Takeaway: Our bullish outlook on Germany remains in place as we head into month-end (etf: EWG).
Editor's note: This unlocked research note was originally published January 29, 2014 at 16:00 in Macro. For more information on how you can subscribe to Hedgeye click here.
Our bullish outlook on Germany remains in place as we head into month-end (etf: EWG).
Below we refresh the charts of the three confidence bureaus we track – ZEW, IFO, and GfK. While the 6-month forward looking ZEW Economic Expectations took a slight dip in the January reading, its first decline in 6 months, it’s but one survey among other very favorable consumer and business sentiment readings and strong Services and Manufacturing PMIs.
We continue to be bullish on German equities and maintain our call of strong EURO/strong DAX that is a function of Keith’s quantitative levels and the correlations we’re seeing between high frequency German data sets and the EUR/USD.
The major takeaway for us is the purchasing power boost that German consumers and businesses are receiving with a strong currency and decelerating inflation. We see a strong currency positively flowing through to confidence and consumption. Also, we do not read recent levels in the EUR/USD (the average over the last year has been $1.3321) as prohibitive to German export expansion.
In the bottom two charts we show Germany’s positive trade balance versus one of its main peers, France. We also note the trend of underlying strong demand from China for German goods –while the latest reading is from 7/2013 (stale), we believe that recent purchasing data and given the basket of German exports—skewed to high tech/specialized goods—should support strong demand in 2014 despite Chinese growth slowing.
As another piece of favorable data, this week the German government reported that it is considering raising its growth forecast for 2014 to 1.8% compared with 1.7% published late last year.
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Takeaway: With respect to the intermediate term, both Indonesia and New Zealand look good on the long side (kind of). Philippines looks like a short.
- We’d like to see Indonesia (EIDO) break out above its TREND line (~3% higher) before we allocate capital here. The immediate-term TRADE was built to front-run the TREND, so we like our chances of this occurring in light of Indonesia’s 1H14 rather positive GIP outlook.
- Philippines’ sour GIP outlook would suggest selling/shorting the country (EPHE) at your leisure.
- We’d like to see New Zealand (ENZL) recapture its TRADE line (~1.5 to 2% higher) before we allocate capital. If the TREND line holds, we’d be comfortable allocating capital to New Zealand as somewhat of a call option on continued commodity reflation. Moreover, we want to be exposed to likely appreciation of the Kiwi dollar.
2014 has certainly been a interesting year with respect to my geographic regions of converge (i.e. Asia, LatAm and Emerging Markets). Only six of the 21 countries I follow closely have equity markets that are up for the YTD and, of those six, only three of them are broadly investable (i.e. excluding Argentina, Vietnam and Venezuela we’re left only with Indonesia, Philippines and New Zealand).
If you run global equity money, you know how important it is to get big in under-indexed names that subsequently go on to outperform the benchmark. With that in mind, we decided to go “squirrel hunting” in three of the more squirrely countries in the sample with the express intent on finding which country(ies) to overweight/get long of and which country(ies) to sell/short with respect to the intermediate term (i.e. 6-9M+).
Indonesia: As of now, our proprietary GIP model has Indonesian real GDP growth accelerating modestly in 2014, with most of the juice coming in 1H14 where compares are easiest. We currently anticipate Indonesian CPI to accelerate modestly in 2014, though moderation in the back half of the year – where compares are toughest and import price pressures are likely to be the least – is also expected. Indonesia’s most recent quarterly real GDP growth and quarterly CPI readings have z-scores (trailing 3Y) of -2.0x and +1.8x, respectively. Lastly, we expect BI to maintain at least rhetorical hawkishness amid elevated rates of inflation and #EmergingOutflows.
Philippines: As of now, our proprietary GIP model has Filipino real GDP growth slowing sharply (~170bps) in 2014 (after the best two-year period of growth in ~60 years), with most of the slowing coming in 1H14 where compares are toughest. We currently anticipate Filipino CPI to accelerate by ~100bps in 2014, with much of that acceleration coming in 1H14 where compares are easiest and import price pressures are the greatest. Philippines’ most recent quarterly real GDP growth and quarterly CPI readings have z-scores (trailing 3Y) of +0.4x and -1.0x, respectively. Lastly, BSP is likely to maintain its neutral bias for the time being (on hold since OCT ’12), though it will likely be feeling the pressure to tighten by 2H14. What they choose to do in an environment of slowing growth is beyond our ability to forecast at the current juncture. This conundrum is precisely why the policy response to Quad #3 on our GIP model says, “IN-A-BOX”.
