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Brexit, sterling and UK bank shares

global-investingnew|By Matein Khalid| Sterling sell off in the world currency markets and the sheer populist appeal of Boris Johnson suggests the world should not rule out a geopolitical shock that will unnerve financial markets and lead to the mother of all rate cuts at the Bank of England. If Britain votes to leave the EU, the only currency I want to own is the Swiss franc and gold, though even the yen could surge higher to 94-96 and spell the nemesis of Abenomics. Brexit will also mean recession in the UK and the end of the Cameron/Osborne era at the helm of Tory politics.

Sterling, naturally will be an immediate sell on Brexit possibly to as low as 1.25 on cable. Gilts would then share the fate of the German Bunds, with the ten year Bund yield a mere 0.16%! I cannot ignore the sheer mood swings of the UK public (from Clem Atlee to the Scottish referendum to the last general election!) in an age of austerity, angst and fears about an influx of Turkish migrants. A Britishs exit would be an ominous precedent for the European Project as German, Italian, French and Spanish political risk has again begun to rise. The AFD/Pegida, National Front, Cinque Stelle and Podemos are all anti EU populist parties.
It is no coincidence that Brexit angst has coincided with the lowest allocation to UK equities since the global crisis, even though the City consensus is hugely Remain. Still, this crowd consensus reflects class interests, not the grim realities on High Street. A Remain vote is, of course, nirvana for Stagecoach, Win Morrison and Lloyds Bank, the most England centric of all UK clearing banks. It saddens me that so many owners of London property have no clue about the coming meltdown in prices. At the very least, a short in Great Portland or Persimmon is a hedge!
Any investor in UK banks has witnessed unmitigated trauma in the past decade. I was in London in June 2007 and witnessed the depositor run on Northern Rock, the first bank run in the sceptered isle since Victorian times. I was also in Edinburgh for a Walter Scott conference in October 2008 but did not meet Alex Salmond in the gala dinner in the Museum of Scotland since Sir Fred the Shred’s RBS, Scotland’s most overrated champion since Bonnie Prince Charlie, went belly up. This was once the world’s biggest bank, not some provincial building society schlock outfit.
2016 has not been a great year for investment ideas in UK banks. My last successful big idea was a short on Standard Chartered at 1500 pence, long covered with a juicy profit. Like Mick Jagger, I can’t get no satisfaction from HSBC and was plain wrong on Barclays, with both Jenkins and Jes unable to move the share price.
The next big variable for capital return and div payout is the Old Lady (the one in Threadneedle Street, not Buck House!) stress test, which are more mission critical to this sector than even the Basel 1 concordat. I expect nothing much from HSBC, RBS and even Barclays, despite the exit from Africa and the end of Bob Diamond’s capital intensive, structured finance excreta.
In any case, the 8.3% HSBC yield screams dividend cut to me and I still doubt if the stock price reflects the lowest growth in China since 1990, rising corporate defaults in the Middle Kingdom, five year lows in the yuan and the rise in South China Sea geopolitics black swans. Lloyds, now the classic Little England bank, will outperform its peers as it will generate excess capital – and paid a special dividend to shareholders, unlike RBS.
Lloyd’s decision to buy back its expensive post 2008 enhanced capital notes will save £1 billion at a time of epic low interest rates. The surcharge on bank profits and stamp duty on buy to lets and a flattening sterling yield curve is not a good omen. This is the reason Lloyds is the ultimate UK value bank as yields rise to 7%, as Senor Horta Osorio wants to double the payouts. I am stunned by the turnaround in Stan Chart as it rebuilds Basel Tier One to 13.1% yet still trades at 0.6 times a book, a 30% discount to HSBC. Will Stan Chart rise to 600 pence? Yes, despite the bearish selling until June 23.
Market View – Strategy and trading ideas in emerging equities markets.
