- Key resistance levels are being tested across the broad spectrum of EM capital and currency markets.
- Importantly, this comes as the top-down, global macro fundamentals are getting far less bearish for emerging market assets, at the margins.
- To the extent we receive quantitative confirmation of our fundamental views, we think the current relief rally across EM capital and currency markets has legs w/ respect to the intermediate term.
On FEB 27 we held a conference call on Brazil (CLICK HERE to access the replay podcast and slide deck). The key purpose of the call was three-fold:
- To alert investors of the potential for a relief rally across EM capital and currency markets in which the most embattled of countries were likely to see their markets outperform;
- To encourage investors to get long the Brazilian real; and
- To lay the groundwork for getting behind Brazilian equities on the long side – Petrobras (PBR) in particular – in preparation for any confirmed quantitative breakout.
To those points:
- EM assets are up an average of +1% at the asset class level since that call, with 2013 crisis countries India (EPI), Turkey (TUR) and Indonesia (EIDO) leading the way to the upside at +8.6%, +7.8% and +5%, respectively;
- The Brazilian real has appreciated +54bps vs. the USD in the spot market, contributing to a total return to +1.32% – good for seventh best among the 23 EM currencies tracked by Bloomberg;
- PBR bottomed on MAR 17 and Brazil (EWZ) put in a higher-low on MAR 14; since FEB 27, they have appreciated +4.2% and +2.1%, respectively.
The performance of those markets surely isn’t anything to write home about as it relates to taking any sort of victory lap. That being said, the aforementioned deltas do indeed increase our conviction in our call for an intermediate-term relief rally across EM capital and currency markets.
We’ve written extensively in recent months on why we think domestic economic growth slowed here in 1Q14 and why we think the slope of reported growth data will remain generally negative on a 3-6M forward basis, so we’ll spare you the details in the pursuit of brevity. Just know that the following quantitative signals remain in support of our research view:
The US dollar, long-term US interest rates both remain bearish from an intermediate-term TREND perspective insomuch as commodities (CRB Index) remain bullish from TREND perspective. Taken in conjunction, we see that macro market participants are effectively front-running a proactively predictable reversal of now-hawkish monetary policy out of the FOMC, at the margins. In our opinion, it would represent a strong lack of fiduciary responsibility for any investor to take the Fed’s forecasts for growth and policy guidance at face value.
The YTD performance spread between the slow-growth Utilities sector (XLU) and the pro-growth Consumer Discretionary sector (XLY) is extremely material at 1105bps wide and is signaling a trip to Quad #3 (i.e. Growth Slows as Inflation Accelerates) on our GIP model.
Domestic economic growth as a style factor at the Macro ETF level is broadly breaking down quantitatively on our Tactical Asset Class Rotation Model (TACRM)™ (to be fully introduced in the coming weeks), while, at the same time, emerging market assets are broadly breaking out. The chart below captures inflection points at critical thresholds of momentum after at least three months above/below the stated threshold (refer to the conclusion of this note for more details).
We don’t want to get above our ski tips for places like Brazil and LatAm, because our backtest data shows that the difference in breaking out above the critical threshold of 0x and +1x is literally the difference between a short-selling opportunity and a buying opportunity. That being said, we do like the composition of those ETFs that have already made it to this quantitative “promised land” (i.e. breaking out above +1x), so we’re inclined to wait in sanguine fashion as it relates to our call.
It’s worth noting that our proprietary risk management levels are essentially signaling the same thing across each of the four primary EM asset classes. The EEM, EMB, EMLC and CEW ETFs have all broken out above their respective TREND lines very recently. We wouldn’t chase ‘em up here, but, for the first time in several quarters, we’d be buyers of EM assets to the extent these broader indices start to make higher-lows above their respective TREND lines – thus confirming any quantitative breakout(s).
Getting into idiosyncratic fundamentals, here are some brief updates on the country-specific strategy calls we’ve been making in recent months:
Long “New China”/Short “Old China (CLICK HERE to review our thesis): Amid headlines of a “currency crisis”, “systemic” defaults and an overhyped run on a miniscule Chinese bank, Chinese leaders continue to hold the line on GDP growth, effectively marking the mid-to-low 7% range as a floor for economic growth. With the Chinese sovereign and PBoC both well-equipped to combat any continued slowing from, we’d be buyers of “New China” outright. Shorting “Old China” exposure against that helps us sleep better at night… An equal weighted strategy of long the MSCI China Technology Index + the MSCI China Consumer Discretionary Index vs. Short the MSCI China Financial Index + the MSCI China Industrials Index has generated a cumulative +3360bps of performance since when we introduced the strategy back on DEC 4, we’d definitely stick with the game plan until the Chinese government tells us not to.
