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EM: Making and losing money

global-investingnew|By Matein Khalid| If ever there was a year to win or lose money big time in emerging markets, 2016 was it. As an investor in the world’s dark alleys (the Third World rebranded as EM!), I am forced to dissect geopolitical, government/monetary policy, foreign exchange, flows, positioning and current account, volatility and credit cycle trends across emerging markets to develop money making strategies. It helps that I am a news junkie, since market intelligence via Bloomberg, greed and fear, wars and rumours of wars, travel at the speed of light. So what next in 2016?

Brazil is the world’s best performing stock market in the Year of the Monkey, up 40% for dollar investors, even though Latin America’s largest economy suffers its worst recession since the Great Depression, a 10% inflation rate and a sovereign credit downgrade spiral. Why? Regime change. The Dilma Rousseff era is over now that the Senate voted for impeachment. Sayonara le bye bye, Senhora Dilma, and the Workers Party, architects of the $100 billion Petrobras Lava Jato corruption scandal that gutted Brazil. A stronger Real, Selic rate cuts, fiscal reforms under Michel Temer, lower inflation and fresh elections with (hopefully) my old Wharton thesis advisor Arminio Fraga as Finance Minister will take Brazil’s Bovespa to 65,000. The real macro trade is in the debt swap market as a receiver of local rates EWZ at 29 is almost 50% above my 20 recommended buy level just before the Rio Carnival. Obrigado, Brazil!
The two major emerging markets to short in 2016 were Poland and China. Andrzej Duda’s Law and Justice party’s bank tax was a disaster for Warsaw equities and S&P has cut Polska’s sovereign rating to BBB+, the first downgrade in a decade. Shanghai was another disaster in 2016 and Xi Jinping should really be renamed Xi (money) Jinxing. China’s macro data, epic debt, Ponzi “shadow banking system”, corporate profit falls, political Maoist “Part discipline” (in America, you find a party, in China, the Party finds you!) have made investing in the Middle Kingdom impossible for me. It does not help that the only words in Chinese that excite me are chow mein, moo goo gai pai, dim sum and won ton. The China A shares index fund has lost 18% in 2016. I see no reason to invest in a market that defines “irrational exuberance” and Maoism was never good for shareholder value. Only a fool bets against history.
Government policy shifts in 2016 cause me to focus on specific themes, like India’s Union Budget/bankruptcy code and Dr. Rajan RBI rate cuts on Indian bank shares. Another example is Saudi Arabia’s Vision 2030 impact on four star budget hotels in Makkah now that the new royal decree’s Ministry of Hajj and Umra will issue 15 million Umra visas by 2020. This is investment nirvana for investors in Makkah four star hotels.
It should not surprise any readers of this column that Pakistan is Asia’s best performing stock market for US dollar GCC investors in 2016. Habib Bank Ltd rose 20% after I profiled it here as a buy at 172 rupees. My other favourite Asian market is South Korea, where forward valuations have dropped to 0.89 price/book value, one sigma down Gangnam style, even though returns on equity have now risen to 8.2%. As Bono’s UB40, the best Irish thing to happen in my life since Joyce, Yeats and Oscar once warned me, wise men think, only fools rush in but I can’t help falling in love with you, you in this case being Seoul’s KOSPI index at 1960 as earnings revisions rise even if export orders fall for a sixteenth successive month and Madame Park is nothing like her legendary father Major General Park, who created the Miracle on the Han River.
Macro opportunity 101? Oil prices have soared 65%, John Kerry has announced the end of Iran sanctions and a Yemen ceasefire could well end yet another tragic Arab civil war. So why has Oman’s Bank Muscat fallen to 0.4 Omani riyals (OR) or 5.8 times earnings and 0.7 times price to book value when GCC banks trade at 13 times earnings and 1.3 times book value? My love for the Omani sultanate and its people often clouds my investing judgement though I will never forget the Gulfar IPO as long as I live. True, Bank Muscat faces government austerity and a higher cost of risk as loan growth slows. Yet the bank’s Basel Tier One is 13.8% and capital adequacy ratio is 16%. The divi is 5% plus. MSM trading volumes will recover. Project finance will be a windfall. Time to make money in Ruwi!
