Archive for April, 2010
With the crisis in Greece and the downgrade of Spain’s debt the very same day, the timing could not have been more apt. As the meeting was conducted under Chatham House rules, I cannot go into details of who said what.
Suffice it to say, the mood was so uniformly pessimistic, I was extremely tempted to leave early and buy long dated call options on National Bank of Greece (NBG). (Don’t bother. The “vega” is way too high, and the options are very expensive).
But as I perused Moody’s research, I was reminded that there are patches of good news coming from countries that are getting the basics right.
The economic ne’er-do-wells of 2009- the ones that Moody’s downgraded in 2009 and 2010- include Japan, Latvia, Lithuania, Ireland, Hungary, Iceland, Ukraine, Jamaica, Barbados, Bermuda, Montenegro, and the Fiji Islands. Greece, Portugal and Spain have joined their ranks in 2010. For most of these, the outlook was also negative.
But these downgrades a have been balanced by upgrades in Brazil, Indonesia, South Africa, Philippines, Uruguay, Chile, Ecuador, Belize, and Lebanon. And the outlook for China, Turkey, Peru, and Hong Kong are all positive.
So what’s the “surprising secret?”
Well, truth be told, you don’t have to be a Jeopardy contest winner in geography to notice a pattern here.
Countries in Asia and Latin America are enjoying steady upgrades.
Japan and the countries on the periphery of Europe are getting downgraded left and right.
As it happens, I am long on the stock markets of Brazil, Indonesia, Chile, and Turkey in both my investment advisory services as well as client accounts at Global Guru Capital. And they are among the best performing stock markets in the world over the past 18 months.
Lest you think investing in countries with high credit ratings is a Holy Grail, remember that Hungary- last year’s “Greece”- has been also one of the best performers of 2010.
The lesson? It’s the “old world” of Europe – not the “new world” of Asia and Latin America- that is now forced to face its fiscal follies. But it’s also worth remembering, that- as the example of Hungary shows- economic conditions improving from “horrible” to just “bad” can yield big investment profits
After all, it wasn’t long ago that Brazil, Indonesia, and Turkey were the world’s biggest economic basket cases. And today they are the rock stars of global stock market performance.
Much like BRIC rival Russia, Pakistan has an image as global troublemaker. The country veers regularly between weak civilian and military governments, none of them particularly confidence-inspiring. It has threatened to use its nuclear arsenal against India and, until recently, was selling these secrets to North Korea, Iran and Libya. Outside of major cities like Islamabad, Karachi and Lahore, most of the country is in chaos. The Pakistani army is bogged down waging war against the militant fundamentalist Taliban in the tribal areas bordering Afghanistan. Baluchistan, a province that makes up almost half of Pakistan’s land mass, is home to yet another insurgency. Meanwhile, thousands of young men are training for jihad at radical Islamic schools that dot the country — all in support of Pakistan’s most famous (likely) resident, Osama bin Laden.
Yet, much like Russia, Pakistan also has been one of the top-performing stock markets over the past decade. Had you been able to invest in the Karachi Stock Exchange at the turn of the millennium, you’d be sitting on a much bigger pile of profits than, say, if you had invested in the “China miracle.” Pakistan offers yet another lesson in how gleaming skyscrapers offer little guidance in predicting future stock market performance.
Investing in Pakistan: Surprisingly Big
Teeming with 169 million souls, Pakistan is the world’s sixth-largest country by population. That makes it smaller than Brazil , but larger that Russia, as well as the “Next BRIC” candidates, Turkey, Mexico, South Korea and Egypt. Bordered by Afghanistan and Iran in the West, India in the East and China in the far Northeast, Pakistan is just about the size of France and the United Kingdom combined.
Pakistan’s real per capita GDP of about $1,250 makes your average Pakistani slightly poorer than his counterpart in India — and far behind the average in booming China. One third of Pakistan’s population lives in poverty, and only half of the population is literate. Yet, Standard Chartered bank estimates that Pakistan has a middle class of 30 million that now earns an average of about $10,000 per year. And adjusted for purchasing power parity (PPP), Pakistan’s per capita GDP approaches $3,000 per head. But take away that bit of economic affirmative action, and Pakistan’s economy drops from the size of New Jersey’s down to that of Alabama.
Investing in Pakistan: Edgy Relations with Uncle Sam
In the bad old days of the Soviet Union, Pakistan was a major U.S. ally. That relationship soured after the United States imposed sanctions on Pakistan after it refused to abandon its nuclear program. The “War on Terror” changed all that. After Pakistan ended its support of the Taliban regime in Kabul, American economic and military aid to Pakistan soared to more than $4 billion within three years of the 9/11 attacks. Indeed, American aid has played no small part in helping Pakistan’s economy flourish over the past decade or so.
