By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
Are we on the precipice of another spasm of intercontinental contagion in the emerging markets like 2018, or the Asian flu, Russian rouble default or the Turkish banking crisis in the 1990’s. Yes. The Shanghai Composite Index has plunged 12% and (17% fall for Shenzhen) since Trump got nasty on the tortuous US-China trade dialogue. The IMF cut its global growth forecast to 3.3% – and EM is an asset class that is a growth warrant on global liquidity. Have the lights gone out for global liquidity? Yes. The Turkish, lira, Argentina peso and Pakistani rupee are all down 18 – 20% in the past year. King Dollar is on a roll almost 98 on the Dixie (DXY) index, thanks to the sad sack Euro, sterling and commodities currencies.
The Volatility Index just doubled to 23 as global equities had a nervous breakdown on Wall Street as Trump threatened tariffs on a China deal. This time the wolf is here and emerging markets is Little Red Riding Hood, innocent, clueless and ripe for the slaughter. If the US-China talks break down, expect the US dollar to soar against EM currencies and a safe haven bid emerge in US Treasury bonds, to the detriment of sovereign junk debt from the Third World. Uncle Sam’s IOU’s are the only global safe haven when USS Abraham Lincoln, an aircraft carrier, with F-18s and Tomahawks sails for the Gulf to confront an Iranian regime that has threatened to mine the Gulf of Hormuz and order Hezbollah to rain its ballistic missiles on Israel in a ghastly replay of July 2006.
Wall Street folklore argues that the big money in emerging markets is made when things go from Godawful to just plain awful. It is impossible for the Federal Reserve to be dovish about interest rates when the unemployment rate is 3.6%, the lowest since 1969 and the US economy added 263,000 in April 2019, way above the 190,000 Bloomberg consensus.
Muted inflation? Sure – for now. Yet the PCE data comes out with a three-month lag and Brent crude is up 40% in the past four months. Net net, the rationale of the Powell Fed’s dual mandate dictates a rise in interest rates this autumn. Is monetary tightening and a new economic Cold War with China (Huawei CFO is under arrest for violating US sanctions against Iran) remotely priced into emerging market valuations? No. True, the Fed hinted at rate cuts in the last two FOMC conclaves – but the Fed is data dependent and reactive under Chairman Powell. If the US economy remains white hot, Powell could well signal a rate hike at the October FOMC.
The global emerging markets village does offer high risk, high yield debt. It is possible to earn 10% in Turkish or Omani telecom bonds at a two times leverage. The Sisi government has slashed inflation to 12%, enacted privatizations, attracted $45 billion in hard currency reserves and offshore capital from Wall Street’s biggest macro hedge funds to its Misr T-bill auctions (17% LCD yields. Yummy!).
Egyptian banking stocks are a play on the sheer growth potential in a 100 million people Arab state that has been dominant since the Pharonic, Byzantine, Ummayad, Abbasid, Seljuk, Mumluk, Ottoman, Mohammed Ali Pasha and post 1952 Free Officer military regime eras. Egyptian GDP growth is 5.6% in 2019 and MSCI Egypt trades at 9.8 times earnings with the prospect of 15% EPS growth. This is a compelling argument for me to buy the Arab tiger on the Nile – and, yes, the Arab tiger on the Tigris/Dejla. Mark my words, we will see an epic bull market in Misr T-bills and banking shares in 2019. That much, at least, is certain.
As Aramco proved, there is a global scramble to acquire Saudi assets now that the kingdom’s current account deficit has fallen to 4% now from 15% in 2015 and the State Budget is more fiscally expansive relative to GDP than the petrodollar bonanza budgets of late King Faisal and Khalid in the mid 1970’s.
The Russian at 67 rouble offers the best volatility adjusted carry revenue in the emerging markets constellation. The political risk of US sanctions/Crimea and the Kremlin succession to Tsar Vlado is priced in to current levels. As inflation falls and oil prices surge, the Central Bank will cut policy rates and Sberbank/Rosneft Eurobonds will print money for punters. Spasiba Bolshoi Tovarich Rasputin! Russia offers the cheapest assets in the Milky way but its thousand-year history teaches me that the ugly stepsisters and not Cinderella win the prince at the fairy tale ball. Lenin proved this tragic existential fact in the October Bolshevik coup d'état that ended the empire of the double headed eagle.
All quite on the Kashmir front, for now (sort of). The Indian rupee could well depreciate to 73 – 74 if Iran tensions escalate into an oil shock and US-China trade unnerves financial markets. Even a BJP win with a reelected Modi may not be sufficient to ignite a sustainable rupee rally against King Dollar.
The economist who engineered Egypt’s draconian 50% devaluation in November 2016 has been imported by Pakistan to implement the IMF’s mandate for a free float FX regime as the governor of the State Bank in Karachi. Dr. Raza Baqir will abandon Bajwa’s managed float and the Pakistani rupee will depreciate to 160 – 170 even as the KSE 100 index falls to 30000 as I predicted months ago, 2019 is the year of living and trading dangerously in the Land of the Pure!