The benchmark returned a small positive in US dollars in the final quarter of 2011 with risk assets bouncing back from large falls in value in September. Rexiter’s local currency emerging market debt portfolio has performed strongly over the last three months generating positive alpha in each. Both country and security selection contributed positively to these strong relative returns with Eastern Europe and Latin America the top performing regions.

Two of our high conviction positions this year generated almost 1% of alpha in the final quarter as political risks in Hungary and unorthodox monetary policy in Turkey started to take their toll on asset prices. We currently hold a 0% weight to Hungarian bonds as policy error has begun to compound structural economic problems in this country. Investors have become increasingly concerned about both the communication and implementation of government policy in Hungary under Prime Minister Orban’s leadership. The recent change to the Central Bank law has effectively reduced this institution’s independence and decreased the probability that Hungary will secure much needed funding from the IMF. We believe that unless this situation reverses in the coming months that bond yields will increase as investors demand a higher risk premium to own Hungarian assets.

Our recent visit to Ankara highlighted just how uncomfortable both local banks and investors are with the central bank’s unorthodox monetary policy. Whilst the focus of the central bank seems to have shifted from generating growth to containing inflation and reducing the current account deficit, the funding uncertainty banks face is likely to send the Turkish economy into recession in 2012. We remain concerned that a deterioration in the European situation will render Turkey vulnerable to further lira weakness – this will feed through into inflation and could ultimately begin to increase expectations that prices are no longer anchored. Given the risks here we continue to hold inflation linked bonds and t-bills.

Market outlook

Until Europe stumbles upon a palatable solution to the structural debt and growth problems that encompass the region we feel that market volatility will continue to be elevated into 2012 across all asset classes. It is our sense that European politicians are happy to sit on their hands for as long as they possibly can however there are plenty of potential trigger events over the next twelve months that could either force decisive action or see the euro zone collapse. Whilst it is difficult to make a judgement call on how events will ultimately play out in Europe we are confident that things will deteriorate further before they get better and under almost any one of our scenarios the euro weakens significantly more against both the dollar and a basket of emerging market currencies.

Although the global economy remains fragile there are many positive stories across emerging markets that we feel investors can capture through an overweight exposure to this asset class. The benchmark yield remains high relative to developed market countries. This carry should continue to attract overseas investment particularly as bond market yields have remained generally stable across emerging economies. This stability in borrowing costs is testament to the huge strides in both fiscal and monetary discipline that many emerging market economies have taken over the past decade. Whilst this is very positive for both lenders and borrowers we feel that this story is not over and that a convergence of both ratings and rates is likely to continue given the stronger balance sheets that emerging economies generally enjoy.

In Asia we expect economies to remain strong and that a wider acceptance and tolerance of currency appreciation is likely to be a theme over the next twelve months. In EMEA however political risks are elevated over the next twelve months. The upcoming Russian elections are not as clear cut as those of recent years, there are questions marks over the health of PM Erdogan in Turkey and policy uncertainty in Hungary remains high.

Strategy

Our strategy continues to be one of relative value investing. As detailed above we remain negative on the situation in developed Europe and have sizeable underweight and short positions in Eastern European assets that we feel do not reflect these risks. There is little room for either fiscal or monetary easing in many of these countries rendering them vulnerable to a sharp slowdown in economic activity. To compound the problem, inflation is elevated in many instances with weak exchange rates, high energy costs and increases to administered prices putting pressure on household spending. Although there are exceptions, we remain unconstructive on this region.

In Latin America we feel the Mexican peso remains under-valued and that the recent improvement in US economic data that should act as a boost to the Mexican economy has not yet been reflected in asset prices in this country. We therefore retain our large overweight exposure to the peso. Although we feel at current levels the Brazilian real better reflects economic fundamentals in this market, positioning remains elevated and we continue to hedge back half of our overweight currency exposure.

The Philippines and Malaysia are our preferred Asian bonds markets as we feel both offer the potential for lower rates given our growth and inflation outlook for these countries. The market is not yet pricing in these potential cuts and at current valuations we find these markets relatively attractive.

Although fundamental analysis continues to be the cornerstone of our investment approach we remain mindful of the excessive volatility that investors need to assess when structuring an emerging market debt and currency portfolio. As a result we will continue in 2012 to implement tactical positions where valuations become stretched either through excessive fear or greed.

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.

Despite a reasonable bounce of 4.5% in the final quarter, 2011 was a poor year for emerging markets.  The 18.2% decline was not only one of the weakest years for the asset class but also only the second time since 2000 that emerging equities underperformed developed markets. 

The fact that both emerging corporate and sovereign debt continued their trend outperformance suggests markets were signalling concerns about growth and/or earnings rather than any significant deterioration in underlying economic or political fundamentals. At a regional level EMEA was the worst performer both during the month and for the year as a whole but the differences were not large; Asia, the best region declined by 19.1%, not much different from the 22.6% decline for EMEA.

At the country level the smaller markets bounced most in the last quarter, Malaysia, Thailand and Peru all showing double figure returns.  Turkey and India (both suffering from the consequences of overheated domestic economies) were the worst performers, down 15.7% and 14.2% respectively.

Market outlook

First, some numbers.  Consensus (IBES) forecasts for 2012 suggest EPS growth of 10.2% for 2012 – a bit less than nominal GDP growth.  These numbers are some 4% less than the estimates from 3 months ago.  At current levels this means emerging markets are, in aggregate, valued at 9.7x 2012 earnings.  This is the low end of the historic range for valuations; interestingly on each occasion in the last decade that prospective multiples have moved into single figures then market returns over the following year have been very strong:

Source:  Factset

We believe the balance of probabilities suggests this pattern can be extended for a fourth time but of course there are risks to offset the rewards. 

Risk 1:  Europe.  A major breakdown in the European banking system would have knock on effects on emerging markets.

Risk 2:  Middle East. Renewed tensions around Iran added to instability in Iraq, Syria and Egypt. 

Risk 3:  Hard landing in China.  We do not expect China to have a hard landing.  The government has already started easing modestly (e.g. RRR cuts in November) and we expect more measures in 2012.  That said growth has been slowing in response to previous tightening and sharp slowdowns in global trade and we expect Q1 numbers to signal a slowdown, especially from exports.  This slowdown should not be a big surprise – it has been well signalled by PMI numbers and other leading indicators.  Nevertheless when the figures are announced (maybe including a y-o-y growth rate starting with “only” a 6) it could add fuel to the fire for already nervous investors.  We believe that the Chinese authorities have enough ammunition to prevent this slowdown accelerating into a hard landing.  The worse the numbers, the more vigorous the policy response will be and so, overall, we maintain our view that China will maintain its growth at a rate sufficient to keep job creation plentiful.  China is and will still be the locomotive for emerging markets. 

Risk 4:  The fabled “Black Swan” – an unforeseen problem.

The first three risks are well known and well researched and we have commented on them all over recent months.  Our position is that, in the end, none of these problems will escalate into a worst case scenario and markets will then re-rate to more normal valuation levels as perceived risks abate.

Strategy

As explained above, we do not share markets’ current pessimism about the prospects for growth in emerging markets.  Our forecast returns for emerging assets on a one year view remain high.  As a consequence, the portfolio is overweight to risky assets.  We acknowledge that we may be early, but if/when confidence begins to return the response will be instant – it will very quickly be “too late” instead of “too early”.  More fundamentally, we have to acknowledge that we will be wrong if the current bout of jitters on any or all of the risk factors listed above deteriorate into a genuine crisis. 

The portfolio is overweight Russia and Argentina, funded by underweights in South Africa, Chile and Taiwan.  There are more significant divergences at the sector level.  The portfolio 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.

MSCI Asia ex Japan eked out a modest gain of 0.59% in the fourth quarter though finished the year -17.3%, the second weakest performance in a decade.  It was another volatile quarter dominated by Europe and near term newsflows.  All of the gains were made in October (up 12%) and were pared away for the remainder of the period as confidence in Europe overrode more positive data from the US and even China which signalled a start to policy easing with a Required Reserve Ratio cut in late November.

The smaller Asean markets continued to outperform this quarter led by Thailand (11.5%) and Malaysia (11.7%).  Indonesia was not far behind (5.7%) and ends the year the only market to make a positive return for 2011 of 4%.

India was the outlier worst performer (again), down 14.2% for the quarter, as it continues to be beset by weaker than expected growth, higher than expected inflation and bad politics.  India ends its annus horribilis down 38% with the Rupee down 19%.

Market outlook

The mood of the markets in December is little changed from recent months thus we repeat the snapshot from last month’s report.  “The developed world continues to ‘muddle’ through its myriad of debt problems and there is definitely a sense of ‘vacuum’ with very low market turnover and no real direction due to a lack of leadership in both Europe and the US…Europe has reached a kind of ‘deal’ but without the UK (no ticket on the Titanic’s final voyage a prominent sceptic put it) and the markets are less than convinced that EU fiscal discipline can really be imposed any more stringently than it was before. Meanwhile the ECB does still not look like initiating QE nor does it look like ‘Eurobonds’ backed by Germany (effectively) will be issued. So far so bad would be the judgement we feel.”