But as with most forms of handouts, gratitude is the least heartfelt of emotions. Anti-Americanism in Pakistan’s free media is just about as virulent as neighboring Iran. The Wall Street Journal’s Pakistan correspondent was ejected from the country after being charged with spying for the United States and Israel. The U.S. State Department advises U.S. citizens not to visit the country and has forbidden the families of its diplomats in Pakistan to visit since 2002.
Investing in Pakistan: A Solid Start to the Millennium
Economically, the first decade of the 21st century has been good to Pakistan. Thanks to economic reforms introduced in 2000 by the former Musharraf government, Pakistan has privatized $5-billion worth of assets, simplified its tax system and attracted large amounts of foreign direct investment (FDI) compared to its GDP. By mid-2005, the Pakistani economy was growing by 8.6%, and the World Bank named Pakistan as the top reformer in its region and among the top 10 reformers globally.
That changed abruptly with the onset of the “Great Recession.” Pakistan’s ensuing balance-of-payments crisis and runaway inflation forced the IMF to step in, and offer a $7.6-billion emergency financing package in late 2008. To its credit, the Pakistani government kept its side of the bargain, maintaining its foreign exchange reserves above target and its fiscal deficit below. The Pakistani economic crisis has eased substantially, and in 2010, the economy is expected to grow at least 4%.
Investing in Pakistan: Limited Access for U.S. Investors
There are all sorts of reasons why U.S. investors are unlikely ever to go gaga over investment opportunities in Pakistan. But surprisingly, other investors have. The stock market index in Karachi has risen by more than 1,000% since 1999. And in 2002, Pakistan was the top-performing stock market in the world.
But even if you develop a rare appetite for Pakistani stocks, they are not easy to access, even by frontier market standards. There are a handful of Pakistani stocks that are traded over the counter in the United States. And Pakistan Telecom has been a core holding in many emerging-market funds for many years. Claymore’s BNY Mellon Frontier Markets ETF ( FRN ) has an allocation of only 0.5% to Pakistan. The most recent addition to the Pakistani investment palate is Global X Management’s announcement that it intends to launch a Pakistani ETF in the near future.
Bottom line? Pakistan has a long way to go. The Commission on Growth and Development once estimated that Pakistan needs 159 years to catch up with industrialized nations. But two years ago, Merrill Lynch’s Chief Asia Strategist picked Pakistan as his top investment prospect among the world’s frontier markets. And as the performance of Pakistan over the past decade has shown, big investment profits can lie in the most unlikely of places.
The S&P 500’s rally of 8.6% this year notwithstanding, the all-stars of the hedge fund world are having a rough start to 2010. Now these hedge funds aren’t the industry’s one hit wonders. They are the Babe Ruth’s of the game. Moore Capital management- whose Louis Bacon has his London digs (OK…more like a palace) right around the corner from me- has only posted gains of 1.58% this year- despite climbing to the top of the U.K.’s “hedge fund rich list” this year with a personal fortune of 1.1 billion British pounds. Last year’s star of the hedge fund the London scene, emerging market manager Greg Coffey who famously left a $200 million bonus on the table at European hedge fund GLG back in 2008- was down 5.88% into mid March. Having recently sat next to the senior macro trader at Tudor Investments at a recent dinner at the swanky Carlton Club, the mood there is scarcely better. Turns out the Tudor BVI Global fund was down 0.55% to mid-March.
This sub-par performance has left investors scratching their heads.
Here are my thoughts. Unlike retail investors, global macro hedge funds- or “multi-strategy funds” aren’t necessarily focused on the U.S stock market. Global stock markets- including emerging markets and the formerly high octane BRICs– are barely above water this year, thanks in part to the rallying U.S. dollar. Few financial bets- except maybe a bet against the euro and the GBP- have yielded big payoffs.
But the real reason is hedge funds are struggling is that hedge fund managers look at risk in a fundamentally different way than retail investors, for whom “buy and hold” remains the dominant investment mantra- the strategy that has worked best over the past 14 months. But after a paradigm shifting 2008, hedge funds are understandably skittish. They are (rightly) worried focused on the downside risks- whether financial contagion from Greece or another “Black Swan” event which by definition they cannot predict.