Market View – France’s financial markets and the 2017 election
The most important event in France last week was the birth of my newest niece in Paris, Diane Laila de Ricaud. Bienvenue, notre bébé comtesse! The other French “événement”, was a full blown political crisis in the Élysée Palace after President Hollande invoked Article 49 of the constitution to reform France’s rigid labour laws ignited a revolt in the National Assembly in his own Sociality Party. Aux armes, citoyens, all over again! I have always wondered why big things happen in France in May, like the birth of little Diane and the no confidence vote against Hollande in 2016. The victory of Mitterrand over Giscard in May 1981. The student revolt against General de Gaulle in May 1968. The fall of France after the Nazi invasion in May 1940.
François Hollande has the lowest approval ratings in the history of the Fifth Republic and his own Socialists want to dump him for reelection next year when he faces Marine Le Pen of the National Front. Prime Minister Manuel Valls has survived a no confidence vote but Article 49 has once again revived the Gaullist/gauchist schism in French politics a generation after the death of the general and Georges Marchais. It is too early to predict if Nicolas Sarkozy’s center-right will benefit from forcing and losing a no-confidence vote only a year before the next Presidential election. Yet the impact of Hollande’s labour laws on the French economy will be a game changer in the dirigiste, Colbertist, Cartesian la belle France of 2016.
France’s largest corporates can now negotiate with their trade unions for deals beyond the 35 hour work week. This could help French companies restructure, boost productivity, reduce costs and ignore industry or sector trade union deals. The labour reforms also makes it easier for companies to cut payrolls if revenues decline. After all, France’s unemployment rate is 10% and the despair in the banlieues is palpable.
Francois Hollande’s legacy will be defined by his labour reform legislation long after the horrific images of Daesh terror attacks on Charlie Hebdo or Bataclan recede in memory. This is also a win for the European project since Brussels demanded labour reforms in exchange for a longer time period to fulfill the Eurozone’s budget deficit criteria.
As a student of French economics and a friend of an École nationale d’administration alum and global economic diplomat who happens to be Diane’s grand-père, I wonder if a coalition of militant trade unions, neo Marxist and even Trotskyite students and Socialist Party bloc MPs will now escalate their protests via street demonstrations. After all, it is imprudent to ignore the lessons of the “événement” of 1968, 1870, 1848, 1830 or even the great revolution and storming of the Bastille ignited by Camille Desmoulins speech in a Paris café on 14th July 1789. Political instability in France, the second largest economy in the EU, will be an unmitigated disaster for the Euro and global markets complacent about volatility shocks. I love Paris in the springtime but “sell in May and go away” (ideally to the beaches of the Bay of Angels in Nice or the Croisette in Cannes”!) makes perfect sense to me. European equities has been a nightmare in 2016, as even the clowns in Magic Planet have learnt the hard way.
France Inc. is not exactly thrilled with the new laws, since Hollande dropped the severance package cap in case of wrongful dismissal. I believe the historic events of the past week increase the odds that Alain Juppé will win the center-right’s nomination and defeat both the Socialists and the National Front to become the next President of France in 2017. Alain Juppé could well prove to be the French Thatcher, Reagan or Macri for the stock market. His programs calls for an end to the 35 hour workweek, a 5% unemployment rate, lower corporate taxes, a rollback of the French welfare state and the sacking of 250,000 fonctionnaire (civil servants). I was in Paris in 1995 in the Chirac era when Juppé’s reform ideas for the welfare state clogged the Champs-Élysées with angry demonstrators. There is no doubt in my mind that Alain Juppé will beat Marine Le Pen in the first round to win the Élysée Palace. This prospect alone could mean a 25% bull run in French equities. But not now. “Attendez” is the French verb to wait and my strategy idea de jour.