That said we feel the ‘Titanic’ scenario is at least very well understood, if not excessively bearish as we move into 2012.

• We are seeing a growing number of positive leading indicator data that defy that scenario.  These include German IFO, European PMI, US retail sales, non farm payrolls, and construction starts and now too, China PMI.  Global growth looks more likely to surprise on the up than the downside?
• Investor positioning meanwhile, is apparently universally cautious for equities, more so than in 2008 with high levels of cash.
• There is potential for reflation in the developed world in the form of QEs as well as rate cuts in Europe.
• We do not expect a hard landing in China and believe the RRR cut in November signalled the shift in policy in favour of loosening, albeit cautiously.  Growth has now become more of a concern to the authorities than inflation and economic slowdown (from tightening and global weakness) will likely spur further policy response.  A weak Q1 GDP is widely expected for China but growth should accelerate in 2H.  The rest of Asia follows a similar theme where inflation appears to have peaked giving scope for easing.  In addition to China, Thailand and Indonesia have started easing and we expect to see more policy responses in 2012.
• Valuations in Asia remain constructive at 10.8x 2012 earnings and 1.6x PB vs a 5 year average of 2x. 

Near term, investors are likely to continue to focus on short term economic and policy events until more comfort can be garnered for Europe or global growth recovery can become apparent.  Markets could therefore stay volatile with risk aversion the ‘neutral’ position of investors.  In this environment, our markets tend to be treated as risk ahead of fundamental investments.

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.

Is something more rotten than usual in the embalmed state that is the Kimdom of the Democratic People’s Republic of Korea (DPRK)?  There is plenty on which to speculate, and the potential cast of characters is greater than it may initially seem. 

After much fruitless speculation since his original stroke(s) in August 2008 and subsequent complications, on 17^th December 2011at 0830hrs, the Dear Leader, Kim Jong-Il, finally met his Dear Demise, apparently whilst on his private armour-plated train.  The train was his cross border conveyance of choice in this world and is presumably the same for his journey into the next.  Demise cause is attributed to stress - “a great mental and physical strain” quoted KCNA … the train took the ultimate (not quite what British Rail had in mind with their ex-advertising slogan), and will now convey him towards the Democratic People’s Pantheon, presumably at its maximum speed of around 60kph.  The northern half of the divided peninsula will be hoping that there are neither leaves on the line nor points that are frozen!  The nasty Fat Controller is ex his platform shoes.  Mind the gap!

Official details of Kim Jong-Il’s birth claim that he was born on 16^th February 1941 or 1942 during the liberation struggle against the Japanese occupation of the Korean peninsula, led of course by his father, the Great Leader, Kim Il-Sung.  Location - a log cabin on the slopes of Mt Paektu, a mountain of particular mythological significance on the border of the DPRK and China.  The event coincided with sightings of a swallow, a brilliant double rainbow and a new bright star in the heavens!  Hail Hallyu (Korean wave)!  Where did that idea come from? 

Reality is somewhat different – Soviet records show that Yuri Irsenovich Kim was born 16^th February 1941 in a camp in Vyatskoye, near Khabarovsk in eastern Siberia where his parents were, dad as a commander of the Soviet 88^th Brigade of Korean and Chinese exiles … Kim Il-Sung had been living in Manchuria since the age of 8 or so and on his return to Korea at the end of World War 2 spoke poor Korean …

… and Joseph Stalin with Police Chief Beria had a lot to do with the “leadership” selection process, and they and China with most of everything that has followed.

It is good bye from me …and hello from him?

Source: www.cleveland.com

Irony; top gear, a mid-70’s Lincoln Continental!

Source: www.businessinsider.com

Big Brother leaves “the house” leaving the “Jong Ones” behind in the apartment!  Princes in the Juche Tower?

The Dear Leader, embodiment of George Orwell’s Big Brother, has finally left the building voted out by the Grim Reaper.  The tragic reality show that is the DPRK has been gripped by scenes of mass hysteria, wailing and gnashing of teeth from the Pyongyang populace (a Pyongyang “post code” as opposed to one for the countryside or gulags accords elite status).  Tearful dongmunim (comrades) vied to outdo each other in exaggerated grief, and diligently brushed snow off the streets along which the cortege was to pass.  Third and youngest son, Kim Jong-Un, Chairman of the Funeral Committee led the funeral under the watchful eyes of his Uncle.  His elder brother and half brother were not obviously in evidence.

DPRK propaganda moved quickly dubbing Kim Jung-Un, the 28 or 29 year old recently anointed heir to the Kimdom, the Great Successor to the revolutionary cause of Juche (self-reliance).  He was the Brilliant Comrade; he is the Great Successor!  Grooming for the position had been “fast tracked” since the Dear Stroke(s), and was publically acknowledged with his promotion from nowhere to Four Star General at the hastily convened 7^th Party Congress last autumn.  Grooming has allegedly included cosmetic surgery and grand paternal mimickery (swagger, demeanor, laugh, clothes, hairstyle) in an effort to legitimise his claim to the dynastic line from revered nation founder, his grandfather, the Great Leader, Kim Il-Sung. 

In a family clean sweep at the self same 7^th Party Conference, Aunt and favoured younger sister of the Dear Leader, Kim Kyong-Hui and her husband/Uncle Jang Sung-Thaek were also both elevated to Four Star Generals.  Token military promotions, or something more?  She joined the Politburo as a full member, and he was appointed an Alternate member.  Alternates can be heard but can not vote – a subtle difference in status.  Blood is thicker than water?  Those moves seem to be designed to keep the Kimdom in the immediate family with the Aunt-Uncle as Regents!  But there are reportedly other moves too …

Auntie Kim Kyong-Hui and Uncle Jang Song-Thaek

The possible Regents, Dear sister Kim Kyong-Hui, and her husband, Jang Song-Thaek high profile companions of Kim Jong-Il on trips post Dear Strokes in the months before the Dear Demise

Source: www.grantmontgomery.blogspot.com

Aunt and uncle have had somewhat chequered “careers” but re-emerged into prominence from June 2009 post the Dear Strokes - Jang was in effect briefly in charge until the Dear Leader limped back onto his feet.  Born in 1946, Kyong-Hui is younger than her brother, and is known for a violent temper, a very stubborn streak and for being a heavy drinker, having enthusiastically joined the Dear drinking binges.  She may be an alcoholic and in poor health.  Of late, she had been one of if not the closest Dear Confidante, until the Dear Successor’s late run.  It was not always thus.

There is also another younger sister, Kim Kyoung-Suk born in 1947, mother of three, but for now out of the picture.  A brother, Kim Pyong-Il was born in 1944 but died in 1947, allegedly drowned in the house swimming pool, with reports, of course unconfirmed, that Kim Jong-Il, aged 5/6, may have caused the accident (who knows?).

Their mother, Kim Jung-Suk (1917-1949, married 1941), was Kim Il-Sung’s first wife dying allegedly in child birth (one story suggests a possible shooting by Kim Il-Sung).  Kim Jong-Il and Kim Kyong-Hui left North Korea during the Korean War.  On returning, Kyong-Hui failed to get on with her new step mother, Kim Song-Ae (born 1924- and as Kim Il-Sung’s former secretary she had taken over running the household on the death of Kim Jung-Suk, “married” 1952).  Some accounts suggest that she deprived or underfed the step children and that Kyong-Hui refused to call her mother.  The step mother bore three rival children, daughter Kim Kyung-Jin (b 1952), and sons Kim Pyong-Il (b 1954 and named after the drowned half brother …) and Kim Yong-Il (1955-2000). 

In the ‘70’s Kim Song-Ae tried to promote her son Pyong-Il (with the closest physical likeness to Kim Il-Sung) as successor as opposed to the older Kim Jong-Il, and expunge Kim Jung-Suk, her predecessor and Kim Jong-Il’s mother, from history.  Long on intrigue, definitely not a recipe for one big happy family, neither before nor after the anointing of Kim Jong-Il as Dear Leader and heir apparent in 1982.  Kim Jong-Il purged his step mother’s clique and brothers, exiled his half siblings, and, following the death of Kim Il-Sung in 1994, kept Kim Song-Ae under house arrest.  Could the two surviving half siblings have a lingering interest in the succession?  Kim Pyong-Il has been “parked” ambassadorially in Europe since 1988, accused of “violating the monolithic ideological system”.  He is well out of Kim Jong-Il’s way, and away from any potential power base, though he returns to DPRK from time to time as his mother is ailing.  His sister has a lower profile.

