strategy is overweight Russia, Turkey and Thailand, funded by underweights in South Africa, Chile and Taiwan.  There are more significant divergences at the sector level.  The strategy is overweight the consumer discretionary sector and underweight consumer staples and energy.  It should also be noted that within the materials area there is no exposure to gold stocks, which are negatively correlated with most other material stocks. 

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

Markets extended their January gains, albeit more modestly and MSCI Asia ex Japan rose 4.7% in GBP terms for the month of February.  Drivers included approval of the second bailout package for Greece, decent US economic data, good reception for the European Central Bank long-term refinancing operation (ECB LTRO) and China easing. These were tempered by sharply higher oil prices on concerns over Iranian supply.

The best performing markets were Thailand (10.9%), Hong Kong (7.3%) and Taiwan (6.1%). With risk ‘on’ and the outlook for consumer demand in the US looking less perilous, the best performing sectors were financials, industrials, materials and technology.

Market outlook

On balance, we retain our positive outlook, but with rather less conviction than before. In particular, the volatile situations in Syria and Iran add an extra layer of risk to the oil price that could easily result in a very damaging spike in oil prices.

All the arguments we outlined in December and January with regard to the relative attractions and favourable risk/reward profile of emerging assets remain valid. However, the fact is that the 30% market rally seen since the low last fall has brought valuations back into a more normal range. Given the extent of the rise and the speed and volume of capital inflows, a bout of profit taking would not be a surprise and would not in itself cause us to reconsider the positive strategy bias.

Strategy

The strategy is overweight China, Singapore and Thailand, funded by an underweight in Taiwan, India and Korea. At the sector level, the strategy is overweight the capital goods, materials, consumer discretionary and technology (particularly software) sectors, whilst underweight telecoms, real estate, banks, and energy. 

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class. This does not mean we are looking to take risk out of the strategy, rather that we are trying to diversify that risk by country and sector.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

The world economy is already in the early stages of a shift in the balance of economic and financial power from the developed to the emerging world. It has also started to witness a shift in the policy-making environment from the G7 to the G20. It is important to keep all this in mind when viewing prospects for the year ahead.  The world is looking eastward again after a hiatus of a few centuries.

Uncertainty and concerns over debt sustainability and deleveraging in the developed world will continue to contribute to volatility and risk aversion early in 2012, before the markets return their focus to the growth, driven by strong prospects across the emerging world. The outcome for any economy depends on the interaction between the fundamentals, policy and confidence. Developed world fundamentals are poor, policy options are limited, and confidence is waning. In contrast, across the emerging world, the fundamentals are good, the policy options are plentiful and confidence is likely to prove resilient.

This will be reflected differently across countries and regions over this coming year. Each country and region needs to be looked at on its own merits. Since the financial crisis began, the world has continued to be hit by shocks, as well as by the consequences of the debt overhang in the advanced economies. One of the challenges in 2012 is that the policy environment in the advanced economies is suffering from fatigue. In contrast, the emerging economies are willing and able to use policy in a counter-cyclical way to boost growth in the year ahead.

Over the next 10 years, debt in developed countries needs to fall. It seems highly unlikely that we continue to lever up like we have over the past 30 years. But deleveraging on this scale has not been attempted since at least the 1930s, and demographics are likely to make things harder now too. The challenge will be to test the linkages between debt growth, economic growth and asset growth to see if we can grow without borrowing. The good news is it’s all about confidence. The bad news is that this makes for a very uncertain environment.

The result is the continuation of our view expressed in 2011’s Outlook; a two-speed world where a fragile developed world contrasts with a robust emerging world. The coming year is also likely to highlight the fact that despite the world economy becoming more divided, no region is fully decoupled from events elsewhere. During the first half of 2012, problems in developed economies, particularly Europe, will weigh on global growth. By the second half, stronger growth across emerging economies should pull up worldwide activity. It will be a recovery made in the emerging world and felt in the advanced economies. This provides clear evidence of the shift in the global economic center toward the emerging markets.

In 2010 the world economy turned around with growth of approximately 4.3%, two factors were primarily behind this move. One was the extent of the policy stimulus in the developed world; the other was the strength of the emerging economies, which drove two-thirds of the world’s growth that year, despite accounting for one-third of the global economy. In the years following, their share of global growth has continued to rise.

Since the summer of 2011 however, it has been events in Europe that have dragged growth down. In last year’s outlook, our warning was that if there were further financial stresses in the emerging world, it was likely to be triggered by an external shock, a policy mistake, or a loss of confidence. Europe provided all three, at the same time.

The last year provided a picture of a divided world economy facing significant policy dilemmas. This year is expected to provide further examples of this. The divisions are apparent in many ways: growth prospects in the emerging markets are far better than in the developed markets, the core of Europe far stronger than the periphery. Then there are the policy dilemmas, not least the need to ensure sustainable growth while addressing longer-term structural problems.

The overhang of debt and the pressure to deleverage will continue to weigh on economies in the developed world. This will restrain growth there. It will also add to pressure on central banks to keep interest rates as low as possible for as long as possible in the US, the UK, the euro area and Japan. Further quantitative easing is extremely likely. This may weigh on developed currencies and in turn feed flows into emerging economies, where growth and longer-term opportunities are better. This will add to dilemmas for policy makers across the emerging world, keeping alive the focus on capital controls, because these country’s need monetary policy for domestic purposes.