Macro Ideas – Duterte and the financial thrilla in Manila
While Pakistan has emerged as Asia’s top performing market in 2016, I am amazed at the Cinderella valuations in regional equities. Asia ex Japan (AXJ) now trades at 1.2 times price to book value, a metric the world last saw in the bear market lows after 9/11 and the US invasion of Afghanistan in October 2001, the Hong Kong SARS crisis and Iraq war in March 2003 and the credit market seizure after Lehman Brothers’s failure in September 2008. Why? Ours is not to reason why, ours is but to do and die, to mutilate a Victorian poet’s take on another valley of death in the Crimean War. The China shock has gutted world trade and Hong Kong/Singapore property bulls finally meet their nemesis in Ursa Maximus. Returns on equity have also been squeezed in China, South Korean and Taiwan. My best short? Iron ore stocks (Vale, Fortesque, BHP) and the Singapore dollar, which I expect to depreciate to 1.40. Hence the Bharat Mata carry trade last week! (long INR/short SGD)
The Philippines fascinated me ever since I befriended the children of the Lopez, Vilar and Marcos clans as a student at the Wharton School in Philadelphia. Derided by economists as “Southeast Asia’s sick man”, the Philippines economic miracle in the Aquino era was an emerging market fairy tale. 6 years of 6% GDP growth, tax reform, a stellar 200% return on Manila equities, $30 billion in annual remittances, a wild property bull run in the Manila and Bagio condo market, multiple sovereign credit upgrade,  a BPO revolution, a stabilized peso. Yet even though my best Filipino friend at Wharton was a Lopez grandson of Magsaysay’s vice president and President Marco’s daughter Irene was a classmate, I could never understand the surreal circus of Filipino politics.
This nation’s economy and politics is dominated by 40 or so dynastic families, de facto oligarchies who emerged to prominence in the Spanish and American colonial era. The Philippines (like Pakistan) had a pathetic tax/GDP ratio and dismal human capital metrics. One tenth of the labour force, the fabled OFWs, lives abroad. Extreme income inequality would make Thomas Malthus, let alone Thomas Piketty, wince Beneath the effervesce of the Makati Village social whirl, the Philippines is a nation with deep socio-economic injustice embedded in its status quo. President Benigno Aquino, scion of one of Tarlac’s great land owning clan, did nothing to end the dynastic chokehold on the economy even as his reforms were a financial windfall for the business elite and foreign investors. My strategy ideas on Manila equities since 2010 were all Radio Gaga.
Rudrigo Duterte (the Punisher of Davao City!) will now move into Malacañang Palace for the next six years. The electorate has spoken and rejected Mar Roxas, Grace Poe and yes, even Bong Bong Marcos. The public has turned against the elite that hoarded wealth in this land for four centuries in a Spanish convent, five years in a (Tojo) Japanese prison and seventy year of Hollywood, albeit with martial law, dictatorships, abortive military coups (Colonel Gringo Honasan!), volcanic eruptions, the Moro secessionist war in Mindanao, the NPA and Abu Sayyaf terrorism.
Manila’s PSE index depreciated 7% in April as Duterte’s lead widened in the polls but has risen 6% of Duterte Harry’s election. Manila is expensive at 17 times earnings for only 8% earnings growth but I cannot forget that the stock market surged 25% in the six months after both Presidents Arroyo and Aquino took office. The economic potential of the Philippines, unlocked by Aquino, is vast. A nation of 100 million people with Southeast Asia’s youngest population, higher call center revenues than India, a potential tourist, mining, agribusiness (Dole) colossus. Consumption is 70% of the Filipino GDP. This is not an Asian tiger but an Asian cheetah!
I think there is big money to be made in the Philippine’s property market, especially if Duterte changes the Constitution to allow foreigners land ownership. Shopping malls (SM Prime), developers (Megaworld, Ayala Land), fast food chains (Jollibees, the kabayan KFC!) and banks (BDO, BPI) are all compelling but only at specific prices much lower prices.
Naturally, I will continue to track the Manila market and get insights in the Tagalog media from my colleagues Janine and Jennifer at Asas Capital DIFC. This is a real live, high stakes financial Thrilla in Manila as Duterte “fattens the fishes” with the corpses of 100,000 executed criminals and confronts the Chinese Navy on a jet ski in Scarborough Shoal!
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.