Whilst studying at Kim Il Sung University, Kyong-Hui met Jang Song-Thaek of a worthy apparatchik background, but without the requisite glorious military heritage befitting the daughter of the founder of the nation.  Kim Il-Sung was opposed to any marriage, moved Jang away from Pyongyang only for daughter to follow, finally conceded and the couple wed in 1972.  Jang’s career proceeded smoothly upwards through various key and powerful positions, until, having been criticized for promoting his own faction, he was temporarily purged by Kim Jong-Il in 2004.  A challenge!  Ooops brother-in-law!  But there is more … Jang was apparently involved in an earlier purge of Kim Yong-Ju, Kim Jong-Il’s uncle, who was instrumental in promoting Kim Jong-Il’s rise!  Rivalry with previous!

Kyong-Hui is reported to have pleaded Jang’s case with her Dear brother.  As a possible aside and interalia, Kyong-Hui and Jang’s daughter, Jang Kum-Song, born in 1977, had studied in Paris and was refusing to return to the DPRK.  She died in 2006, circumstances unclear, possibly suicide or possibly murder. If suicide, that then may have contributed to Kim Jong-Il pardoning his sister and her husband for his factional inclinations, and could partly explain their rehabilitation within a couple of years in 2006.  However if murder, this would raise some intriguing complications, and temptations.  Could be the marzipan layer?

So is it her and/or her husband with or without others?

Kim Kyong-Hui may be the possibly pickled second generation guardian of the Kim blood line, but even through an alcoholic haze, she could harbour ambitions of her own, with or without her husband?  Jang, reluctantly approved of by Kim Il-Sung all those years ago, complicit in the purge of Kim Jong-Il’s uncle, more recently purged himself, albeit briefly, by his brother-in-law for factional inclinations, and having lost a daughter in mysterious circumstances has previous, with or without his wife!  Patience rewarded?  He just may find his nephews rather troublesome.  Or have there been moves to once again clip his wings? 

1951 Kyong-Hui with Kim Jong-Il, and brother and father in 1966

Sources: nkleadershipwatch.wordpress.com and www.koreaherald.com     

Jang Song-Thaek, 65

Source: Wikipedia.com

History is not replete with examples of Regents happily stepping aside as and when.

The “Jong Ones”

The Young Ones was an anarchic, abusive and physically rough alternative comedy series shown on British TV in the ‘80’s with certain inspiration from the “rock” deity Cliff Richard and the Shadows. 

The “Jong Ones” show Shadowy similarities in the tragic rather than comic category.

There are three key players in this saga, together with a growing supporting cast!  Kim Jong-Il seems to have sired 7 children (four daughters and three sons) from covering five “wives” (acknowledged as such if not formally married to them), and others could emerge. 

For the moment the daughters perhaps have less relevance; they will presumably not want to cross their tipsy Auntie Kyong-Hui.

The “Jong Ones” are the third generation of Kim sons;

Jong-Nam, the eldest born in 1971, mothered by Song Hye-Rim (1937-2002), an older married actress who did not meet with Great Leader approval, living in “disgrace” in Macau since 2004 effectively under the protection of China, and the father of six of his own children.  He could now be based in China, or still in Macau.  In between bouts of roulette there are suggestions that he may be preparing to publish his book on it all!  Kim Il-Sung had removed Song Hye-Rim early on in the piece and Kim Jong-Il was apparently not aware of his son until Jong-Nam was several years old, or perhaps it was the other way around with Kim Jong-Il hiding him and her, and Kim Il-Sung was in ignorance.  Anyway.  Initially raised by his mother’s sister, Sung Hye-Ryang, he then spent much of the ‘80’s in Moscow with his by then exiled mother and in Switzerland before returning to Korea in the ‘90’s.  In the late-90’s Jong-Nam was looking in pole position as eventual successor (1998-2001) before he got ahead of himself with reformist zeal and it all went horribly wrong.  The damage may have been done before his arrest in Tokyo on a forged Dominican Republic passport attempting to take family to Tokyo Disneyland amidst other unseemly revelations concerning the extent of his endowment and disbursements therefrom.  Anyway Japan was the last straw.  He now claims to be against dynastic succession, but in the past tried to assassinate his irritating younger half-brothers.  He allegedly paid his respects to his father going to Pyongyang on 17^th December, but leaving after a few days well before the funeral.  Love is lost and all has yet to end well.

Jong-Chul, the middle one born 1981 mothered by Ko Young-Hee (1953-2004), alleged Dear Paramour.  An ethnic Korean from Japan, daughter of a professional wrestler, she was a dancer in the Mansudae Art Troupe (more less-than-suitable maternity, but she was promoted as the “Respected Mother” from 2003 possibly to promote Jong-Chul).  He is living in Pyongyang, married but reportedly less than manly in countenance and behaviour, and as such is an unacceptable succession candidate, clearly not in any of the Great, Dear or Brilliant moulds.  But he is a fan of Eric Clapton and apparently attended a concert in Singapore in February 2011.  Ooooh, you are awful, but I don’t like you! 

Jong-Un, the Brilliant Successor, likes guns.  He is a “genius of artillery”.  He was born 8th January 1981 (clearly not given brother’s birthday) or possibly 1983, mothered also by Ko Young-Hee, who apparently doted upon him, calling him the “Morning Star King”.  He spent some undistinguished years at school in Berne, Switzerland (1993-98), before the usual Kim Il-Sung University finishing school and Kim Il-Sung Military Academy.  He could more recently have developed a violent and unpredictable streak, and is possibly showing early signs of less than rude health (allegedly diabetes and heart disease, but who knows).  Jong-Un reportedly tried to assassinate Jong-Nam just last year in Macau, but the plot was foiled, and Jong-Nam was saved by the Chinese authorities.  Jong-Un was appointed Supreme Commander of the Korean People’s Army on 30^th December 2011, a post of great titular significance.

Squabbling princes in the Juche Tower?  How long will Auntie or Uncle tolerate Successor peccadilloes, however Great, before calling for the “butt of malmsey” soju?  But hark!  In December in the days immediately before the Dear Demise, Jong-Un and Kim Jong-Il oversaw a purge led by U Dong-Chik, Senior Deputy Chief of State Security of 200 supporters of … Uncle Jang, and General O Kuk-Ryol, a Vice Chairman of the National Defence Commission, heroic Korean war orphan and childhood friend of Kim Jong-Il, and for long considered the number two to Kim Jong-Il.  Perhaps too long?  The raids discovered stashes of US dollars (counterfeit or real?  General O was behind the DPRK’s extensive counterfeit currency printing activities) with anyone having over $50,000 expected to be shot!  Ebb and flow testing survival skills? 

How long now before the Great Successor is in a position to initiate his own purges from a position of strength?  It took Kim Jong-Il three years from his father’s death in 1994 to consolidate power, courtesy of the military.   He held sway, but can Junior?  The military holds the key….    

The Military and the Propaganda

Since the death of his father in 1994, Kim Jong-Il followed a policy of Songun, military first, granting the military primacy in DPRK government and society.  It was his only choice to defeat the old partisans/party cadres and to secure his position.  This policy initially worked alongside Juche (self reliance) before effectively if not officially supplanting it.  In 1998, the Defence Commission Chairmanship, held by Kim Jong-Il was declared the “the highest post in the state”!  The economy has been on a permanent war footing.

Songun has broken the economy, imposing untold hardship and famine.  Military personnel total 1.2million, out of a total population of 24.5million.  At official exchange rates, 2009 GDP is estimated at $28bn, of which defence spending was around 23% of GDP, the highest proportion of any country in the world, and double that in second place.  Per capita GDP was $1,800 with the official monthly wage estimated at $2, augmented through the black economy to an estimated $15.  The economy shrunk by 0.9% in 2009, with exports of $1.997bn and imports of $3.096bn.  Official exports are augmented by sales of missiles and weapons, drugs, and counterfeit cigarettes and currency.  China was 75% of trade, with RoK in second place.  

The legacy of Songun is a powerful military clique.  It was the military that staged the Dear funeral ceremony.

For many years General O Kuk-Ryol had been seen as the de facto number two to Kim Jong-Il, until he tripped up.  The December purge of his followers probably puts an end to his future prospects.  Anyway there is a rising star in Vice Marshall Ri Yong-Ho, Chief of General Staff of the Korean People’s Army since February 2009, and elected to the Politburo and appointed Vice Chairman of the Central Military Commission on 28^th September 2010.  Pay special attention to photo shoot positioning!

Kim Jong-Un on the right hubcap, Jang Song-Thaek watching his back, and Vice Marshall Ri Yong-Ho left flanking in a “standard” military manoeuvre

Source: www.theatlantic.com

Vice Marshall Ri Yong-Ho flanked by the Kims 9th Sep 2011 at a 63rd Anniversary parade in Pyongyang

Source: www.independent.co.uk

Ri Yong-Ho, 69, is the son and grandson of key Kim military aides and a known hard-liner and long time member of the Kim Jong-Il inner military circle.  He was appointed Commander of the Pyongyang Defence Command in 2003 (a key position) which he held until 2009 when he was promoted to Chief of General Staff of the Korean People’s Army.  In 2010 he was promoted to Vice Marshall (there are three in total; one is also powerful and active, Kim Yong-Chun, 75, minister of the armed forces and Vice Chairman of the National Defence Commission, and the third is not).  He is also a member of the Politburo.  The next General of significance is Kim Jong-Gak who is an alternate member of the Politburo.