New Zealand: As of now, our proprietary GIP model has New Zealand real GDP growth coming in essentially flat in 2014; a slight deceleration in 1Q14, where compares are toughest, is likely to be overshadowed by an acceleration in 2Q14.We currently anticipate New Zealand CPI to accelerate a noteworthy amount (~70bps) in 2014 due to easy compares that remain in place all year. Those are, however, offset by negligible, if not inverted, import price pressures throughout the balance of the year. New Zealand’s most recent quarterly real GDP growth and quarterly CPI readings have z-scores (trailing 3Y) of +0.7x and -1.0x, respectively. Lastly, with 1Y OIS trading at a ~90bps premium to the benchmark policy rate, RBNZ Governor Graeme Wheeler’s telegraphed hawkish rhetoric has been well understood by the marketplace; the swaps market now sees a ~90% chance +25bps hike by March.
Indonesia’s key idiosyncratic risk is its bloated current account deficit, which contributes to its rather poor Pillar I score on our propriety EM Crisis Risk Index. The results of July’s presidential election may serve to create consternation in the eyes of foreign investors; it could also lead to reform-minded admiration. Right now it’s too early to tell. From our purview, the key idiosyncratic risk to investing in the Philippines right now are its souring GIP trends and its lack of size/liquidity amid index-driven #EmergingOutflows. That said, however, its current account surplus and healthy score on our EM Crisis Risk index should protect it from experiencing material capital outflows. In New Zealand, the key idiosyncratic risk we see right now is the fact that the RBNZ may very well be the developed world’s most hawkish central bank over the intermediate term. While that may weigh on expectations for economic growth, it might also attract incremental capital flows that are very much needed to finance the country’s bloated current account deficit. Continued commodity reflation would also be a boon to New Zealand’s current account deficit financing (see our 1Q14 Macro Theme titled: #InflationAccelerating for more details).
Indonesia: Bullish TRADE/Bearish TREND. We’d like to see the EIDO ETF break out above its TREND line (~3% higher) before we allocate capital here. The immediate-term TRADE was built to front-run the TREND, so we like our chances of this occurring in light of Indonesia’s 1H14 rather positive GIP outlook.
Philippines: Demonstrably broken from both a TRADE and TREND perspective. Philippines’ sour GIP outlook would suggest selling/shorting the EPHE ETF at your leisure.
New Zealand: Bearish TRADE/Bullish TREND. We’d like to see the ENZL ETF recapture its TRADE line (~1.5 to 2% higher) before we allocate capital. If the TREND line holds, we’d be comfortable allocating capital to New Zealand as somewhat of a call option on continued commodity reflation. Moreover, we want to be exposed to likely appreciation of the Kiwi dollar.
Best of luck out there risk managing the gong show that 2014 has morphed into!
Associate: Macro Team
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Takeaway: The indicators in China look less than rosy.
In case you missed it, the HSBC China manufacturing PMI just came out showing a decline below 50. Not good.
The last time it dipped below this threshold was back in August. (A reading above 50 typically signals expansion, below 50 signals contraction).
On a related note, here’s an eye-catching chart from Hedgeye Industrials analyst Jay Van Sciver revealing weakness in Chinese construction materials prices.
Again, not good.
Van Sciver highlights falling inflation-adjusted average rebar prices (that metal rod used to reinforce cement) as an additional sign that fixed asset investment growth in China may be slowing.
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Takeaway: Don’t write-off outflows from EM funds as panic selling. In reality, the cycle has turned and most investors are just now figuring that out.
If you didn’t know the global macro super-cycle has turned, now you know. As most recently outlined in our latest EM strategy note titled: “NAVIGATING #EMERGINGOUTFLOWS: STRATEGY FROM THE SOURCE” (1/27/14):
“We remain broadly bearish on EM assets and continue to see them for what they are: overpriced relative to a long-term TAIL investment cycle that has clearly turned in favor of DM assets, at the margins.”
