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Macro ideas in Asian currencies, crude

|By Matein Khalid| Even as China’s President meets the capo di tutti capi in Seattle, its manufacturing PMI falls to 47, a post Lehman low, with new export orders in a slump. I found it significant that the offshore yuan fell 200 pips to 6.4346 after the PMI. This proves my core argument, outlined a month ago. The Middle Kingdom will respond to its economic decline and financial market carnage with massive credit creation, exactly as it did in 1989 (Tiananmen), 1997 (Asian flu) and 2008 (subprime/Lehman). King Dollar gutted the competitiveness of Chinese exporters since mid 2014. The Politburo and the PBOC cannot allow this to happen again. Expect the yuan’s decline to accelerate to 6.56 by year end 2015 and 7.20 by end 2016. Like the Fed in 2008, or the ECB in 2014, the Chinese central bank has recalibrated policy to “lender of the last resort” mode.

The most obvious macro trade from the China PMI is to short Brent crude as history’s biggest, most energy intensive economy slows down. This is no idea for widows, orphans or those who do not understand contango/rollover risk in the crude oil futures market but 50% plus Brent volatility is a license to print money selling high delta ICE Brent calls if a trader is convinced that the primary trend is bearish, as I am. I would not be surprised if Brent crude falls to $40 by December 2015.
I once invested in the Singapore dollar as a proxy for a rising Chinese yuan after July 2005. Now the macro trade de jour is to sell the Malaysian ringgit on China data shock. Malaysian is both Southeast Asia’s largest oil/LNG exporter, a tin/rubber/palm oil exporter now mired in its worst political crisis since former PM Mahathir jailed Anwer Ibrahim in 1998. The Malaysia ringgit has plummeted 19% against the US dollar even though its current account surplus is 4% of GDP. A weak China, terms of trade shocks and competitive devaluations in Asia mean Malaysia cannot “export” its path to higher growth via a cheaper ringgit. The MDP sovereign wealth scandal has now escalated into an international money laundering investigation. The respected Bank Negara governor Zeti Akhtar Aziz will retire soon. I see no reason why the Malaysian ringgit will not test Asian flu lows near 4.80 against the US dollar.
India has Asia’s lowest trade exposure to China at only 5% of exports. Yet India is vulnerable to a global capital exodus from emerging markets since it was the consensus overweight by 500 – 800 basis points ever since the BJP vanquished Congress in the May 2014, general election on the eve of an epic plunge in crude oil, a $50 billion gift to the Indian current account. As offshore capital fled Dalal Street since August, the Indian rupee has depreciated 5% to 66 against the US dollar as the Sensex dropped 12%.
While Indian exports will not be immune to slower global growth and the iffy monsoon did not goose rural demand, capex/infrastructure is robust and can lead to a reacceleration in Indian GDP growth to 7.5%. India is not only the fastest growing major economy in the emerging markets but has minimal external debt, unlike Turkey, Brazil or South Africa. Inflation has fallen below 4%, Modi promises to slash the public deficit black  hole and the current account deficit has narrowed since the August 2013 taper tantrum/rupee crisis. In my macro crystal ball, I see the Reserve Bank of India cut its 7.25% repo rate on September 2015. This makes me hugely bullish G-Sec debt and Indian bank shares, as my arguments on the bullish case on ICICI Bank demonstrates. Note that India’s reserves have risen while China lost $600 billion, a testament to the vast wealth of the global NRI diaspora. This is the signal to buy Indian rupee against the yen, the won and the ringgit as central banks print money in Tokyo, Seoul and KL.
The Canadian dollar has hit new lows below 1.3325 despite positive data surprises. The reprieve from no September FOMC rate hike did not last. Hilary Clinton’s opposition to the Keystone pipeline is another loonie negative data point while Ontario/Quebec’s debt louds are scary in an economy in technical recession. I had recommended shorting the Canadian dollar last summer at 1.06 for a 1.35 target by year end. Canada now trades at 1.3350. This macro trade idea continues to print money as the cognoscenti go loonie hunting on Planet Forex!
Market View – The Volkswagen AG short ideas was a winner!
