“The financial system is broke and we are all doomed.” So says Marc Faber, making yet another splendidly bearish splash in his monthly GloomBoomDoom investor newsletter following his appearance last week at the CLSA investors’ conference in Tokyo.
Of course, he adds, impending destruction shouldn’t distract us from trying to preserve wealth as well as possible. Remember, he says, before declaring sovereign defaults, governments will do what they always did in the past: print money.
As he told Bloomberg in Tokyo last week (videos here, and here) Faber warns that equities are not great value. But, he asks this week, is cash better value at zero interest rates when health care and educational costs are rising at double digit rates?
Also at the Tokyo investment forum, Faber was joined by another famously bearish commentator, CLSA’s own Christopher Wood, taking a similarly dim view on some asset classes – although not surprisingly, Wood boosted gold as well as some Asian and other EM stocks. He also warned of China’s spiralling asset bubble and – oh yes, a possible sovereign debt crisis looming in Japan.
Not to be outdone, Harvard economist Ken Rogoff also warned the forum about more sovereign debt crises to come as well as an impending financial crisis in China that may trigger a regional slump in Asia.
But in the past week, the FT has highlighted two striking trends in emerging markets that could augur well for some investment asset classes – including local currency bonds – and not so well for others.
Even as growing investor caution about possible big interest rate rises in EM economies fuels fears of a stock market sell-off, EM local currency bonds are gaining popularity among investors, the FT reported last week.
So popular, in fact, that “even the most cautious of institutions have developed an appetite”, the report addded.
In Asia, at least, the appetite is indeed, robust, as FT Alphaville noted last month, with outstanding local currency bonds topping $4,200bn at end-September 2009, according to the Asian Development Bank’s latest figures.
Meanwhile, adds the FT, US pension funds are planning to pour almost $100bn into EM debt in the next five years, according to JPMorgan.
This potentially will help push yields relative to US Treasuries to a record low. But while spreads on dollar-denominated EM bonds have narrowed to levels last seen before the collapse of Lehman Brothers, local-currency denominated EM bonds, such as the Brazilian real, present investment opportunities, Alexander Kozhemiakin, director of emerging market strategies at asset manager Standish, told the FT.
For one thing, say Kozhemiakin and other EM watchers, local currency EM bonds appeal to both retail and institutional investors seeking stronger returns and diversification away from dollar assets.
On top of that is the somewhat ironic view, in light of the Greek debt crisis, that emerging markets present a more secure alternative amid concerns about the creditworthiness of governments in the developed world.
Michael Gomez, co-head of emerging markets and portfolio management at bond giant Pimco told the FT:
“More and more investors are looking to emerging market local bonds as an alternative to standard global bond allocations, as the problems in Greece and the European periphery highlight the credit risks of that market that have been long underpriced.”
He cited the 7.2 per cent yield on the JPMorgan GBI EM Global Diversified Index in noting that yields on local currency EM bonds remain attractive.
On the EM downside, as highlighted in a separate FT analysis, the withdrawal of cheap central bank money in the industrialised world coupled with fallout in the eurozone over the Greek debt crisis could combine with sharp EM rate rises to dent overall investor confidence.
Significant rate increases are being forecast in Brazil, Turkey, Mexico and India, the FT adds. Brazilian forward markets are pricing in a 256bps rate increase to 11.50 per cent by the end of the year.
Turkish markets, meanwhile, are pricing in a 186bp rise to 9.05 per cent and Indian markets a 119bp increase to 4.66 per cent. Mexican markets are currently pricing in a 115bp rise to 5.81 per cent by the year-end.
In China, bank lending rates are not expected to rise sharply, although Beijing – grappling with the risk of an over-heating economy – is moving to tighten credit by raising capital reserve requirements for commercial banks, among other measures.
That comes on top of growing speculation about a revaluation (upwards) of the renminbi by as much as 5 per cent against the dollar by the end of the year.
All this is likely to take the edge off EM equities, which have rallied in the past year to strongly outperform the developed world – and possibly even drive a sharp correction.
That, in turn, could also weigh on EM dollar-denominated bond markets. But, any significant monetary tightening should also boost Asian EM currencies, which could well help the prospects for EM local-currency bonds.
Also on the downside, though, is the ever-present possibility that a fresh bout of risk aversion in global markets triggers a sharp sell-off in EM debt.
But Jerome Booth, head of research at Ashmore Investment Management, believes that currency appreciation will be the main source of return for local EM debt portfolios in the medium term, saying, as the FT reports:
“The only questions are when it starts and whether it happens fast or slow: with old world currency crashes or managed adjustment,” he says.
Booth also argues that local bonds are the best insurance against a dollar crash, saying they are “much better than gold, which is a volatile non-yielding commodity and, like US Treasuries, with a homogeneous concentrated central bank investor base.”
He sums up:
“Arguably, and especially in the worst-case environments in the US/Europe of depression – which despite some current complacency is still a significant risk – emerging market local currency debt is the safest asset class in the world.”
Related links:
Asia’s booming bond markets - FTAlphaville
Asian central banks signal a tightening trend – WSJ
Emerging economy bond markets – Urbanomics
Investment Outlook – Doo-Doo Economics – Pimco
Asian local currency bonds are looking pretty good – FTAlphaville