Exploring Emerging Markets

Takeaway: The dollar is surging, commodity prices are tumbling. Is Emerging Market investing a one-trick pony whose time has come and gone?

Submerging Markets: A Hedgeye Exclusive Presentation

Hedgeye Senior Analyst Darius Dale presented an exhaustive report in an institutional conference call today.  “Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle” drew an enthusiastic response from our global investor client base, many of whom run “long-only” mutual funds, investment vehicles that are contractually required to always be fully invested, owning a portfolio of stocks drawn from pre-determined market or geographical sectors.  These long-only investors are often among the first to suffer when there is uncertainty in the marketplace.  Put yourself in the position of a long-only manager when volatility rocks the boat, all you can do is hold on for dear life and hope the storm passes.  In times like these, Hedgeye’s Macro work becomes critical to plotting a course through turbulent waters.


Emerging Markets – What Are The Risks?

Perhaps the overarching risk in EM investing is the shift in attitude that leads investors, first to chase investments they would normally shun, then to suddenly shun investments they recently adored.  Markets reflect mass perceptions, and when the mass of investors fear a further decline in formerly-stable markets – as occurred in the US markets in the depths of the financial crisis – they seek refuge in hopeful markets.  This may not appear highly intellectual or disciplined – in fact, it’s not.  But it is the way many investors behave.  “Many” investors becomes a statistic, and a string of statistics establishes a trend.  Before you know it, the “smart” money identifies the trend and hops on the bandwagon.  


In short, much of what we have seen in major global moves in asset prices and stock markets has been the result of waves of panic sweeping across large swathes of the investment community.


For this you got an Ivy League MBA?

There’s a critical point to keep in mind when assessing risks in global markets.  There are huge pockets of vulnerability across the EM space, but exposure to the possibility of a crisis does not guarantee that there will be a crisis.  As a 2010 IMF report on emerging market crises states, “Crises require some triggering event.”  What we shall call “Dale’s Corollary” is the critical observation that Crises tend to start when investors apply developed market rigor to analyzing emerging markets.

It’s impossible to put too much emphasis on this point.  “Hot Money” is driven by the hunt for yield.  In global terms this translates into investors seeking opportunity in foreign markets – what’s known as Private Capital Flows.


As interest rates on US Treasuries declined, and as investment returns dropped across the developed world in the aftermath of the financial crisis, portfolio managers and investment analysts gladly applied different standards to analyzing the Emerging Economies, leading to a global arc of cross-border investment driven by a perception of strong commodity demand.  The stark message here is that – as Hedgeye’s Macro team has been saying – maybe it was all just the Dollar all along.  As Hedgeye CEO Keith McCullough frequently observes: “If you get the Dollar right, you’ll get a lot of other things right.”  Dale’s analysis indicates the notion of global commodity demand may be a fantasy.  The twin sibling of the chimera of perpetually-increasing house prices that drove the US economy up, up, up… over the tippy-top and into Mr. Greenspan’s executive toilet. 


Four Pillars of EM Wisdom

Dale’s presentation targets a complex set of risks in emerging markets and points to drivers of EM vulnerability.  


For starters, EM stock markets are largely tied to local commodities, and Dale measures levels of beta market volatility associated with this commodity exposure.  Continued unwinding of the global commodity bubble could be a very powerful tail wagging such dogs as Russia (70% volatility exposure to commodity prices), and Brazil (43%).


Dale then presents the “Hedgeye Macro Emerging Market Crisis Risk Index,” constructed on four “Pillars,” each measuring ten key economic indicators, including: 

  • Pillar I: External Sector – Currency exposure, including exchange rate and foreign currency reserves on hand; the costs of foreign trade, including commodities exposure; and the costs of short-term debt.  
  • Pillar II: Fiscal Policy – Sovereign debt; tax policy.
  • Pillar III: Financial Sector – Bank capital adequacy; cash and cash equivalents in the marketplace; real rates of interest; stock market.
  • Pillar IV: Political and Regulatory Risk – Ease of doing business; enforceability of contracts; unemployment; measures of inequality.