The only thing more shocking than Volkswagen AG’s emissions software scandal was the public execution of its shares in Frankfurt. I had recommended a short on Volkswagen at €182 for a €150 target. The fraud at Wolfsburg has slammed the shares to €112. The loss in market cap far exceeds the $18 billion fines the company faces but litigation is now a sword of Damocles on the shares. This will have a horrible, negative impact on the global VW, Porsche and Audi brand, hit German economic growth (one in seven workers employed in the auto industry) and gut the valuation of global auto stocks, down 20% from their spring 2015 highs. The sector was under pressure from China’s shock yuan move, the plunge in Asian currencies, recession in Brazil and Russia in any case. Yet if any sector defines Lord Rothschild’s recommendation to buy when there is “blood on the street”, European auto is it.
It is far too speculative to bottom fish in Volkswagen AG or its core US suppliers BorgWarner, Tenneco and Delphi. The CEO who allowed cheating on EPA emissions test is toast and Wall Street will punish the shares, as will the Obama White House. Wal-Mart lagged the indices for years after its Mexican bribery scandal. The US has launched a criminal probe, a grim omen and engine exhaust emissions software is now radioactive to regulators. I was negative on Volkswagen because China was 20% of revenues and 50% of profit. Now the US market share is also at risk. The legal, financial and reputation risk is openended. However, the Volkswagen AG short trade’s performance has exceeded my wildest expectations, though not for the reason (China exposure) I had originally recommended the bearish case.
The bloodbath in European auto shares last week has offered up a prize in the stock market. Fiat Chrysler Automobiles trades at €11.80 in Milan as I write. This is 7.4 times forward earnings and 3 times enterprise value/EBITda for one of the world’s great auto brands. I consider Sergio Marchionne a genius, a deal maker in the mold of Gianni Agnelli and Carlo De Bendetti. Fiat Chrysler’s exposure to China or even emerging markets (ex Brazil) is minimal compared to Toyota, VW, Nissan or BMW. I see powerful catalysts for its shares in 2015-16. The shares had surged 45% in the first six months of 2015 due to the global euphoria over the planned Ferrari IPO in New York. The August hit in global equities and the emissions scandal bloodbath has led to a 20% fall in FCA since its peak.
I concede FCA could lose $500 million in Latin America and the Chinese joint venture income could fall by one third. Yet Ferrari could well be valued by the stock market at $10 billion US. The end of the capex cycles in 2016 promises a free cash flow tsunami. The Chrysler, Dodge, Jeep and RAM brands command 13% of the vast US market (Volkswagen AG is a mere 3%). Jeep boast no less than 50% of the high growth, premium SUV market in the States. RAM is a market leader in light trucks, one of the most profitable niches in the North American auto constellation. Marchionne has resurrected the fabled Alfa Romeo brand and will roll out new models for both Ferrari and Maserati. I expect the Euro to fall to parity and even lower against he US dollar since I expect a “shock and awe” ECB asset purchase this autumn. Sometime this winter, I expect another 30% bull run in FCA shares, as in autumn 2014. Stay tuned, raggazi!
General Motors (GM) is a broken auto share, after the $900 million criminal charges into its failure to recall faulty ignition switches that cost 100 lives and settlement of the class action lawsuits. GM was dead money for the past two years as Wall Street detests litigation risk Margins were 12% in the US and break even in Europe in the second quarter. Product mix and truck sales were also positive though China exposure is a major drag that I believe is now priced into the shares below 30. After all, dividend yield is now 4.8%. GM trades below 7 times forward earnings, inexpensive for a firm that emerged from bankruptcy to reinvent its franchise. Can Mary Barra be the alchemist who finally unlocks value at GM?
Stock Pick – My bullish case for ICICI Bank
ICICI Bank, India’s largest private bank, has underperformed both the Sensex and the Banking Index on rising non-performing loans. However, I now believe that one of Asia’s growth banking franchises is on sale at 1.6 times forward book value and 12.8 times earnings. I have no problem bottom fishing at INR 265 in a bank whose retail franchise grows 20% per year in a 7.5% GDP growth economy while improving margins and reducing the cost income ratio 600 points to 36% in the past three years. ICICI’s loan growth will be faster than any other private sector Indian bank in the next three years.