The Military top brass have all vowed “to become human rifles and bombs” should the DPRK be threatened and have pledged support to the Great Successor.  They have moved fast.  On Monday 19^th December, on announcement of the Dear Demise, two short range missiles were fired, presumably creating two vapour trails to evoke the double rainbow that appeared at the time of the Dear Birth. 

Tearful military top brass at Kumsusan Memorial Hall

Source: www.news.yahoo.com

The state propaganda machine screened a documentary on the Great Successor on 8^th January, his birthday, which explained his military genius.  He apparently wrote his first thesis on military strategy at the age of 16, and was described by his father as “the genius of the geniuses in military knowledge”. 

An iron horse, my Kimdom for an iron horse … or the front end of the eponymous pantomime animal

Sources: rokdrop.com and guardian.co.uk

The Great Successor has said that nothing will change.  Bet the Generals back that, but is it his decision? 

The Respected Mother

So far the state propaganda system has focused more on Kim Jong-Un’s grand mother, Kim Jung-Suk, the first wife of Kim Il-Sung, and her heroic efforts.  Under normal circumstances it should be only a matter of time before Jong-Un’s mother, Ko Young-Hee (1953-2004), would be idolized, but this presents a few problems.  As an ethnic Korean from Japan and daughter of a professional wrestler, her quality and purity is not of sufficiently high grade, and her career as a dancer is far from the socialist ideal, however many veils were cast off for the Dear Leader.  Her future status will be an interesting side show.

Kim Jong-Suk, heroic grandmother, and Ko Young-Hee, Dear Paramour, dancer, ethnic Korean from Japan, wife 3/4 of Kim Jong-Il, mother of Kim Jung-Un

Sources: nkleadershipwatch.wordpress.com, www.japanfocus.com and english.chosun.com

What next?

In a New Year message for 2012, it was declared that the military would be bolstered and food shortages addressed.  The DPRK will become “a mighty and prosperous nation”.  And “the whole party, the entire army and all the people should possess a firm conviction that they will become human bulwarks and human shields in defending Kim Jong-Un unto death”.

15^th April 2012 is the centenary of the birth of Kim Il-Sung, a date by which the country has repeatedly vowed to become a prosperous nation.  What chance that national prosperity will be evidenced solely and exclusively by another nuclear test?

It is also the centenary of the sinking of the Titanic.  So adoption by the DPRK of the Celine Dion anthem, “My Heart Will Go On”?  Every night in my dreams I see you, I feel you that is how I know you go on. 

If it were done when ‘tis done, then ‘twere well if it were done quickly, or, is now the winter of our discontent? 

With the onset of spring can we expect the arrival of a Kimjongunia flower, dandelion (le pis-en-lit) perhaps, to join the orchid Kimilsungia and the begonia Kimjongilia.

Stability?

The world called for it.  Pundits have predicted or identified it.  Neighbouring external geo-political interests and markets want it – no or little change, not wanting to face up to the alternative.  The internal DPRK military clique and party apparatchiks will want little or no change too, as indeed will Kim Jong-Un, none wishing to put themselves out of a job.  The passing of an utterly ruthless autocrat, who demanded absolute loyalty and brooked no criticism, and the arrival of a callow youth reliant on others?  With those others in the mix and moving targets, toadying will become so much more complicated … can the situation in the upper echelons really be described as stable?  Borgia versus Medici … and hope for no overspill.  

Conclusion

The pain of the popular TV durama (soap operas) in the RoK and increasingly screened around the world ceases when the television is switched off, and life goes on.  The pain in the durama that is life in the DPRK for the average Dongmu (comrade) looks set to continue for some time yet.

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. 

North Korea announced at noon Seoul time yesterday that its leader Kim Jong Il, the Dear leader, had passed away of ‘exhaustion’ while on a domestic train trip on December 17. A flavour of North Korea can be garnered from the fact the state television announcer wept as they read the news, while thousands in the main square in Pyongyang chanted in unison and waved ‘Kimjongilia’, a flower named after the deceased leader. The son of Kim Il Sung (the Great Leader), Kim ruled North Korea for 17 years after coming to power in July 1994. The South Korean army and government were put on full alert and developments will be closely watched worldwide. Given the uncertainty it will unquestionably cause the market, the impact is clearly negative, at least in the short term. Having said that, history tells us not to panic. The most recent ‘flare ups’ were the North Korean torpedo attacks on a South Korean warship on 26 March 2010 (killing 46 sailors) and the firing of artillery shells on Yeonpyeong Island on 23rd November 2010 (killing 2 soldiers and 2 civilians). In both cases, the market digested concerns and regained pre-accident levels within a week. Post the announcement on Monday the Kospi index lost 3.4%, but regained some of that today. The Korean Won fell 1.6% to a 2 month low of 1177 per dollar but regained all of that today.

Kim Jong Il. Source: MBC News.

Kim Jong Il was a chain smoking recluse who it is understood had a stroke in August 2008 and was also rumoured to have contracted pancreatic cancer. He was officially 69 and Russian records indicate he was born in Siberia in February 1941. His family returned to Pyongyang post WW11 in 1945 (his father was a major in the Russian Red Army). He graduated from Pyongyang (Kim Il Sung) University in 1964, became heir-designate in 1974 and made co-ruler in 1984. As head of party’s propaganda department he was seen as responsible for ‘deifying’ his father and leading the North Korean version of the cultural revolution.

Until the early 1970s, North Korea’s command economy performed well relative to the capitalist South, but then the South economy took off and the North focussed on grandiose schemes commemorating the ‘Kim’ dynasty. He did allow tourists in the late 1990s to Mount Geumgang, but since a South Korean tourist was shot there in 2008 this has also been stopped. Because Kim Jong Il took over from his father in 1994, i.e. post the Berlin wall coming down in 1989, he no longer had Russian backing - specifically aid. This has left China as the main benefactor accounting for 83% of North Korea’s trade. Economic reform has been minimal with only a small opening of the Gaesong Industrial Complex (100 South Korean companies) in 1998. His major recent legacy was his withdrawal from the Nuclear Non Proliferation Treaty in 2003 leading to the 6 party talks (US, Russia, Japan, China, N&S Korea). In 2009 he said it would withdraw permanently from these talks and after the UN denounced a ballistic missile test, received further UN sanctions. His perceived skill in ‘playing a weak hand’ was exemplified by leveraging the detention of 2 female US journalists in 2009 winning a visit by former US president Clinton to garner their release.

Source: FN News

Some will say Kim Jong Il defied global condemnation to build nuclear weapons while his people starved. He leaves behind an economy less than 3% the size of South Korea’s and which has relied on economic handouts since the 1990s when an estimated 2 million died from famine. He put in place a succession plan last year when his little known third son Kim Jong-eun (the Brilliant Leader or the Great Successor) was appointed as general and vice chairman of the Central Military Commission. The chances of a regime change have increased either by coup or a failed attempt to reform the political and/or economic system. There is also a slight chance that regime change could lead to anarchy and civil war.

Kim Jong-eun. Source: MBC News

Obviously talk of reunification will be raised, so as a starting comment, one similar to Germany is not on the cards. German reunification is estimated to have cost almost 50% of German GDP (over 10 years) while this would be much larger for South Korea (i.e. ruling this out). Simply, East Germany had 1/4 of the West’s population whilst North Korea is 1/2 of the South. East Germany was relatively rich with GDP per head 1/4 of the West whilst North Korea is estimated at 1/10 of the South. 40% of the North is estimated to suffer from malnutrition according to the world food program. However, if reunification isn’t the goal but normalisation of relations is, there are various advantages. Germany exchanged currencies at 1-1 whereas in this case, South Korean and other capital could employ surplus North Korean labour more cheaply (more like Hong Kong companies moving into Southern China in the 1960s/70s and 80s). Huge savings could be made in the North by cutting the North Korean military (around 30% of GDP). In 2010 President Lee Myung Bak did float the idea of a reunification tax however, the South has consistently pursued a policy of fiscal prudence towards the North and this is likely to continue. Having said that, South Korean debt to GDP is 30% and they aim for a balanced budget by 2014. This does in theory at least leave significant scope for debt financing were the regime in the North to collapse.

We are one day on from the announcement of Kim Jong Il’s death and it seems that succession is working in a fairly smooth way. It looks as if the ‘leadership’ group in North Korea are following some sort of ‘manual’ prepared a while ago according to press release, and aggressive action by the North is not expected in the short term even if that has been prevalent in the past at times such as these. There are though, some who believe that Kim Jong-eun won’t last and he will eventually step down or be forced out. This certainly would cause major anxiety in markets were it to happen.