Taking previous EM crises as a guide, Dale’s work applied this rigorous analysis to 29 EM countries, as represented primarily in the 21-nation MSCI Emerging Markets Index.  Ranking these nations from lowest to highest risk, Dale found different Pillars, unsurprisingly, had different weights.  


A House of BRICS

We’ll use the BRICS (Brazil, Russia, India, China and South Africa) to demonstrate how Dale’s complex analysis presents these risks.  It looks like the third Little Piggy may finally be out of luck – not because the wolf is any stronger, but Dale has found a design flaw in the BRICS.  Dale’s Pillars measure risk across the 29-nation sample, with countries ranked by how many standard deviations they fall either above or below the average for those metrics.  


In Pillar I, Balance of Payments and Currency Risk, the high-risk BRICS countries are South Africa, Brazil and Russia, while India and China fall well below the mean.  


Pillar II, Fiscal Sustainability Risk, sees Russia and China as rather safe, with South Africa only marginally safer than the average.  India and Brazil, however, ranked as the third and second most risky on this metric, only topped by Egypt.

Pillar III, Financial Crisis Risk, ranks Brazil and Russia at below average risk, but the More Risk side of the chart features India and South Africa, and is topped by China, which comes out a whopping two standard deviations above the norm of the 29-nation sample.


Pillar IV, Political and Regulatory Risk, is led by India (1.8 standard deviations above average), followed by South Africa and Brazil, while Russia and China are relatively lower risk on those metrics.


Finally, three of the BRICS nations are among the top 4 for Aggregate Risk: India is highest aggregate risk, while South Africa and Brazil are at third and fourth places – the second slot is occupied by Egypt, which we think says rather a lot about The Company You Keep.  Dale singles out India, Brazil and South Africa as “outliers,” meaning they are “more than averagely more than average” risky.


But wait – there’s more!


The Elephant In The Emerging Room



Need we say more?  All right, then we will.


China occupies a dominant position in the global marketplace – and in most investors’ minds.  Dale devoted an entire second half of his presentation to the question “Will China Blow?”  (Spoiler alert: the answer is “We have no idea, but we have some important observations that can tell you what to watch for.”)


“China sticks out like a sore thumb on the Hedgeye Emerging Market Financial Crisis Index,” says Dale.  And, while we remind you that Vulnerability does not mean a crisis is certain, it’s one heck of a wake-up call.


How often have you heard stock market pundits enthusiastic about the bottomless well of Chinese demand?  “There’s over a billion of ‘em!” they would chortle.  “That’s a lot of cell phones! (TV sets, automobiles, athletic shoes, personal care products… or whatever it is you’re touting…)”


Says Dale’s analysis, “Oops…!” 


A number of factors point to a dramatic shrinking of Chinese demand:

  • Financial repression has left little-to-no place for Chinese savers to put their money.
  • Artificially low prices of basic inputs such as water, gas and labor have allowed state-sponsored enterprises to fuel systematic over-investment – despite being much less profitable than private businesses.
  • Over-investment creates excess capacity throughout the economy, leading to potential maturity mismatches and nonperforming loans – on and off bank balance sheets
  • … China’s expansion of credit is greater than any expansion in any “bubble” economy in recent decades.  By a lot.

Chinese savers have no place to get what used to be a normal rate of return on their hard-earned money (sounds like your money market account, doesn’t it?) and have taken to investing in risky off-book trusts and wealth management products structured by Chinese banks.  These vehicles operate like blind pools, investing deposits in high-yield projects.  China’s own minister of finance has publicly called these trusts “Ponzi Schemes.”


Other potentially massive risks include regional funding shortfalls.  Local governments are not allowed to issue their own debt, and so they rely on land sales to plug funding gaps.  Some of these sales are of disputed property, which may lead to social unrest as China’s social activist bloggers continue to gain traction.


What’s The Endgame?

Dale says China has implemented – or announced – a number of key reforms.  Among those either in the works or on the launch pad:

  • Bank deposit reform, including interest rate liberalization and some form of deposit insurance
  • Deepening of financial markets, including increased supervision, better central bank intervention policies, and financial crisis policy
  • Currency policy, including a looser exchange rate trading range and more flexibility on dealing across China’s borders
  • Capital account policy, allowing freedom of investment to attract portfolio flows, but also to permit Chinese to invest offshore.