That’s why many funds went into defensive mode after the sharp sell-off in January. And they have been scrambling to recover ever since, as the market has turned back up. And after an eight consecutive weeks rally in the U.S. markets, the sharpness and suddenness of the January sell-off has faded into distant memory. For U.S. investors glued to the live video game that is CNBC, “fear” has rapidly transformed into “greed.” As the economist John Kenneth Galbraith observed: “The financial memory is very short.”
Isolated pockets of emerging economies are surprisingly wealthy. When I visited Moscow this past fall, it struck me at how much wealthier it was than I had expected. Turns out I wasn’t wrong. A back of the envelope calculation on Moscow’s economy showed that Moscow has a per capita GDP that worked out to over $33,000. The U.S. average is around $45,800. To be fair, that number was distorted by the fact that in 2008, Moscow had 74 billionaires with average wealth of $5.9 billion, which placed it above New York’s 71 billionaires. The median number is likely a lot lower than the mean. And Moscow’s number of billionaires plummeted as a result of the financial crisis. But the point still stands: the wealth of BRIC countries is not just a promise of the future. It’s a reality already today.
Egypt evokes images of the Great Pyramid at Giza , the Nile River and the vast expanse of the Sinai Peninsula. Egypt’s population of 83 million also makes it the Arab world’s most populous country. The Nile River is the lifeblood of the country, and most of Egypt’s population is concentrated within 20 miles on either side of the world’s second longest river. In terms of economic heft, Egypt’s Gross Domestic Product (GDP) of $452.5 billion in 2008 makes its economy roughly half the size of Turkey — and about as large as the state of Ohio.
Although Egypt is unlikely to ever take its place alongside dynamic economies like Indonesia, Mexico, and Turkey as the next BRIC economy, Egypt offers a good example of how the combination of deregulation, free-market reforms and generous financial support by the U.S. government can help nudge an Arabic country out of isolation into the global community of nations.
I have visited Egypt half a dozen times over the past decade or so, including the cities of Cairo, Luxor, the resort town of Sharm El Sheikh and the ancient city of Alexandria. My overall impression? Despite progress over the past ten years, Egypt remains a scruffy, haphazard place. Cairo’s bustling central market lacks the sophistication of the Turkish capital, Istanbul. You spend a lot of time fending off cries of baksheesh from local “guides” and beggars. Las Vegas-style real estate developments dot the outskirts of the capital city. Hand-painted billboards advertising preparation for U.S. college admissions exams line the highways. Surprisingly, my most lasting impression of Egypt wasn’t the pyramids of Giza, but the most recent incarnation of Alexander the Great’s ancient library of Alexandria, a striking piece of architecture that cost more than $220 million to construct. Although our tour guide’s assertion that the library was among the three largest libraries in the world proved to be an empty boast, the library’s censored collection of books is an impressive, though incongruous, monument to man’s spirit of inquiry.
Benefiting from U.S. Support
Politically, Egypt is a linchpin in U.S.-Middle Eastern politics. No wonder Barack Obama chose Cairo to deliver the first major speech of his young administration last June. That said, Egypt isn’t exactly a hotbed of U.S.-style democracy. President Hosni Mubarak is head of what effectively is a single party in an authoritarian state — though one that likes to present itself as a stable and reliable Western ally.
Economically, Egypt has benefited tremendously from huge amounts of U.S. foreign aid, trade and investment since Camp David Accords. In 2006, Washington provided $1.3 billion in annual military aid, equal to 80% of the Egyptian military’s budget. Two-way trade totaled $8.5 billion last year, having grown by 10-15% annually since 2004. U.S. foreign direct investment in Egypt amounts to about $7.5 billion. Only Israel benefits from more U.S. largesse.
…and Some Free-Market Reforms
Even if indirectly, U.S. influence has pushed Egypt toward free-market economic reforms. Beginning in 1991, Egypt has relaxed price controls, trimmed subsidies, reduced inflation, cut taxes and partially liberalized trade and investment. The public sector no longer dominates heavy industries. Construction, non-financial services, and domestic wholesale and retail trades are largely private. Agriculture is mainly in private hands.
The result? Egyptian GDP has grown steadily over the past three decades. Per capita GDP more than tripled from $1,355 in 1981 to an estimated $4,535 in 2006. As a result, the World Bank has graduated Egypt from the “low income” to the “lower-middle income” category.
Egypt also weathered the “Great Recession” fairly well, with economic growth slowing only to 4.5% in 2009. The economy grew a better-than-expected 5.1% in the fourth quarter. Just to make sure the country’s economic growth remains on track, the government plans to spend $2 billion on infrastructure projects in the coming year.