It is clear that China was informed first of the death and it is also likely given their desperate economic situation that more dependency on China is expected in the future. Rather like the recent transition in Myanmah, it could be that this dynastic change results in further opening of the North in the form of more economic zones or capital aid from China as an economic ‘kick-start’ once the political dust has settled (for example China might send more oil or rice as a goodwill gesture). Up until his death, Kim Jong Il had been aggressive in negotiating with the US for receiving aid in exchange for some degree of nuclear abandonment. Thus, a resumption of the 6 party talks along these lines could be anticipated in time.

This leadership change in the North could also have significant electoral effects in the South because the South has National Assembly Elections in April and Presidential ones in December. The current President, Lee Myun Bak, whose current popularity is at a relative low point, is of the Grand National Party who historically has taken a tough stance with the North and this could be more popular in the short term and thus, boost his party’s vote. On the other hand, if the North shows encouraging signs of a more conciliatory approach, or even opens up a little, then it could help the opposition or newly emerging political groups in the South such as Ahn, Chul Soo, a possible Presidential candidate in 2012. A previous President, Kim Dae Yung, from the opposition party, won the Nobel Peace prize, somewhat prematurely it seems, for his reconciliation efforts with the Northern Stalinist Dictator Kim Jong Il.

The new leader, the 28 year old Kim Jong-eun, who takes over is, unusually for dynastic successions, the third and youngest son, as opposed to the eldest. He and his elder brother Jong Chul were born to a Japanese-Korean dancer and were both educated in Swiss boarding schools. There is another, the eldest brother, a step brother, Kim Jong Nam, who resides in exile in Macau and Beijing. It will be interesting to follow China’s treatment of him given the appointment of his younger sibling as successor. There are also 4 sisters from various wives or mistresses of Kim Jong Il, of which little is known. Perhaps more significantly, when the new leader Kim Jong-eun was made a 4 star general about a year ago, his Aunt, Kim Kyong Hui, and her husband were also made generals or as some portrayed this – ‘protectors’.

The funeral of Kim Jong Il will be held on December 28th following a ten day period of national mourning during which period all entertainment, such that there is in North Korea, will be banned. Kim Jong Il had 20 years to prepare to take over and establish himself as the successor from his father, Kim Il Sung, benefiting from his cult of personality. Kim Jong-eun has had barely a year to do the same. It is rumoured that the grandson has deliberately been modelled on, and made to look like, the grandfather to further this cult. His grandfather invaded the South in 1950 causing the Korean war, which claimed 3 million lives, and they remain technically at war. It is why the North has 1.1m troops and the South 680,000 either side of the Korean DMZ (demilitarized zone) which runs along the 38th parallel and why the US still has 28,000 troops stationed in the South, 61 years on.

If Kim Jong-eun, the Great Successor, opens up the North and becomes the great reformer, it could have major consequences. When the Japanese ran Korea pre WWII, all the industry was in the North and there are significant mineral resources, unlike the South. They could also supply cheap workers for the South’s major corporates whilst reducing the global defence bill. This is the optimistic scenario. The other extreme is that without a unifying leader, fighting breaks out amongst factions leading either to war, starvation, and on an even worse scale, anarchy or floods of refugees over the border (into China rather than the South). China and Kim Jong-eun will be working towards stability and progress at all costs.

Sources: Bloomberg, RBS and BoAML.

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.

Whenever the leader dies in a highly centralised dictatorship, worries about instability and succession struggles arise. When the country concerned is a failed state such as North Korea, when its neighbours are the two largest emerging markets (China and South Korea) and when the country concerned is trying to develop nuclear weapons, then the worries are that much greater.

Kim Jong-il has nominated his youngest son Kim Jong-eun to continue the dynasty into its third generation, but he is young (28) and others within the government and army will no doubt be manoeuvring to either control or replace him. The relative power bases and influence of these people is impenetrable to outsiders, so we can only work from first principles and make educated guesses from there about who will win and what it will mean. In summary these opinions are:

Fact: The army is the key domestic power base. Whoever controls that controls everything.

Opinion: Whoever emerges as the new leader will have to placate and impress the army and so the chances of low level military actions have risen. The presence of Kim, Jong Il’s sister and brother-in-law in the army are designed to help his son to placate the army, so Kim Jong-eun may well be at least the titular leader for now.

Fact: China is the key international player. They are almost alone in being able to influence North Korea.

Opinion: China will act to prevent a fresh wave of refugees crossing its border, but has shown no particular desire to encourage better relations between North and South Korea. This policy mix will not change.

Fact: North Korea was richer than its Southern neighbours 40 years ago and now endures famines and abject poverty. The old guard in North Korea have shown no regard at all for their own citizens. 

Opinion: Sadly, this will not change in the short term. In the medium term we must hope that the new leadership will move to open the economy to aid and capital. For now this must remain a hope rather than an expectation.

Fact: South Korean and other regional stock markets have fallen between 2 and 5% on the news.

Opinion: This is a reasonable and proportionate reaction to bad news. The chance of the news changing from “bad” to “catastrophic” has ratcheted upwards, but only modestly. “Uncertainty” is the main issue at the moment. We are not so sure what will happen in the North as very limited information has been leaked. If there are no further follow-ups then the shock to financial markets seems to be already reflected. However, given that the death was released after two days, it’s very difficult to comprehend what’s happening in the North, so more volatility would not be a surprise.

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.

November brought yet another turn in the direction of performance for emerging markets local currency debt, with a down month following October’s recovery.  With the exception of Peru, all countries within JP Morgan’s GBI EM Global Diversified index suffered losses over the month.  The three month return is -8.04% although the 1 year return for the index remains positive at 2.84%.  Despite the near term volatility in monthly returns, Rexiter’s strategy continues to add positively to performance, highlighting the non-directional dependency of its underlying positioning.  Yet again this month the individual performance of country returns are widely dispersed due to the large amount of risk aversion that overshadows markets, with the European debt sustainability concerns.  We reiterate our position that there are large amounts of implementation risk for any solutions presented by European policy makers.

Although almost all countries posted negative performance, it was the difference between the regional returns that was most startling.  With the well publicised problems we have seen in Europe, this dragged central Europe lower the most, by region.  Hungary, the most exposed emerging market to core-Europe, was the largest loser by country by falling over 7% over the month.  This makes Hungary losses close to 20% over the last 3 months, which came mainly via the depreciation of the currency.  The pace and the magnitude of the fall of the forint gave us some cause for concern that this move down may well be over done. Elsewhere, however, despite being fundamentally stronger, Latin America and Asia were pulled down in this sell off.

Market outlook

In the closing months of 2011, the market is waiting with baited breath over any news on the European debt situation.  We will not achieve the returns we had expected for local currency debt for the year but we will likely achieve yet another year of positive returns for the asset class.  We believe that emerging market countries will be priced on their own individual strengths and weaknesses.  Market participants will keep a close watch on these large systemic events and will be the main backdrop for the scene going forward.  From a regional perspective, we still continue to believe that fundamentals in Latin America and Asia versus Eastern Europe have the strongest case for prospective investment.  The outlook remains, at best, uncertain at the moment.

With concerns over the external environment, we are starting to mark down our expectations for economic growth from Asian countries although we do still view future growth being still relatively strong.   In a slowing global economy, the weaker Asian countries will be those with open exporting economies such as Thailand, Malaysia, Singapore and South Korea.  Although Asia is slowly becoming less reliant on the external sector it cannot escape the negative effects from Europe.  Countries that display stronger domestic consumption, such as Indonesia and the Philippines, are in a better position to weather these external forces.  However we feel that much of this is in the price for Indonesia, so will be looking to reduce our exposures to the country in the near term.  The likely recipient of capital will be the Philippines.

Strategy

Markets remain fragile and very sensitive to negative news coming from Europe.  The asset class has posted weak overall performance recently, which has effectively reduced our expectations of a strongly positive return for the 2011 but we do still believe it will be positive.  Most of the strong gains made by local emerging market debt in the first half of the year were removed in the last few months.  Speaking from a broad strategic view, we view the central European states as being most vulnerable at the moment.  We will continue to avoid these weak countries and tactically transact in their currencies, when we see opportunities.  As mentioned last month, the market uncertainty and resulting volatility has caused the cost of dealing spreads to widen making it much cheaper to implement strategy with the use of currency forward positions.  The currency overlay is where we believe we can be most nimble with the current market conditions.  

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. 

Like the ten thousand men of the Grand old Duke of York, markets marched up the hill in October only to be marched back down again in November. The MSCI EM fell 6.7% as hopes for a swift resolution to Greece’s debt problems morphed into worries about Italy’s larger debt overhang.  In addition, economic indicators have been showing a slowing trend in growth across the world, stoking fears of a new global recession.

Within EM, Asia was hit hardest falling -8.5% with Latin America down -6.2% and EMEA declining -1.8%.  Only South Africa managed to eke out a positive gain in November – India was the worst performing market (-16%) as the country continues to grapple with slowing growth and above trend inflation. Egypt was weak (-10.4%) on continuing difficulties from the transition to democracy. 