Conclusion: Read My Lips

China’s financial and political system is, in the words of one senior official, “unbalanced, unstable, uncoordinated, and unsustainable.”  But Dale reminds us, this situation will only turn into a full-blown crisis if there is a triggering event.  Dale says China’s economic policies are well suited to address the myriad problems facing the nation.


So, can they do it?  


China has accomplished most of the easier reforms.  The bad news is, that still leaves the hard ones.  Dale points to historical precedents, and to recent analysis by the IMF, that indicate China can thread this needle, but he cautions this situation is so complex there is no way to predict the final outcome. 


Still, Dale says policies adopted by the Party all point to the right solutions – if they can be implemented both effectively, and on time.  Says Dale, “Chinese officials almost always do what they say.”  That should make for a refreshing change while we bite our nails waiting for the next financial crisis.  


For more on Darius Dale’s work on China – and more on Hedgeye’s Macro coverage – please go to


We remember, vividly, the Street writing Brinker’s obituary in October 2012.


Specifically, it was October 24th and Brinker had just reported its 1QFY13 earnings.  The company reported a 23% increase in EPS on 2.8% Chili’s comp but that was not good enough.  The industry was experiencing a sales slowdown in September 2012 and was continuing into October.  Apparently, at the time, it was game over for Chili’s and the stock ended up down nearly 10% that day, closing at $30.00.


Fast forward to the just reported 3QFY13 earnings call the stock is now $37 and trading down on good volume all because Chili’s lost ground to the Knapp Track bench mark in the month of March.  Is the Brinker story over again for the second time in 6 months?


We need to ask the same question today as in October 2012: Has anything changed on the margin that has cause the story to change for EAT?

  1. Have the competition responded to counter the Chili’s sales momentum?
  2. Have the critical financial metrics of the company slowed?
  3. Did management use weather as an excuse to justify the slowing performance?
  4. Has management’s tone changed toward the future goals?
  5. Did guidance change?


Some of these questions are more difficult to answer but the most important ones for the long-term TAIL thesis, 2, 4 and 5, can be answered with resounding "no"s. The March results were certainly weaker than we were looking for.  Specific details on the quarter were positive, however, with the company reiterating its FY2010 promise to double EPS by the end of FY14 and emphasizing a recovery from initial operational difficulties around the roll-out of pizza in its Chili’s stores. 


While many on the sell-side view Brinker with more than a little skepticism, perhaps because of disappointments in the pre-FY10 era, we believe the current management team has earned a heightened level of credibility (particularly versus some competing management teams).  The company’s guidance of roughly $2.35 in FY13 EPS versus consensus $2.32 implies, to us, that the earnings power of the company has not deteriorated. We retain a positive bias on Brinker over the longer-term TAIL.



Howard Penney

Managing Director


Rory Green

Senior Analyst

S&P 500: Staying The Course

The S&P 500 is up +10.7% year-to-date and is outperforming other asset classes including fixed-income (bonds) and commodities by a wide margin. Comparatively, the CRB Commodities Index, which measures 19 different commodities, is down nearly -6% so far this year. One of the most widely traded bond ETFs out there, the iShares Barclays 20+ Year Treasury Bond ETF (TLT), is up only +1.19% for the same time period.


S&P 500: Staying The Course - SPXYTD today

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.43%
  • SHORT SIGNALS 78.34%


To listen to the replay of this morning’s call on Emerging Market Crises led by Senior Analyst Darius Dale of the Hedgeye Macro Team, please CLICK HERE. To download the associated presentation, please CLICK HERE.


You’ll need your login information to access the replay; if you need those credentials or if you’re having trouble accessing any of the links, please email .


Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle

On the call, we walked through Hedgeye's proprietary model for identifying and ranking emerging market economies (EMEs) according to their levels of risk. In addition, we addressed the following key questions:


  • Today's Setup: What risks are our proprietary, multi-factor model signaling across the various EMEs?
  • Crisis Trigger Scenario Analysis: All crises need tipping points. What event(s) will trigger them this time around?
  • "BRICS" or Bricks?: How do these darlings of the investment community stack up relative to their peers?
  • Threading the Needle: Is China careening towards a financial crisis?