Emerging markets equities have been hugely profitable in 2016 but picking the right country/sector for investing was critical. For instance, I thought the Russian rouble at 78 and the Russian equities index fund (RSX) at 14 were grossly undervalued, despite the geopolitical risks of the Kremlin’s intervention in Crimea, eastern Ukraine and Syria. The Russian rouble has surged to 64 against the US dollar and the Russian stock market index fund is up 20% in the last three months. My call to buy Indian banks before the Union Budget, the RBI repo rate cuts, Dr. Rajan’s banking reforms and a positively sloped G-Sec rupee yield curve has produced a fabulous 25% return in ICICI, India’s largest private sector bank.
Pakistan’s catalyst was its military’s success against the Taliban, the $6.7 billion IMF loan, President Xi Jinping’s state visit and the $46 billion (dream on) Economic Corridor, the MSCI upgrade from frontier to emerging markets and the fall in interest rates to 40 years lows with valuations at 8 times earnings. This meant a 20% return in Pakistani equities since March. I went gaga over President Macri’s historical win over the Peronists who ruined Argentina since the time Juan Domingo and Evita ruled the roost in the Casa Rosada. Investors went gaga on Buenos Aires bank Banco Macro, which surged 60% in its New York ADR. Emaar Properties rose from 4.5 after my recommendation to 6.8 AED three months later, a stellar 50% return. Nothing beats a well timed emerging markets strategy idea!
Nobody can accuse me of being an emerging markets equities permabull. In fact, I have dissed this asset class since 2011, when it began to underperform US equities. The surge in the US dollar that began in April 2014 made it impossible to recommend emerging markets particularly geopolitical black swans like Russia’s invasion of the Crimea, Brazil’s mega Petrobras corruption scandal, the 70% crash in crude oil prices, Malaysia’s $6 billion state fund rip off and Turkey’s renewed war with the Kurdish secessionist PKK is Southeast Anatolia and its bloody blowback on the streets of Istanbul, Izmir and Ankara. I often find my degrees in international relations from Penn help me make more money in emerging markets equities, currencies (the South African Rand at 15, the Indian rupee against the Malaysian Ringgit since India will be upgraded while Fraudiputra Central faces a sovereign downgrade!) and debt. (Argentina Treasury bills, long duration Indian G-Secs, rupiah bank debt). The macro omens now suggest a high beta blitz across the emerging markets Maginot Line.
It helps that financial flows to emerging markets (ex China) have finally turned positive for the first time since 2012. The aggregate EM trade deficit (ex China) has also turned positive. Chicago Fed Funds/Eurodollar futures markets price no aggressive Fed rate hikes this summer. Brent crude trades above $51 despite no Saudi Arabian agreement on output ceilings in Vienna and a surge in post sanction Iran export well beyond IEA forecasts. This macro scenario implies strength in some (but definitely not all) emerging markets currencies, which were devastated by the 2012 – 15 bear market.
Of course, it is suicidal to be Panglossian on emerging markets at all time, particularly the long only, oil/retail money dominated stock markets of the GCC, whose 50% implied volatilities, low liquidity and lack of traded index options/risk insurance products make them some of the most riskiest financial markets on earth. Africa? Only Azania. Of course, China is the constant 800 pound gorilla in this asset class. With a debt load of 240% of GDP, its trillion dollar Ponzi “shadow banking system” and proven regulatory failures cast a malign shadow at a time when world trade/growth has slumped.
The tragic bomb blasts in Istanbul, near an area north of the Grand Bazaar I know well and a horrific war in the Qandil Mountains turns my thoughts to Turkish equities. The May jobs number was cheered on the Bosphorus as no aggressive Fed rate hikes means Turkey can continue to finance its current account deficit via offshore hot money investing in high yield lira debt. Economic and earnings momentum has turned positive, despite the ware with the PKK and the Syrian horror story. True, Erdogan’s policies have ruined relations with Berlin, Washington, Moscow, Cairo, Riyadh and Tel Aviv. The sacking of Prime Minister Ahmet Davutoglu was a blow to investor confidence. Still, the big money is made when things go from Godawful to just plain awful on the Potomac – and the Bosphorus!