In this continued “risk on- risk off” mood predictably it was more defensive biased sectors generating the best returns (or lowest losses) in falling markets, with Staples (-1.5%), Telecoms (-1.7%) and Utilities (-3.9%).  Materials (-9%), Financials (-9.8%) and Industrials (-10%) were the main sectoral laggards.

Market outlook

Market sentiment continues to be dominated by events in the Eurozone and China. On the Eurozone we continue to believe that policymakers will ultimately stabilise the situation and restore some market confidence to both their debt and currency.  However the road to recovery, especially in Europe, is still littered with obstacles and European politicians seem to move at the pace of a snail compared with market’s (unrealistic?) high speed expectation. The fragile improvement in sentiment is thus easily destroyed on an ill-timed statement or problematic debt auction.  Early 2012 has a heavy debt auction calendar for several Euro area states, so the market will be paying very close attention to any lack of progress in finding a solution to the crisis.

The Chinese economy is now exhibiting signs of slowing, as the loose policies of the post Lehman era were tightened in 2010.  The desired slowdown is now coming through and once again the authorities have begun to gently ease policy – it started with selective measures targeted at specific sectors and has now moved to a cut in reserve requirements, freeing up liquidity into the banking system.  Our base case is that China is successful in engineering a soft landing for its economy, but with the weaker global growth backdrop, the chances of a policy error have increased.

On a longer term view (defined as 1 year plus) we continue to  think there is plenty of upside – provided we are right that a) Europe will not see a catastrophic break-up of the Euro and b) economic growth in most emerging economies slows only marginally from 2011 into 2012.  As a consequence, we have not yet changed the positive bias to the portfolio.

Strategy

The strategy is overweight Russia and Argentina, funded by under weights in South Africa, Taiwan and Mexico.  With the exception of the bias in favour of Russia, these divergences reflect our long term strategic perspective. At the sector level the portfolio is overweight the Consumer Discretionary sector and Metals and Mining and underweight Banks and Wireless Telecoms.  These biases reflect our positive short term stance on markets and our desire to tilt the strategy in favour of higher beta sectors and 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.

MSCI Asia ex Japan gave up a significant proportion of the previous month’s gains this month, falling 8.3%.  Europe was again the key cause for concerns but risks in the other large economies remain with attention this month on the failure of the US Congress super committee to make progress on US deficit reduction.  China hard-landing fears continue though increasingly, there is the view that the worse it gets – the more likely a positive policy response.  A 50 bps cut in Reserve Requirement Ratio in tandem with other liquidity supportive measures by other major central banks helped lift markets at the very end of the month.

India (-16%) was the standout worst performer this month as the domestic macro picture deteriorated with growth weaker than expected (2QFY12 GDP growth at 6.9% was disappointing) and inflation still untamed.

The most resilient markets were, as usual, the smaller Asean countries.  Thailand was down 3.2% and Malaysia, 4.5%.

Market outlook

The developed world continues to ‘muddle’ through its myriad of debt problems and there is definitely a sense of ‘vacuum’ with very low market turnover and no real direction due to a lack of leadership in both Europe and the US -  only partly due to the lead up to Christmas and the year end. The markets were very weak in September, very strong in October and fairly weak in November. Europe has reached a kind of ‘deal’ but without the UK (no ticket on the Titanic’s final voyage a prominent sceptic put it) and the markets are less than convinced that EU fiscal discipline can really be imposed any more stringently than it was before. Meanwhile the ECB does still not look like initiating more QE nor does it look like ‘Eurobonds’ backed by Germany (effectively) will be issued. So far so bad would be the judgement we feel. However there was some good news with Italian bond yields falling back post the new Governments austerity package, the US ‘Black Friday’ retail sales figures were much ahead of expectations (+16%), the UK’s exports were much stronger than expected and China starting ‘easing’ (reducing reserve requirements) for the first time in 3 years. Despite this, most regions’ GDP growth figures are being lowered.

Thus this economic background is definitively not good and there is no getting away from that. So the age old question is whether this is in the price. Can the markets look through current difficulties to late 2012 / 2013 and possible recovery and how much will Western weakness affect Asia?  To a certain extent they probably are already looking through current difficulties. Markets have been weak but they could have been a lot weaker. They are not discounting a credit crisis in the West but they are probably discounting a mild recession in Europe and a slowdown in the US. Asian markets on the latest consensus numbers now trade on 11.5x 2011 eps and 10.4x 2012. Earnings growth is forecast at 10.5% in 2012 after 6.1% in 2011. Asian markets are also trading at 1.6 Price/book versus a 5 year average of 2.0. Trailing dividend yields are 2.9% versus a 5 year average of 2.5%. (source: Credit Suisse 12 Dec Asian Daily). These consensus numbers suggest very good value and that investors should buy now, buy Asia ahead of developed and buy for the longer term. However against that our view would be that markets wont ‘run’ for anything other than short periods until there is more economic or political catalysts to do so, given that it is possible that growth and earnings numbers could still be too optimistic and thus valuations not as cheap as they look. Quantitative easing by the ECB, further monetary easing in China and an agreed plan on the US deficit reduction would be 3 positive catalysts…..and thus it is not beyond the bounds of possibility that by the end of 2012 markets are substantially higher…. in fact we think this much more likely than the opposite, hence our positive stance.

Strategy

The strategy 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 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 third quarter proved volatile for all risk assets, as investors struggled with assessing the impact of several as of yet unresolved developed market solvency issues. In August it was partisan politics in the US threatening to prevent the debt ceiling from being raised, through to September where consensus is growing in Europe that a restructuring in Greece (and perhaps elsewhere) is inevitable. These issues have spilled over into fears of another banking system crisis led by Europe’s undercapitalised banks and the sharp slowdown in global growth that such a crisis could precipitate. This latter scenario proved costly for emerging markets local currency debt as the asset class suffered its worst quarter since its inception in 2003; down 8.55% in USD terms. Rexiter outperformed by 80 basis points over this period. Interestingly however, lower growth expectations were reflected in bond prices with curves rallying across many of the benchmark countries, and the losses stemming entirely from FX. Only two countries in the benchmark posted positive total returns for the quarter: Indonesia where collapsing rates and a high yield more than offset a modest (-2.44%) currency loss, and Peru where the currency barely moved at all (-85bps).

Market outlook

Going forward, our assessment of the asset class has not been significantly impacted by recent events. We still see emerging market debt very favourably compared to developed markets on both a long term fundamental and a shorter term technical basis. Generally speaking, the countries we invest in have low debt levels and small fiscal deficits meaning policy makers can engage in fiscal expansion to counter the downtrend in global growth expectations. Also, with local rates across the asset class at historically wide levels relative to developed markets, there is significant room for monetary easing as commodity prices and global inflation expectations fall. Probably the biggest change we see to our forward looking forecasts is that we expect a greater portion of the strategy’s total return to come from capital gains as rates are cut.

FX valuations also look attractive as the recent sell off has pushed a number of currencies below our estimation of fair value. We believe that the currencies of several of the fundamentally stronger countries will trend back to their pre-August level by year end making the fourth quarter a good entry point for investors in the asset class. The rising likelihood of another round of quantitative easing in the US and perhaps even in Europe supports this outlook. That said we believe there is no easy solution to the problems faced by developed markets and this uncertainty will continue to weigh on countries in Emerging Europe such as Hungary.

Strategy

Going into the fourth quarter, the strategy is positioned to take advantage of what we believe will be a relative quick bounce back into positive territory for some of the fundamentally stronger countries we invest in. We have unwound several short currency positions and further reduced our Emerging Europe exposure where underperformance is likelier to persist. The strategy has finished the quarter with some spare capacity in the forward currency overlay which we will look to re-deploy over the next couple of months.

In terms of duration, the strategy remains short relative to the benchmark overall but with several significant overweights at the country level. The impact that lower global growth assumptions has on each country’s inflation outlook varies considerably, depending on factors such as recent currency performance, commodity pricing impact on inflation and domestic growth factors. In particular, we favour the long end of Brazil and South Africa where falling commodity prices will offset currency weakness and where the domestic economies are slowing sharply. Also, high real rates in both countries also give policy makers additional room to shift policy rates further down.

We don’t think there will be any easy solutions to the solvency issues facing the European banking sector and select sovereigns and that this will weigh on risk assets as we work our way through. However, much of Latin America and Asia are well positioned to weather the storm and have capacity to cut rates and increase spending to counter external weakness.

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.

Investors definitely needed hard hats and strong stomachs during the third quarter.  MSCI EM Index fell 22.46% over three months and underperformed the World index by some 6%. Investor sentiment was battered by a trilogy of worries – Euro sovereign debt, slowing Chinese economic growth and fears of a second US recession. After a weak August, falls in emerging markets were exacerbated in September by a flight to the perceived safety of the US Dollar - the resulting outflows of capital led to emerging market currencies falling by -7.8% against the USD, including some dramatic moves in the Brazilian Real (-15.5%) and South African Rand (-13.7%) over the month.