Making Money in the Land of the Pharaohs
As a mutual fund manager in London during the late 1990s, I invested in Commercial International Bank of Egypt — the first Egyptian stock that was available to foreign institutional investors. But Egypt is still a relative latecomer to the emerging markets game — and even more so for U.S. retail investors. Market Vectors launched an Egyptian ETF, the Market Vectors Egypt Index (EGPT), on Feb. 16. Since then, its performance has been choppy and mixed.
The largest sector allocation in the fund is financials, with a 42.4% weighting, followed by telecommunications (17.3%), industrials (15.9%) and materials (14.2%).
Bottom line? Egypt is an unlikely candidate for the title of the “next BRIC” economy. That said, a few years ago, the Arab markets, including Egypt and Saudi Arabia, were the top-performing stock markets on the planet. The addition of the Market Vectors Egypt ETF to your palette of investment opportunities will allow you to take advantage of the next boom in Arabic markets when it arrives.
Until then, there are bigger fish to fry in the world of the next BRICs.
Yesterday, I came across the September, 2009 issue of the CFA Institute’s Conference Proceedings Quarterly. In it, I re-read the text of Nouriel Roubini’s (aka “Dr. Doom’s”) predictions made at the CFA Institute Annual Conference on April 26th, 2009 concerning the global economy over the coming 18 months or so.
For an economist who made his reputation as the intellectual renegade who accurately predicted the collapse of the global economy, Roubini’s assessments for the year ahead were astonishingly off the mark.
1) Roubini’s projected economic growth rates in the U.S. in Q4 to be -2%.
Reality: Growth rates hit 5.6% in Q4 of 2009. Roubini was off by an eye-popping 7.6%.
2) Roubini’s projected economic growth for the U.S. in 2010 was 0.5%- above the IMF’s projection of 0%.
Reality: Today, the IMF’s predicted growth rate for the U.S. in 2010 stands at 3%.
3) Roubini dismissed the then “green shoots” of economic recovery in the global economy by stating: “The United States is not at the end of a severe recession.”
Reality: Robert Gordon of Northwestern who sits on the National Bureau of Economic Research – the official body that is responsible for setting an end date to the recession – stated last week that indicators of industrial production, manufacturing and other economic variables pointed to last June as the trough of the contraction- just five weeks after Roubini gave his speech in Orlando.
4) Speaking after a 25% rally since the March 9th lows, Roubini wrote: “Worse than expected macro news, worse than expected earnings news, worse than expected financial shocks indicate we have not yet reached the bottom of the economic contraction, which means that the current rally is indeed a bear market rally.”
Reality: The S&P 500 has rallied from a low of 666 to over 1200 in the last 14 months.
At times like this, I keep returning to George Soros’ throw away comment in an interview with John Train many years ago.
“My system doesn’t work by making accurate predictions. It works by recognizing when I am wrong.”
Yogi Berra’s famous quip embodies the dilemma of financial prognostication. For all the gallons of (virtual) ink spilt on where the market will be trading a year from now, it’s startling how few of the “no brainer” predictions made by the world’s top analysts come true. Luckily, few of them — whether relative upstarts like Nouriel Roubini or eminence grises like Richard Russell — ever have to answer for the accuracy of their calls. Sadly, life’s a bit tougher for those of us who actually manage money for a living.
You only have to think back to one year ago, when everyone from the mainstream media to super speculator George Soros dismissed the then-two-week-old pop in the S&P 500 as a “sucker’s rally.” Financial Armageddon was still on the horizon. Both U.S. Treasuries and the U.S. dollar were set to go off of a cliff. Gold bugs gleefully projected that Keynes’ “barbarous relic” would hit $2,000 an ounce before the end of 2009. The only stock market even worth considering was the economic juggernaut that was China — the savvy savior of the global economy that could do no wrong.
Fast forward to today and the world is a very different place. The S&P 500 is up almost 73%. U.S Treasuries are broadly flat. And the U.S dollar has rallied more than 5% during the last six months. And the Shanghai stock exchange is among the worst-performing stock markets on the planet since it peaked in August.
The bottom line? Pursuing the simplest strategy — staying “dumb and long” — has been the single best moneymaker over the past year. Yet, you’d be hard pressed to find any financial prognosticator, who also manages money for a living, who made that call 12 months ago, though, to be fair, both Warren Buffett and the United Kingdom’s Anthony Bolton did so in October 2008.
Being reminded of how badly the top investment themes of a year ago fared 12 months later won’t instill any modesty in us professional prognosticators.
None of us is ever wrong. We’re just early…