The key challenge this year is the need to balance short-term uncertainties against longer-term positives. These positives are highlighted by significant, underlying structural factors. These trends will continue to be accentuated in 2012. They include the growth of consumer markets across the emerging world as the middle class expands, helped by rising incomes and growing populations. Other drivers include the emerging economies moving up the value curve, with increased investment, higher urbanization rates, and higher infrastructure spending. Funding this infrastructure boom across the globe remains one of the underlying challenges and opportunities.

Another key feature has been the growth in new trade corridors, reflecting increased flows of goods, commodities, remittances, and portfolio and direct investment. Some features will be both drivers and consequences of growth, such as the rise of the middle class and development of financial markets. To move from export-led to domestically driven growth, many emerging regions need to create better social safety nets, discourage high domestic savings, help the small and medium-sized firms that are key to job generation, and deepen and broaden their bond markets.

Emerging economies are not immune to events in the developed world. Ahead of the 2007-08 crisis, we stressed that emerging economies were not decoupled, but were better insulated. This resilience is also likely to be seen now. Any problems in the West will have a global impact – via trade and financial linkages – but emerging economies will have the ability to rebound. Furthermore, emerging economies across Africa, Latin America and Asia are now seeing stronger domestic demand.

The financial crisis highlighted the imbalanced nature of the world economy, which still needs to be addressed. The savers need to spend more, including the Gulf countries, China, Japan and northern Europe. The debtors need to spend less. Currencies need to adjust. One of the challenges for the world economy and for the euro area in 2012 is the deflationary bias that is being built into the system as pressure is put on deficit countries to do most of the adjustment.

Given high rates of unemployment, particularly youth unemployment, there may be continued political uncertainty in the West, louder calls for populist measures, and rising fears of protectionism. We are not expecting trade barriers, but with the multilateral trade round having broken down, we expect to see further growth in bilateral and regional trade deals.  This will further enhance existing South-South trade corridors, with Brazil now exporting more to China than the U.S.

Currency volatility will persist in the coming year. The euro looks overvalued given problems in the region, while many emerging market currencies look oversold. But if the euro were to collapse, the initial beneficiary would likely be the US dollar. Thus, a key focus in 2012 will be the euro. The euro cannot survive in its present format. It will have to become a political union to survive, but that is unlikely to happen immediately, despite some recent moves in that direction. Given the fundamental flaws at the heart of the euro, its collapse, and the possibility of one or more countries leaving, will continue to place financial stress on markets.

In conclusion, we have summarized the key issues facing the world and have looked at them from a global, regional and local perspective. Emerging Asia and Latin America should continue to grow relatively fast even if the euro-zone slides into prolonged recession, as long as the U.S. avoids the same fate. The outlook for emerging Europe is much worse. Thus, even though the advanced economies are fragile, emerging economies are in far better shape to cope with the likely volatility ahead in 2012.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.

After a muted close to 2011, EM local currency debt started the year very strongly, generating returns of 7.4% for investors in US dollar terms in January. While each of the four regions that comprise JP Morgan’s GBI EM Global Diversified index rose substantially, it was the higher beta currencies in Latin America and Eastern Europe that led the way. While some of the gains were surely the result of short covering after a dismal Q4 last year in countries like Hungary, a slew of supportive macro results globally, combined with reaffirmation in the US that easy monetary conditions will persist for some time, lifted demand for local EM assets.

In the US strong trailing employment and manufacturing data shows a growing divergence with the Eurozone that we believe will continue throughout 2012. This trend, combined with low rates that should persist this year and next, should be supportive of EM growth and commodity prices. It can be argued that US monetary policy will only remain aggressively expansionary as long as poor economic conditions persist. But it is our opinion that the Fed will err on the side of caution, keeping rates “lower for longer” rather than risk disrupting a fragile recovery with premature tightening.

Market outlook

It is likely that the market euphoria seen in January should subside considerably, giving way to more modest gains for local EMD over the next several months. While we are not predicting any sort of imminent economic catastrophe, still unresolved sovereign risks in Europe will weigh on investor risk appetite and capital flows into emerging markets. At the same time, the ECB’s liquidity operations have been very supportive of the European banking system and have greatly reduced the risk of serious problems occurring in that sector. It still remains to be seen whether further cooperation and greater fiscal integration will be achievable, which would be a necessary condition for any permanent solution to the European periphery’s solvency problems.

Emerging markets in Asia and Latin America on the other hand, seem well positioned to weather the storm. Key factors across these regions that support this conclusion include further scope for fiscal and monetary easing, resilient consumer demand, low degrees of leverage at both the household and government levels, and generally well capitalised banking systems. Additionally, in spite of volatile headline inflation figures driven primarily by food prices, EM core inflation has been modest, and in many countries, is converging to target. This supports our view that there is still considerable value to be found in select emerging market curves in spite of the large fall in nominal rates that has occurred over the past couple of years.

Strategy

With our central global scenario for 2012 being one of slow growth (with the exception of recession in the Eurozone) and very accommodative monetary conditions in developed markets, demand for EM local currency assets and commodities should remain positive. Flows will likely favour higher yielding names and real assets which should be of particular benefit to investors in Latin America. The strategy is maintaining large exposures in the Philippines, Mexico and Brazil, and underweight exposures in Eastern Europe and South Africa.

Overall, exposure to global themes remains fairly balanced with country level active positions being determined by idiosyncratic factors, rather than a portfolio level tilt. We remain short duration relative to the benchmark, largely driven by Asia where we see considerably less value in rates after recent strong performance.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.