Contrast our view with that of Mark Mobius, chairman of the Templeton Emerging Markets Group (i.e. one of, if not the world’s largest EM fund umbrellas):
“People are enjoying what they see as a bull market in the U.S. As we go forward, we’re going to see a lot of overweight positions in the U.S. So, given the fact that emerging markets are still growing fast, given that they have low debt-to-gross domestic product ratios, given that they have high foreign-exchange reserves, we believe that money will be flowing back in again to emerging markets.”
We don’t write that to pick on Mr. Mobius, who has obviously had a very long and successful career managing EM assets. In fact, he probably forgets more about emerging markets on the way to lunch than I have ever learned as a quote/unquote “26-year-old-analyst” (ask @JimCramer for context).
Rather, we wrote that to juxtapose how our investment framework focuses on changes on the margin – particularly relative to expectations – versus the framework employed by many investors: i.e. a narrow focus on absolutes with a dash of consensus storytelling.
Another reason we wrote that was to show you where the quote/unquote “smart money” consensus likely still is with respect to EM assets. We know the quote/unquote “dumb money” has been pulling funds out of EM assets for 6-9M now and are doing so on an accelerated basis in the YTD. With respect to the current asset price cycle, you tell me who’s “smarter”?:
- “The MSCI Emerging Markets Index of equities is off to the worst start to a year since 2008, with about $468 billion erased from stocks this year.” – Bloomberg (1/30/14)
- “More than $7 billion flowed from ETFs investing in developing-nation assets in January, the most since the securities were created, data compiled by Bloomberg show.” – Bloomberg (1/30/14)
- “The iShares MSCI Emerging Markets ETF has seen its assets shrink by 11 percent, while the Vanguard FTSE Emerging Markets ETF is poised for the biggest monthly redemption since the fund was started in 2005.” – Bloomberg (1/30/14)
- “The WisdomTree Emerging Markets Local Debt Fund is on track for an eighth straight month of withdrawals… About $58 million has been withdrawn from the WisdomTree debt fund this month, bringing the total redemption since June to $752 million.” – Bloomberg (1/30/14)
- “Withdrawals from the iShares fund and the Vanguard ETF, the largest such products by assets for emerging markets, totaled $1.9 billion on Jan. 27, the biggest one-day redemption since 2005, data compiled by Bloomberg show.” – Bloomberg (1/30/14)
- “ETFs accounted for almost half the $2.5 billion outflows from emerging equities last week. So far this year, a net $4.12 billion has flowed out, amounting to three quarters of the total $5.7 billion that has fled, the fund tracker said.” – Reuters (1/27/14)
In the context of the sheer amount of dough plowed into EM assets over the last ~10-12 years amid Federal Reserve-style financial repression, we could see EM assets underperform by much more and for much longer than many investors currently think. This is how people get blown up buying the [perceived] bottom. Don’t buy the [perceived] bottom in EM assets – at least not until you get the green light to do so from the Fed.
- “Emerging markets have attracted about $7 trillion since 2005 through a mix of direct investment in manufacturing and services, mergers and acquisitions, and investment in stocks and bonds, the Institute for International Finance estimates.” – Reuters (1/27/14)
- “JPMorgan estimates outstanding emerging market bonds at $10 trillion compared with just $422 billion in 1993.” – Reuters (1/27/14)
- “Assets of funds benchmarked to emerging debt indices stand at $603 billion, more than double 2007 levels, it said, and over $1.3 trillion now follows MSCI's main emerging equity index.” – Reuters (1/27/14)
- “Assets of emerging equity ETFs tracked by EPFR Global ballooned to a peak of almost $300 billion, tripling since 2008 and up from next to nothing in 2004.” – Reuters (1/27/14)
- “Mutual fund data from Lipper, a ThomsonReuters service, shows that in the past 10 years net inflows into debt and equity markets was in the region of $412 billion.” – Reuters (1/27/14)
If you recall the following slide (#74) from our 4/23/13 presentation titled: “Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle”, this should all sound very familiar:
Net-net, investors have two choices when it comes to playing EM assets from here: 1) buckle up; or 2) pray to God that Janet Yellen backs away from the monetary tightening ledge. Moreover, the fact that so many institutional investors “have to be invested” in EM assets only insulates our bearish bias if things really take a turn for the worse because we haven’t actually seen any “real” selling yet…
Please feel free to ping us with any feedback or questions.
Associate: Macro Team
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