Greece fails to form a government space and takes another step towards euro-exit
Emerging Markets equities trading down in a classic risk-off fashion
We Still Like Russia and Chinese H-shares based on liquidity and valuation
India's policy machine is undermining the Sensex and INR
Gold's behavior since Q3 last year resembles a risk asset
Regardless of price, gold should form part of long-term portfolio plans
The failure of Greece to agree on a convincing government opens the door to a
prolonged period of increased political uncertainty in southern Europe. It hardly needs
stating that the world economy is now two years into a European debt crisis and it
doesn't appear to be anyone in European political circles with a clear plan. The
absence of a government in Greece makes it ever more likely that the country will
sooner or later be forced to admit that it cannot service its obligations. Default will
inevitably follow, and probably exit from the Eurozone thereafter. Investors thinking that
this is a quick win with little pain on the other side should consider that one default and
exit will trail blaze the path that allows others to follow. The road to a permanent
solution to Europe's property, banking and government debt problems is a long one and
stretches far into the distance.
It is against this backdrop that markets in both the developed and less-indebted
emerging nations are going through another period of risk aversion and the continuation
of moderate volatility. Month-to-date developed country equities have fallen 3.9% while
in emerging markets equities declines have been much more severe. Ukraine has lost
almost 11%, Russia is down 9.5% and Hong Kong's China H-share market has given
up 80% of its year-to-date gains. H-shares have lost almost 9% month-to-date. Being
cheap, relative to history and relative to EM benchmark valuations has not helped
markets avoid the move back out of risk assets.
A number of equity markets have not been helped by recent growth numbers and
decisions in taken in political circles. Russia's imposition of higher taxation on gas
companies has hurt the hydrocarbon sector. The drop in Brent crude from USD125pb
to USD110 has also had an impact. In India, fiscal uncertainty and changes to tax laws
has increased financial uncertainty into equity markets. The announcement today that
India's wholesale price inflation rate has risen from 6.7%y/y in March to 7.2%y/y has
undermined calls for the Reserve Bank of India to cut interest rates further and more
quickly. India's capital expenditure has been hurt by high interest rates and tight
liquidity. Rising inflation is not a welcome addition for Indian equities and bonds.
Unsurprisingly, INR continues to face selling pressure, despite measures introduced by
the RBI last week to increase demand for local currency by forcing traders to convert
foreign currency earnings into rupees.
China's H-share market has been undermined largely due to growth concerns in the
world's second largest economy and fears that the PBOC will not begin to loosen
monetary policy quickly enough to insure against a slowdown. There is no need to
repeat at length that China's property market decline is policy-induced. It is important to
repeat that China's overall data is reasonably encouraging. Exports growth to the
European Union has clearly stalled, but exports to the rest of Asia and to the Americas
continue to hold up well. The concern gripping markets though loan data which came in
well below market expectations in March. The PBOC responded quickly over the
weekend by imposing a further cut in the banking sector's reserve requirement. Seen
as a knee-jerk reaction to bad news, a loss of faith in China's equity market has been
swift.
From a tactical perspective we continue to see reason for holding positions in Russia
and China's H-share markets. Russian equities are trading at less than 5x forward
earnings and growth remains well supported by energy prices. Unless there is a
sustained downswing in oil prices or the re-emergence of political instability liquidity
models continue to point towards higher equity prices. Russia, like all emerging
markets, suffers during periods of risk aversion. But the combination of attractive
valuations and abundant liquidity makes for a compelling story. China's H-share market
has different dynamics but similarly attractive valuations. Not driven by hydrocarbons,
China's market relies on growth signals and monetary expansion. With the exception of
the most recent loans data, much of the recent data from China has pointed towards a
bottoming out of its growth profile in Q4. With M3 growing well in excess of real
economic activity, there is plentiful funding available for equities.
Lastly, gold's heavily falls since end-April. Since mid-Q3, when equity markets turned
on better US economic data, the price of gold has essentially followed risk appetite.
When markets, particularly equity markets in the emerging world, gained quickly in
October and into early November gold rose by USD200/oz to USD1,800/oz thereafter to
give back all its gains by year end. In the market boom of January and February, gold
once again rose by USD200/oz and has almost given back all of its gains. It is tempting
to believe that a continuation of risk-aversion makes for lower gold prices. Here, it is
important to re-state the view that gold should form a portion of all portfolios, not as a
trading asset but as a store of value and one which is a hedge against inflation or
financial distress. Regardless of the purchase price, gold should be in long-term
portfolio plans.
Mark McFarland
smark@emiratesnbd.com
+971.4. 609.3560
© Press Release 2012