Over the quarter there was little to provide shelter from the storm, with no market, sector or country able to provide a positive return in US Dollars.  Asia was the best performing region (-13%) followed by EMEA (-17.3%) and Latin America (-17.5%), as the latter two regions bore the brunt of currency weakness in the last weeks of the quarter.

Peru (-5.2%), Philippines (-7.7%) and Morocco (-9.6%) were the best performing markets, with Hungary (-44.1%), Poland (-34.7%) and Russia (-31%) the worst.  Hungary and Poland are the two countries within emerging markets with the most direct exposure to the Euro zone and Euro.

Telecoms (-11%) and Consumer Staples (-13.3%) provided the best relative sector returns as investors sought the safety of these defensive areas. Conversely, economically sensitive sectors such as Industrials (-29.6%) and Materials (-28.2%) fared worst.

Market outlook

When looking at the problems of developed economies the only thing that we can be sure of now is that there is no magic wand that can be waved to make the problems disappear – we are in for a prolonged period of uncertainty.  For the time being the direction of emerging markets will be determined by developments in peripheral Europe and on Wall Street.  For most of the last two years our central scenario has been that the West will “muddle through”, thus providing a background of low interest rates and low growth from developed economies.  The risks of a worst case outcome – namely a second credit crunch, a double dip in the United States and the possible disintegration of the Euro have clearly risen. 

The pressure on European politicians (especially in Germany and France) to “do something” about Greece has been building steadily as the economic environment deteriorates.  They probably actually welcome that pressure, since it makes it easier for them to sell the eventual rescue package to their own electorates.  Our bet is that they will, belatedly, succeed in insulating Spain and Italy from Greek contagion.

We have not changed our medium-term view - we continue to expect solid growth in emerging economies, driven by China, and slower growth in the West.  As before, we believe that the Chinese authorities will succeed in a “soft landing” of the economy (we define this as a higher than 7% GDP growth rate).  Its worth  noting that China is finding it tricky to slow an economy with a lot of growth momentum – any worry about a hard landing would likely see the authorities willing and able to lift their foot off the brakes a little.  Compare and contrast with the West, where growth is going through a soft patch despite extreme monetary stimulation such as the aforementioned Quantitative Easing programmes. 

Strategy

We do not share markets’ current pessimism about the prospects for growth in emerging economies and we were already anticipating a low-growth environment in developed economies.  Our forecast returns for emerging assets on a one year view are now as high as they were in the 2008 crisis.  As a consequence, we have increased the sensitivity of the portfolio to risky assets by reducing outperforming “defensive” stocks and increasing exposure to growth sensitive stocks.  We acknowledge that we may be early, but if/when confidence begins to return the response will be instant – it will very quickly be “too late” instead of “too early”.  More fundamentally, we have to acknowledge that we will be wrong if the current bout of jitters turns into a full blown credit crisis along the lines of 2008.  At that time, emerging markets underperformed developed for about six months, and took another six to claw back the losses.

During the weak markets of August and September we have, at the margin, reduced exposure to defensive sectors such as consumer durables, with the funds being employed to add to hard-hit high conviction stocks in areas of the portfolio more sensitive to economic growth.  The portfolio is overweight Russia and Argentina, funded by underweights in South Africa, Chile and Taiwan.  There are more significant divergences at the sector level.  The portfolio 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. 

Given the highly correlated “risk-on, risk-off” nature of markets at the moment, it may be useful to outline the “top down” perspective reflected in the portfolio. 

Global environment: Continued low growth and low interest rates for the foreseeable future.  Possible “double dip”, but a gentle recession – not a depression.

Europe and the Euro: No uncontrolled break-up of the Euro.  Politicians eventually succeed in putting together a rescue plan for Greece, probably in line with the recently leaked proposals of 40-50% write-downs on Greek sovereign debt.  Italy and Spain do not follow Greece into restructuring.

China.  No hard landing – growth is slowing, but this is good, not bad, and we still forecast 8%+ this year and next.

Rest of emerging world:  Economic activity and corporate earnings growth are slowing, but only modestly.  Provided we are right on the global environment, we expect both to surprise current consensus on the upside.

Of those factors it is the problems of the Euro that are the most difficult to predict.  If we are wrong and this situation deteriorates far enough to break up the Euro, it would trigger unsolvable liquidity problems in the global banking system. This would obviously be catastrophic for both developed and emerging economies.  In such an eventuality, emerging markets would be impacted more severely than we now anticipate and our strategy will suffer accordingly.

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 sharply, down 20.9% for the quarter. Starting with fears over political impasse in the US, this rolled into escalating concerns over European policy paralysis and then into China hard landing prospects.  This mix has been a potent negative for our markets with all of them falling meaningfully. China  (-22.9%) led the way down, but in general, open and liquid markets fared amongst the worst (Korea, Taiwan, Hong Kong) while the smaller Asean markets (Indonesia and The Philippines) fared relatively better.

Market outlook

We’ve said this before but when looking at the problems of developed economies the only thing that we can be sure of now is that there is no magic wand that can be waved to make the problems disappear – we are in for a prolonged period of uncertainty.  For the time being the direction of emerging markets will be determined by developments in peripheral Europe and on Wall Street.  For most of the last two years our central scenario has been that the West will “muddle through”, thus providing a background of low interest rates and low growth from developed economies.  The risks of a worst case outcome – namely a second credit crunch, a double dip in the United States and the possible disintegration of the Euro have clearly risen. 

The pressure on European politicians (especially in Germany and France) to “do something” about Greece has been building steadily as the economic environment deteriorates.  They probably actually welcome that pressure, since it makes it easier for them to sell the eventual rescue package to their own electorates.  Our bet is that they will, belatedly, succeed in insulating Spain and Italy from contagion from Greece.

We have not changed our medium-term view - we continue to expect solid growth in emerging economies, driven by China, and slower growth in the West.  As before, we believe that the Chinese authorities will succeed in a “soft landing” of the economy (we define this as a higher than 7% GDP growth rate).  Its worth  noting that China had been finding it tricky to slow an economy with a lot of growth momentum – now that there are some concerns about a hard landing the authorities appear willing and able to lift their foot off the brakes a little.  Compare and contrast with the West, where growth is going through a soft patch despite extreme monetary stimulation such as the aforementioned Quantitative Easing programmes.

We now feel that Asian markets have overcorrected particularly some more cyclical stocks. If we do ‘muddle through’ in the west, as we believe, markets should recover possibly quite strongly.

Strategy

The portfolio is overweight China, Singapore and Thailand, funded by an underweight in Taiwan and to a much lesser extent Indonesia and Korea. At the sector level the portfolio is overweight the capital goods, materials, utilities and consumer discretionary sectors, slightly over in technology and consumer staples 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.

Source: theaustralian.com.au

Thailand is suffering with the worst flooding in 50 years, which has already displaced over 2 million people, killing nearly 300. There is no sign of let up and the country is bracing itself for worse. While 30 of Thailand’s 77 provinces have been severely affected, Bangkok is now bracing itself, as floods from over-spilling dams in the north of the country are expected to affect the city in the coming days.  15% of farmland is affected and evacuation centres around the country are being set up. The government has started to bolster Bangkok’s flood defences. 

Thai businesses are being seriously affected - the central province of Ayutthaya, a large industrial centre has suffered markedly. Honda Motor and Hanna Microelectronics are amongst more than the 300 out of 2150 business units that have been closed in the province. Nikon, Canon and Siam Cement have plants closed. Food processing and other important sectors, such as tourism, will no doubt take a knock. As such, we can expect to see forecasts for overall economic activity to fall while the country struggles to cope (estimates vary wildly, but it has been estimated that approximately 1% will be shaved of headline GDP). There will, however, be an economic swing once the floods abate, with companies working hard to complete unfilled orders. 

It is also likely that the flooding will have an inflationary impact on prices. Food prices were expected to fall in the latest inflation print, but the food component of the consumer basket remained surprisingly high. With the damage that has been done to rice crops, where Thailand is the world’s largest exporter, we can expect food prices to remain at elevated levels for the time being and the increased rice prices will have implications in other regional countries, with rice being a high weight in local baskets. We would however, expect the Bank of Thailand to keep monetary policy loose, with the Bank remaining focused on overall economic growth. Although there will no doubt be a strong relief effort, we do not believe there will be any material increase in the current government debt stock, to finance the efforts. Here we are not concerned, as our emerging market local currency bond strategy is currently underweight Thai Government Bonds. If the situation worsens we may even see a slight further weakening of the baht. We will however, not know the full extent of the damage in Bangkok until waters that have breached dams in the north of the country arrive later in the week. For our fixed income strategy, we will remain allocated to countries that offer a better potential risk adjusted return.

