Market Analysis – Monday, February 13, 2017

Overview

This market analysis examines the recent performance of global financial markets, the role of liquidity in supporting financial markets, and the prospect of currency wars from the viewpoint of an analyst-trader that utilizes fundamental, technical, quantitative, and big data analyses.

It’s All About Liquidity

20170213-chart1As discussed ad nauseam, governments relied on loose monetary policies in the aftermath of the 2007-2008 Financial Crises to prop up financial markets as exorbitant debt levels curtailed fiscal remedies and fear of political blame prevented necessary structural changes. Like passing the baton in a relay race (or a game of hot potato), monetary bodies took turns implementing different brands of QE. In approximate order: Fed (QE1, QE2, Op Twist, ZIRP, QE3), BoE (asset purchases), BOJ (asset purchases, ZIRP, NIRP), SNB (asset purchases), ECB (asset purchases, ZIRP, NIRP). But, despite the influx of paper money, developed and many developing economies failed to rise from the mat leading to the next phase of the Financial Crises: currency wars.

Currency Wars

Fear of a repeat of the 1989 Tiananmen Square protests, China unilaterally devalued the yuan twice in August (~2.9%) and December (~4.4%) 2015 in an effort to boost exports and jobs, resulting in a significant global sell-off each time (light blue boxes in Charts 1 and 2). Leaders from Washington to Brussels to Tokyo gasped and an undisclosed agreement was made at the Feb 2016 G20 finance ministers and central bankers meeting in Shanghai between the US, China, EU, and Japan (G4) to prevent a future financial market panic. As described by Jim Rickards, China would peg the renminbi to the USD (e.g. CNY6.50-6.30, Nov 2015 to Feb 2016 range) which would weaken, while the yen and euro would strengthen (Charts 2 and 3). But, a funny thing happened on the way to the pagoda. With the US presidential elections approaching and Donald Trump unseemingly holding steady, DXY drifted upwards starting in May 2016 as the markets factored in the remote possibility of a Trump win and a pro-growth platform. Not part of the agreement, China devalued in May-Jul (~3.4%) and again in Oct-Dec (~4.9%), contributing to a minor sell-off in stocks (green boxes in Charts 1 and 2). Now, with Trump in the White House, all bets are off as the greenback reached a 15-year high in Jan (black circle in Chart 2; DXY intraday high 103.82 on Jan 3).

Pushing an “America first agenda,” Pres Trump has threatened to institute import tariffs, declared China a currency manipulator, counteract China’s aggressive posture in the South China Sea, and has pivoted the US away from China and towards Russia. Many of his cabinet appointees support this view. Nevertheless, the Communist Party’s cling to power resides in its ability to provide jobs for the masses and keep the economy growing – no amount of antagonizing is going to change its stance. With problems of its own making, China must battle internal political unrest stemming from Pres Xi’s centralization of power, a massive credit bubble, and capital flight, to name a few. If push comes to shove, China may forego mini-devaluations and opt for a 20-30% maxi-devaluation, which some neocons would surely label as an act of war. The situation could go pear shape in the short future.

Coming Soon

My next post will examine the current state of financial markets in detail, discuss the role of complexity theory in analyzing the global financial markets, drawing reference to the Thai butterfly that caused the 1997 Asian Crisis (see Case Study: 1997 Asian Financial Crises, Parts I and II), and apply complexity theory and Bayesian statistics to today’s markets to determine the key drivers that could trigger a global market sell-off. My subsequent post will discuss the role of gold, SDRs, or eDollars in the event of a financial market meltdown that surpasses those of 1987, 1998, 2000, and 2007-2008 and the importance of China having a seat at the table of the next global financial system reset. Ultimately, I shall post on my results of using big data analysis, predictive analytics, and ensembles modeling techniques to produce leading drivers and their assigned probabilities of inducing a major market correction using the conclusions from my next post. Stay tuned!

Emerging Markets Analysis – Tuesday, April 19, 2016

Country Focus: Philippines

Overview

This emerging markets analysis examines Philippine portfolio capital flows, recent performance and outlook of Philippine bonds / yields, equities, and the Peso from the perspective of an analyst/trader that utilizes fundamental, technical, quantitative, and intermarket analyses. Lastly, some final thoughts are provided, as well as a Philippine Financials and Capital Flow Dashboard.

Philippine Capital Flows

The prospect of US normalization of interest rates led to net outflow of foreign portfolio investments of about  $310 mn and $600 mn in 2014 and 2015, respectively. However, the dovish-reversal of the Fed (see Emerging Market Analysis for Apr 4) in Jan has sent risk capital in search of yield as the likelihood of a rate rise diminishes. As discussed in previous reports, this author believes no rate rise will occur this (election) year and that the next major US monetary action shall be a rate cut, ZIRP or NIRP, and, possibly, QE4.

While more permanent-term capital started returning early in 2016, portfolio capital flows lagged slightly. FDI recorded $587 mn net inflow to start the year, a 123% increase from last Jan and represents the largest intake since Sep’s $1.519 bn haul. FDI flows targeted: $257 mn equity, $257 mn debt, and $73 mn reinvested earnings (Chart 1). After taking in $5.724 bn in net FDI inflows in 2015 versus $5.74 bn in 2014, the  government hopes to reach $6 bn this year.