Currencies – The Canadian dollar bulls and macro risks
I spent 2014-2015 recommending shorts on the Canadian dollar as it plunged from 1.13 to 1.46, where I found loonie love. Why? Justin Trudeau is the popular Prime Minister is one of the world’s stablest democracies where fiscal stimulus will work its magic in tandem with a stable monetary policy and a positive yield curve. Canada has the stablest banking system in the Western world and the commodity rally has ballast now that Brent is above $60. So it was time to say O Canada and go long the loonie after the May payroll shocker and the macro bid in black gold. This idea was profitable as the Canadian dollar rose from 1.30 to 1.26.
It is ironic that safe havens (gold, Swiss francs, Japanese yen, US Treasury notes) are making new highs at the same time as the S&P 500 index and junk bonds, both corporate and sovereign. The Volatility Index, credit risk spreads and credit default swaps totally camouflage the systemic, policy and macro risks in the global markets. So the USS Harry Truman, which does not report to Central Command, sails from the Gulf of the eastern Mediterranean. Why? A message to the Kremlin from Uncle Sam. Back off, Vlado, Sykes Picot will not be replaced by a Putin-Khamenei political order in the Levant!
The May payrolls shock dictates maximum exposure (for now) in high beta emerging market equities/currencies, gold, commodities, Japanese yen, Swiss francs and, yes, the Canadian dollar. If no summer Fed rate is imminent, then the liquidity driven macro “dash for trash” makes total sense. Yet making money in 2016 is all about rotating sectors, currencies and countries, surfing the macro waves on our Bloomberg. The Heisenberg Principle said it so well. The act of observation changes the nature of the object being observed.
It is ironic that the worst US job growth since 2010 is greeted with joy by global stock markets even if it is obvious that China, Europe, Japan and most of the world’s oil provinces are trapped in a deflation wave. That is the message of negative interest rates in Europe and Japan, moribund property markets in the Gulf, a chronic hard currency shortage in Egypt and Nigeria, the massive losses in Chinese and Japanese industrial exporters. Fed Funds futures now predict the odds of a July rate hike at only 20%.
Global macro storm clouds are getting darker by the week even beyond the risk of Brexit. The World Bank slashed its global growth forecast to 2.4%. Global operating margins and earnings growth is embarrassing. Valuations are a joke in most developed markets, led by the US and Europe. So it is strange to see the Australian dollar rise to almost 75 cents when China’s credit time bomb has burst, defaults have hiked, flight capital (to Sydney and Melbourne property too LOL!) has accelerated, growth has declined to Politburo targets to 26 year lows and the Chinese yuan is now at five year lows as the Middle Kingdom’s export colossus sags.
The only conviction macro idea I have now is to be long both silver and the Volatility Index. The cross-correlation coefficient among global equities and debt markets are dangerously high for any comfort.
The blowout sovereign bond issue from Argentina and the 30% returns on Russian Eurobonds in 2015 makes me believe the macro milieu is just right to make money in emerging market debt. This is the time to buy Argentine short dated bonos, South African and Indian local currency debt, though Azania is on global credit rating watch and tight stops are essential. The biggest EM short is Malaysian ringgit bonds given that countries where $6 billion get embezzled from a state fund and $680 million lands in the Prime Minister’s bank account to be spent on property, jewelry and filming the “Wolf of Wall Street” should be off limits to foreign investors. What Sigmund Freud says about death wishes is more important than what Janet Yellen says about interest rates – and what George Soros says about global markets is the most important data point of all. Soros is short the S&P 500 index, long gold and Barrick (up 28%). Since he earned $30 billion in global macro investing, it is not prudent to ignore the views of the hedge fund king who once broke the Bank of England and is the most brilliant man I have ever met in my life!
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.