Despite the large and yet unknown impact of the flooding, the Thai stock market has risen recently (in line with other Asian markets due to the improvement in global sentiment on hopes for resolution on the Greek debt and European bank crisis). In both our GEM and Asian equity portfolios we are overweight Thailand and, importantly, our holdings should be unaffected directly by the floods. In both strategies we hold Banpu which is a coal stock with nearly all its assets outside of Thailand (primarily Indonesia) and a bank. The impact is mostly on industrial companies, particularly multinational subsidiaries and specifically auto related businesses. Overall the impact though could be felt through a dip in GDP due to a manufacturing slowdown and a reduction in tourism, but only for a limited period. We don’t see this as having any long term impact.

We believe that post the election earlier this year the political background is more stable than it has been for some time however, there remains the issue of the succession to the elderly King. We forecast GDP growth of approximately 3% this year and next, a current account and trade surplus, regardless of the impact in the loss of production in the auto sector. Although we may see a shock to the price of food, inflationary pressures should continue to ease from about 4% this year to under 3% next year. The equity market currently trades on a Price Earnings Ratio multiple of 10x and even though we forecast earnings growth of only 12% this year and 5% next year (much lower than consensus of 20.5% this year and 13% next year) we still see decent upside in the equity market, despite the fact that it has been one of the better performers since the 2008 crisis. Besides, perhaps more importantly for banks and property companies, the government approved Thailand’s corporate tax rate to be cut from 30% to 23% this week, which will be effective from the start of 2012. This will have a positive uplift for profit growth, which perhaps also explains the recent rise in valuations in these sectors. 

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.

http://www.pensionfundsonline.co.uk/articles/rexiteremdebt.aspx

Pension funds looking for reliable returns in a time of economic turbulence in Europe and North America should embrace emerging market debt, says the head of Rexiter asset management.

Managing director and chief investment officer of fixed income, John Morton, says that pension funds should consider hedging away from holdings in ‘overleveraged’ developed economies that face “persistent and constant crises, perhaps as frequently as every six months and for as long as the next 20 years.”

Morton claims that “diversified emerging market debt portfolios can still yield 7% on average – which can be very useful in a world where pension fund members are expecting the same solid returns on their investments that they saw in the past.”

Morton adds that “unwinding the financial engineering in the developed markets from the last 20 years will make the developing market debt an attractive prospect as it is already deep, liquid, and has a broad range of participation from investors”.

He argues that while debt fears plague the developed world, much of the developing world is caught in a “positive feedback loop, with strong growth driving consumer demand (with) that then creating a need for large scale investment in property and infrastructure.”

He sees emerging markets on the whole as being in a period of “convergence at a time of decoupling” with the economic situation in emerging regions improving with similar characteristics whilst their economic health becomes less dependent on their traditional export markets of North America and Europe.

Morton told Pension Funds Insider that he believes “most big pension plans realise that they need to have emerging market debt” although he conceded that memories of the Latin America and Asian debt crises in the 1980s and 1990s respectively are making some investors view the assets with “unwarranted” scepticism.  

Rexiter’s fixed income research analyst Lewis Jones added that “central bankers in emerging economies have worked so hard to establish independence and credibility that they are not going to give that up easily, and the market is underestimating that fact.”

The State Street Global Investors subsidiary manages some £4bn in its emerging market debt and equity funds. Their London-based global emerging markets local currency bond strategy manages some US$234 million in assets and is principally invested in Brazilian, Mexican, Polish, Malaysian and Indonesian bonds.

The views from Rexiter come on the back of an IMF preview of their Global Financial Stability Report which also indicated that pension funds would be well served increasing their holdings of emerging market assets.

The IMF polled pension funds and insurance companies worldwide for the report and found that one-fifth of funds are planning to increase their exposure to risk in forthcoming years to make up for poor returns in developed markets. Respondents approved emerging market exposure as a means to boost returns without taking on extra risk.

The IMF’s assistant director of the monetary and capital markets department even accused pension funds of allowing fear to deter them from moves into emerging market assets.

Laura Kodres said that "one could envision the tendency of some pension funds and insurance companies to try and cover for their underwater positions by taking on riskier investments. But so far it appears they are paralysed like a deer in the headlights of a car, afraid to move."

14.09.2011

dbillingham@wilmington.co.uk

Poster for ANC conference (source: sahistory.org.za)

South Africans don’t need much of an excuse for a party and as next January marks the one hundredth anniversary of the founding of the ruling African National Congress (ANC), the Capes’ vineyards are certain to be doing great business come 2012. However, although it is now seventeen years since Mandela’s historic election victory in 1994, not all South Africans will be drinking hard to celebrate. Over half of the country’s youth remain unemployed, their futures bleak, and there is a growing sense that black empowerment is an ideology now abused to help the privileged few rather than the impoverished many.

Although the ANC can look back fondly through its history and reflect upon many ground breaking achievements, cracks are beginning to appear from within the party and external threats are growing. Like many centurions the ANC is vulnerable. Much of this vulnerability however is of its own doing and has been brought about by internal greed and indecision. The ANC was formed to fight apartheid; membership privileges were confined to self-sacrifice and a belief in a strong ideology. With apartheid now history, the party has created an environment for self advancement and cronyism. Having recently returned from Johannesburg and spoken with celebrated political journalist Allistar Sparks, I believe that the trigger point for a catalytic event has never been closer. This spells danger for political and economic stability. Investors in South African assets need to pay close attention as events unfold.

Firstly, the ANC appear vulnerable. In the past two years the economy has underperformed its potential, strike action is on the up and the young, largely unemployed rural population of South Africa feel increasingly disenfranchised from the ANC machine. A generational change is taking place and many of South Africa’s young voters have little empathy with “the struggle”. Anecdotally, a recent poll indicated that a high percentage of the nation’s youth had never heard of Steve Biko. Their vote is becoming more colour blind. They want a leadership that will put their interests first. The municipal elections in May of this year are a strong indicator of the declining popularity of the ANC. The centrist Democratic Alliance increased its share of the vote from 15% to 25% - predominantly at the expense of the ANC.

Steve Biko… the forgotten man? (source: news.bbc.co.uk)

Whilst it is unlikely that the ANC will lose the 2013 election, any further deterioration in their popularity is likely to increase political “noise” for the remainder of 2011 and into 2012. At the extreme the ANC could call a state of emergency to ensure control. A greater probability, however, can be attached to a ramp up in populist rhetoric, which will lead to heightened volatility in the rand, bond and equity prices.

Secondly, Jacob Zuma is vulnerable. It is by no means certain that Zuma will lead the ANC into the next election. Whilst his two years as President have not been successful in transforming the South African economy, his policies have represented little danger to foreign investment. With the threat of more leftist candidates for the leadership emerging this policy continuity has been welcome.

Zuma has adopted a conciliatory approach to leadership throughout his tenure and this lack of direction could lead to his downfall as factions have grown within the party as a result.

In recent months the ANC youth wing leader, Julius Malema, has emerged as a potential candidate to the presidency. By challenging Zuma from the left, Malema is attempting to position Zuma as an ally of the white businessman. Malema’s policies include the nationalisation of the mining and banking sector – moves that Zuma dare not directly oppose for fear of alienating voters.

The result of an in-party disciplinary hearing against Malema, this week, for bringing the party into disrepute is crucial. If Malema is suspended from the ANC, Zuma can begin to re-build his power base. If Malena survives there is a feeling that Zuma is finished politically and investors will demand considerably higher risk premium for owning South African assets than they do today.

Although Zuma currently has no other standout rival, the environment is ripe for one to emerge. COSATU (Congress of South Africa Trade Unions) has become unhappy with Zuma. Having helped sweep him to the leadership of the ANC, there is a feeling within that payback has been insufficient. With public sector wages settling at “only” 6.8% last month there is an increasing chance that they will place their valuable support elsewhere. Zuma’s campaign anthem is “bring me my machine gun” but with his failure to support COSATU sufficiently he may well have shot himself in the foot.

Over recent years investors in South Africa have become immune to doomsayers. The stock market has performed as well as most of its competitors: foreign direct investment is up (Walmart’s acquisition of Massmart being the most recent example); the economy did not collapse because of AIDS; the country did not follow the path of Zimbabwe to anarchy and hyper-inflation and it has not suffered from wholesale capital flight from the white minority. South Africa is also very fortunate in that it benefits from a tolerant society unlikely to descend into a Libyan-style crisis, extremely well run corporations, and an impressive forward thinking central bank and finance ministry that minimise the potential for extreme policy error. However, this is all well known and likely to be reflected in asset prices. 

Nevertheless, the deep structural fault lines running through the economy are a source of constant concern and commentators who forecast more troubles ahead cannot be ignored just because the ever growing ranks of the young poor have stayed quiet until now. The 2013 general election is more than a year away but events in 2012 will be crucial in shaping their outcome. Political and economic risk in South Africa is on the increase and investors need to be ready to react if the situation deteriorates further or risk suffering a nasty hangover before the anniversary celebrations have even begun. 

Zuma and Malema… more united times? (source: independent.co.uk)

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.