Summary Conclusions:

  • We currently see a pervasive level of risk across the emerging market space at the country level and have quantified which countries are most vulnerable
    • Generally speaking, the famed “BRICS” economies screen very poorly on our model
    • China is particularly vulnerable to experiencing a financial crisis
  • As such, we find it prudent for investors to reduce their allocations to emerging market equity and currency risk in favor of US equity and US dollar exposure
    • SHORTS: iShares MSCI EM Index Fund (EEM), Freeport-McMoRan (FCX), Latin American and African commodity currencies (PEN, CLP, COP, ARS, NGN, DZD)
    • LONGS: US Dollar (UUP), Healthcare SPDR (XLV) and Consumer Discretionary SPDR (XLY)
    • RELATIVE PLAYS: Long/Overweight Indonesia (EIDO), Philippines (EPHE) and Mexico (EWW) vs. Short/Underweight Russia (RSX), Brazil (EWZ) and South Africa (EZA)
  • #StrongDollar and commodity price deflation have been and should continue to be key catalysts for EM underperformance


Best regards,


The Hedgeye Macro Team


In preparation for BYD's F1Q 2013 earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.





  • Locals commentary:
    • "We saw reasons for guarded optimism in this region later in the quarter, as business trends started to improve. The declines we saw in October to November moderated in December, and that positive trend has continued into the first quarter."
    • "Customer accounts are up. Spend per visitor is down."
    • "We refined our marketing and advertising programs and made significant changes on our casino floor, and we began to see the benefits of this in the fourth quarter as visitation strengthened month-by-month across our Locals business. In 2013, we will continue looking for ways to improve our core business, not just in Nevada, but across our portfolio."
  • "As other companies in our industry have already reported, gaming customers nationwide pulled back in the fourth quarter due largely to economic uncertainty surrounding the elections and the fiscal cliff. While we actively worked to mitigate the impacts of these trends on our business, they did affect our operations. These trends continued into the first quarter. Our customers are now adapting to the impact of higher payroll taxes that took effect January 1; continued uncertainty from Washington over federal spending and taxes is affecting consumer behavior as well."
  • "We are encouraged by signs of continued improvement in the Southern Nevada economy. The unemployment rate has been declining in recent months and home prices rose substantially throughout 2012. Las Vegas is still far from the boom years, but the trend is in the right direction, and we believe we will see modest improvement throughout this business in 2013."
  • "Visitation remains solid, especially among our Hawaiian customer base, and we gained 250 basis points in market share from the third quarter to the fourth, further expanding our leading position in the Downtown market. We believe those positive trends will continue. Our Hawaiian business remains strong and we will benefit from the ongoing redevelopment of Downtown, which continues to drive new business, new visitors and new residents into the area."
  • [Midwest/South/Peninsula] "While business from our core players remained solid, we saw declines in both visitation and spending among casual players."
  • [Kansas Star] "With the permanent casino opened, the property is now on track to open a 4,200 seat arena by mid year."
  • "Looking ahead to the first quarter, Kansas Star will be comparing to a strong introductory period, when it was able to generate robust visitation with very little marketing spend. That is obviously not sustainable and customer reinvestment has increased to more realistic levels. Winter weather has presented more of a challenge in the first quarter of 2013 as well. But we remain quite optimistic about Kansas Star's long-term potential and we expect that Kansas Star's margins will remain the highest in the Peninsula portfolio and project that the property will generate about $100 million in annual EBITDA going forward."
  • "The transactions to dispose of the Echelon site and Dania will result in our leverage improving by over half a turn this year."
  • "So, regarding the property tax appeal at the Borgata, I think the only thing I can really say is it is going to trial in late March and we won't provide any commentary other than the fact it's going to trial in late March and we're hopeful of a positive outcome."

HOUSING: Raise The Roof

New Home Sales rose 1.5% this morning to 417,000 at an annual rate. This news is decidedly bullish for housing in general as home sale volumes continue to rise in tandem with home prices. Currently, new homes account for 7.8% of all sales and we expect growth to continue as inventory levels rise. The median price of new homes sold in March rose 5.3% vs the prior year, down slightly from the prior month's 5.6% year-over-year increase.











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