Rise in treasury yields may prove disastrous for countries like Turkey and South Africa, writes Matein Khalid
I had written about Chinese shares and the "Politburo Put" in a Asia strategy column two weeks ago, musing if the central bank easing (the Politburo Put, as expressed in a rise in the M2 money supply, fall in Shanghai interbank money market rates, corporate credit bond swaps) meant if it was time to buy Chinese shares at distressed valuations. It obviously was. China is up seven per cent in the past two weeks after one of the most brutal valuation deratings since Shanghai peaked above 6,000 the Composite Index in 2011.
Will the Chinese rally continue? Yes. One, the Politburo has decided on easy money and an expansion of fiscal policy after three years of austerity.
Two, Chinese banks, telecoms and energy shares trade at valuations that are below October 2008 levels, when Lehman had failed and the world economy was in free fall.
Three, rail freight rates have finally began to rise, as have container shipping indices and ports throughputs.
Four, Chinese PMI are moving higher, so the Politburo Put has goosed economic growth.
Five, the world's fund managers are still underweight China and since India is expensive, Brazil is dodgy and post Crimea, post Ukraine, post sanctions Russia uninvestible, China is the macro flavour de jour.
Six, even after the July rally, MSCI China still trades at nine times earnings if earnings growth is in the seven-eight per cent range.
Seven, Chinese export growth has begun to rise.
The strategy to make money in 2014 was to either buy a stellar macro theme (is Taiwan an emerging market? Am I a humanoid?) or political/reform catalyst markets, such as India and Indonesia. These three Asian markets provided alpha with a vengeance though I regret I missed the eight per cent pop in Brazil last month, given that my focus was on the EstÁdio MaracanÃ and not the Bovespa index.
I believe the inevitable rise in US Treasury yields will also prove disastrous for countries like Turkey and South Africa, since current account deficits transmit credit shocks via hot money capital outflows.
Remember May 2013? Last summer proved Armageddon for emerging markets. So if an emerging market has a current account deficit, I am cherry picking strategic shorts in currencies and banks. Where? The Bosphorus, the Rand, Mother Rus, the Straits of Malacca! I argue that the classiest emerging markets are those that benefit from a stronger US economy, a steeper Uncle Sam yield curve, export growth and expansionary fiscal policies/current account surplus. This means I have to be bullish Taiwan, Mexico, South Korea and Saudi Arabia (a $780 billion economy not in MXEM index! Wow!).
I invariably look at China, the US Treasury yield curve, earnings revision/macro high frequency data and commodities in my tactical paradigm in emerging markets. So the high beta markets made total sense once the US Treasury 10-year note yield fell to 2.60 per cent (and now 2.46 per cent) while China PMI rocketed higher after the Golden Week.
Indonesia has been the winner market in 2014, up 28 per cent. Russia has been a disaster after Crimea, Flight 17, sanctions. However, I am prouder of a 16 per cent return in Taiwan on my published calls than a 29 per cent return in Indonesia since, frankly, nations which are corrupt/unstable can never make credible long term investments.
I have been a fan of Singapore shares, even if for no other reason than we both share the same birthday August 9. However, I believe Singapore's Straits Times Index is now overvalued at 15.4 times forward earnings. Singapore's earnings revision momentum is negative even though DBS, Noble and Mapletree Logistics Trust beat, though Singapore Airlines, Neptune Orient, StarHub and Wilmar did not. Consensus EPS growth in the seven-eight per cent range is now unrealistic.
The Straits Times index has lagged the go go Southeast Asian markets in Jakarta, Manila, Bangkok and Hanoi even before last week's Wagnerian sturm und drang. Higher US Treasury yields are a kiss of death for most Singapore REITs. Singapore's cost curves and labour bottlenecks will hit exports. I will not be surprised to see the Sing dollar fall to 1.32. The banking system faces a leveraged consumer time bomb. Even at the risk of being dissed next time at Changi, long China/Taiwan, short Singapore is my Asia strategy.
Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at: email@example.com