Long the Brazilian real (CLICK HERE to review our thesis): It would appear that the well-telegraphed S&P downgrade of Brazilian sovereign debt to BBB- effectively marked the bottom in Brazilian equities. Classic lagging indicator. Recent polling and consumer confidence data insulate our call that both the campaign cycle and eventual election results will force fiscal policy to remain at least rhetorically tight ahead of the elections and outright tighter in the subsequent quarters. The market doesn’t think Tombini will have enough headroom on growth to keep hiking here, but our World Cup impact analysis suggests he will. That’s positive for the BRL and positive for the country’s woeful BoP dynamics – as is the World Cup… Introduced as a Best Ideas 1M ago, we’d definitely stick with the game plan here, as this idea remains far from consensus.
Long India (CLICK HERE to review our thesis): No major updates here. The RBI, chaired by Dr. Rajan, continues to maintain a hawkish policy bias and the opposition, led by prime ministerial candidate Naredra Modi, continues to gain momentum in the eyes of investors ahead of the upcoming parliamentary elections – particularly when juxtaposed with recent empty promises of 8% GDP growth out of the “ruling” Congress party. India’s “turnaround story” continues… India (EPI) is up +9.14% since we introduced the call back on OCT 29; that’s good for the third-best return across the investable EM ETF universe (29 in total) and one of only four that have posted positive performance since then. Stick with the game plan here, as most of our positive political and GIP catalysts have yet to materialize.
Long Indonesia (CLICK HERE to review our thesis): The [positive] “Jokowi Effect” was even larger than we had initially anticipated, as evidenced by the dramatic melt-up in both Indonesian equities and the IDR in recent weeks into and through the MAR 14 announcement of ever-popular Jakarta governor Joko Widodo’s candidacy for JUL’s presidential ballot, which is only a few months after next month’s parliamentary election where Jokowi’s PDI-P party should take the largest share of seats. Amid the campaigning, Bank Indonesia has pledged to maintain its hawkish policy bias and there are talks of a meaningful economic reform package to be introduced shortly after the elections. Check. Check. Check… Indonesia (EIDO) is up +16.1% since we introduced the call back on JAN 30; that’s good for the second best performance among EM equity ETFs since then. Like India, many of the positive political and GIP catalysts have yet to materialize, so we’d stick with the game plan here as well.
Short Philippines (CLICK HERE to review our thesis): Short-term rates (i.e. 2Y sovereign yields) in the Philippines are ripping (+51bps WoW) as central bank governor Amando Tetangco confirmed that his policy board favors “early, measured adjustments” in monetary policy, effectively puling forward an expectations for policy rate normalization. It’s worth noting that this commentary comes roughly six weeks after he presented a hawkish outlook for local inflation back in mid-JAN… We’ve gotten this one wrong, with Philippines (EPHE) appreciating +7.9% since our JAN 30 note. Specifically, we think the market is paying up for what is clearly one of the better secular growth and investment stories remaining in the EM universe. We’re not inclined to fight the tide here, so we’d be inclined to “book” the loss here.
Short the Chilean peso (CLICK HERE to review our thesis): The central bank, led by President Rodrigo Vergara, has maintained a dovish bias in recent months, but, as of last Friday, the degree of dovishness is now under review. With headline economic growth basically getting cut in half in the most recently reported quarter, we’d take the other side of the central bank’s +4.3% 2014 forecast, which means they’ll likely be easing more dramatically and for longer than even they expect… Another solid “win” for us in the currency market to-date, with the CLP declining -1.8% vs. the USD in the spot market since our JAN 21 note. That’s good for the third-worst spot return across the 21 currencies I actively monitor within my coverage universe. That being said, near uniform testing of the aforementioned TREND lines mitigates any patience we once had on the short side of EM capital and currency markets. As such, we’re inclined to “book” the gain here. We can revist the trade later if beta once again turns negative, as the GIP fundamentals do indeed support a lower value for the Chilean peso.
As always, please feel free to ping us with any questions and/or critical observations you believe we may have missed.
Associate: Macro Team
TACRM Volatility-Adjusted Multi-Duration Momentum Indicator (VAMDMI):
TACRM™ is specifically designed to provide tactical security selection, general global macro market color and suggested dynamic asset allocation weightings. One of the ways it does this is by providing a standardized measure of momentum across various asset classes and systematically making sense of those signals.
This VAMDMI score is derived by calculating three independent z-scores of closing price data on a weekly basis and then calculating the arithmetic mean of this sample.
- Short-term z-score: 1-3M sample
- Intermediate-term z-score: 3-6M sample
- Long-term z-score: 6-12M sample
Each independent sample size is determined dynamically by prevailing trends in global macro volatility. Specifically, if the BofA Global Financial Stress Index is making lower-lows on an intermediate-term basis, then each of the sample sizes are larger in duration; if the BofA Global Financial Stress Index is making higher-lows on an intermediate-term basis, then each of the sample sizes are smaller in duration.