Modinomics’s reform agenda has been uneven but the pro-business, pragmatic ideology of the BJP government is intact. ICICI Bank is a hugely profitable bank relative to its global peers, posting a return on assets (ROA) of 1.90% and a return on equity (ROE) in the 14 – 15% range. I do not want to gloss over the NPL dark shadow in Corporate India, commodity loans or infrastructure projects. NPL concerns are priced into the price. After all, ICICI Bank traded at 2.5 times book value in 2010 when its return on asset (ROA) was below 1.6% and India was ruled by a populist Congress government while the RBI Governor was Subbarao, who presided over a 50% plunge in the Indian rupee. ICICI Bank traded at 2.4 times book value amid Dalal Street’s bull run after the BJP landslide win in the May 2014 general election. The scale of the correction  in the bank’s shares has been brutal. A bank with 1.9% ROA, 15% ROE, demonstrated cost discipline and rising operating margins in the world’s fastest growing emerging market on the eve of RBI repo rate cuts has been seen its valuation metrics derated to 1.6 times price to book value. The net stress loan ratio should peak at 5.6% next year, a scenario that is priced into the shares.
Yet book value on ICICI will be at least 160 rupees, making the valuation case for ICICI Bank simply too compelling to ignore. On September 29, the RBI will cut the repo rate since consumer price inflation has fallen below 4% and Governor Rajan has really no other choice than to cut the policy rate. This means a steeper Indian rupee money market yield curve that will goose the bank’s inventory of long duration G-Sec (government debt) portfolio.
ICICI Bank CEO Chanda Advani Kochar has explained that the addition to non-performing assets (NPA) ratio was due to troubled/restructured loans and “not new problem assets”. She also forecasts that the bank’s credit growth will be 18 – 20%, driven primarily by the 20% growth the retail loan book, where the NPL ratio is not rising. While asset quality angst will continue, ICICI Bank is one of the best managed, trophy growth franchises in Asia.
Since I was born on the western side of Sir Cyril Radcliffe’s Award, even though my ancestral epicenter has been South Bombay ever since the time of the Bengal Army’s Mutiny, I trade ICICI Bank’s New York ADR, which has fallen from $13.5 to a mere $8.4 in the past year. At these prices, I believe the bank’s New York ADR is undervalued by 30%. Axis Bank trades at 2 times book value, a 20% premium over ICICI Bank. This makes no sense to me.
The digital revolution will be the next “jewel in the crown” time in Indian banking. I am stunned to see Indians who have never used a credit card or written a bank cheque au courant with Skype, smartphones and the AppStore. If Modi gets this right, historians will remember him a century from now in the same august league as Lord Curzon, once Viceroy when Victoria was Empress of India. Biometric ID’s can well lead to 500 million new bank accounts accessible by mobile phones. India’s demographics make e-banking and a electronic payment systems a winner. India has a 2% credit card penetration ratio. ICICI Bank has positioned its technology platforms for a digital revolution that Wall Street barely grasps. Hence I evoke the ghost of E.M. Foster for my own “passage to India!” in this bank, with a target price of INR 350.
Written by

Mr. Matein Khalid serves as Head of Capital Markets and Advisor to the Chairman at Bin Zayed Group LLC. Mr. Khalid serves as the Chief Investment Officer of Salama. He manages Bin Zayed's global equities portfolios in the US, Russia, Latin America, Europe and the Far East. He is responsible for the Bin Zayed's hedge funds / private equities portfolios and external fund manager selection. He also advises the Chairman and board on investment banking relationships, financing and new issues in the international debt markets and merger/acquisition deal flow. Mr. Khalid has 20 years experience in the international capital markets and has worked with investment banks, private banks and securities firms in New York, London, Chicago, Geneva, Abu Dhabi and Dubai. He is an adjunct professor of banking and finance at the American College of Dubai, where he is also a member of the Board of Directors. Mr. Khalid writes on global financial markets and Middle East studies for newspapers and magazines in the UAE, Bahrain, Oman, Qatar and the United States. He has also taught courses on capital markets at J.P. Morgan Chase, (New York), SP Jain and Emirates Institute of Banking (Dubai). He has also taught at capital market seminars at Morgan Stanley (London), Chase Manhattan Bank (Geneva) and Barclays Capital (Hong Kong). Mr. Khalid has briefed ASEAN finance ministers and ultra high net worth investors in Hong Kong at the invitation of the chairman of Barclays Capital. He holds an MBA in finance and BS in Economics from the Wharton Business School and a BA/MA in international relations from the University of Pennsylvania in the US.