Foreign portfolio investments continued cautiously in Jan, turning positive in Feb, before shedding the reins with a $482 mn net inflow in Mar, the biggest accrual in 13 months (Chart 2). According to the BSP, United Kingdom, US, Singapore, Luxembourg, and Hong Kong accounted for 80% of inflows in 2015, of which 78% were invested in PSE-securities and 22% in PH government securities.

20160419 Chart 3

Although not counted in capital flows, personal remittances (which is recorded in the current account balance) represents a major source of capital for the Philippines. Personal remittances from overseas increased 4.4% to $28.48 bn in 2015, representing roughly 10% of GDP. Foreign investors pondering a course of action for the Philippines may take a cue from what OFWs are currently thinking: Through the first two months of the year, personal remittances are up over 6% YoY, with Feb remittances jumping 9.0% from the prior year.

Steady private investment, construction, and infrastructure projects are expected to keep the Philippine economy humming (2016 GDP growth estimates range from 6% to 7%), negating the debilitating effect of a weaker external environment, increased financial market volatility, and potential havoc a weakening greenback (and strengthening local currency) can have on exports. Despite the difficult environment emerging economies faced last year, the Philippines GDP grew 5.8% and ended Q4 with a 6.3% annualized spurt. The current account surplus came in at 4.4% of GDP, sixth best out of twenty-eight emerging economies. Throughout, inflation remains subdued at around 1.4%. Thus, buoyed by solid economic fundamentals, the Philippines should expect increasing capital net inflows over the next 12 months, but risks remain. Next, a peak at bonds.

Philippine Bonds and Yields

The Philippine government remains active in the sovereign bond market. In Feb, the Philippine treasury department visited the international capital markets completing a 25Y USD 2 bn par issue with a 3.70% coupon, maturing in 2041, which improves on last year’s call (25Y USD 2 bn par issue with a 3.95% coupon, maturing in 2040). Similar to 2015, a portion of the proceeds went to buyback and retire higher-paying coupon bonds.

According to Reuters, Philippine companies are expected to raise over P100 bn ($2.1 bn) via the bond markets in 2016 as increased volatility last year kept many away. Much of the proceeds would be used for public-private partnership (PPP) projects, including toll roads, schools, an automated fare collection system, a railroad, a hospital and a bulk water project, as well as to pay-off retiring obligations. Corporates with an international investor following may take a looksy at the international bond market. Several weeks ago, Ireland successfully issued a 100-year (“century bond”) 2.35% coupon sovereign debt, just years after paying off its bailout loans from the European Debt Crisis in 2011. The Irish paper was priced to yield 31 bps below 30Y US Treasury bonds! Great timing or Luck ‘O The Irish?

Philippine Peso 10Y bond yields fell at the beginning of the year (first arrow in DB Chart 2). But, anticipation of the government’s jumbo USD sovereign bond offering sent yields sky-rocketing as investors positioned themselves (second arrow in DB Chart 2). Already, yields are drifting lower and should stabilize. A glance at the Philippine USD yield curve reveals that Philippine USD paper provides around 150 bps and 100 bps pick-up over US treasuries at 10-15 year and >15year maturities, respectively (DB Chart 4).

Recent Performance of Philippine Equities

Strong net foreign portfolio investment outflows last year led to a 3.9% drop in the PSEi Composite Index in 2015. But, the abrupt shift in sentiment starting in mid-Jan resulted in a “V” shaped reversal as foreigners plowed back in and locals piggy-backed for the ride (Chart 4). Since mid-Mar, a flag pattern has emerged signifying a rolling-stop as early-profit takers depart and new investors clamber aboard – note confirming volume slow down (Chart 5).  As a continuing indicator, the flag suggests the PSEi would likely run to about 8600-8700 before the first significant correction. Looking ahead, forceful penetration of the upper resistance zone of the flag at around 7370-7380 denotes resumption of the bullish trend. The trigger could emanate from any direction: poor Q1 US earnings announcements, more dovish Fed talk (next FOMC Meeting, Apr 26-27), major FDI announcement, strong OFW remittance inflows, relatively smooth Philippine presidential election (May 9). Two major risks facing the Philippines are the perceived outcome of May’s elections and yet another flip-flop by the Fed. A down-break below 7180 on heavy volume nullifies the bullish trend set-up, requiring reassessment of the (then) current situation. Next, let’s see what currency markets are saying.

Outlook for the Peso

For all the money printing and expanding Fed balance sheet, USD reigns supreme in the currency waters and when it decides its time to change direction, like an EEE-Class container ship, best to stand clear as all currencies feel the impact. As laid out in the previous report (Emerging Markets Analysis for Apr 4), with interest-rate hikes on hold, the USD Index, which has been trading in a consolidation zone since early 2015, will test its lower support level at 93-94 (far right DB Chart 9). As USD weakens, the PBOC will likely re-peg the renminbi to the greenback to help Chinese exporters and, hopefully, stabilize the weakening Chinese economy. Of course, other exporting countries may further loosen monetary policies and lower interest rates to defend their exports. On Apr 14, Singapore’s MAS switched to a neutral stance (by pegging SGD to a currency basket) to keep the SGD from strengthening against the depreciating greenback. The currency wars continue.

Meanwhile, the Peso will likely go with the flow, moving in between large waves like an agile cutter, with the BSP tweaking monetary policy here and there. After reaching its weakest point in six years on Jan 26 at P48.15/USD, the Peso has strengthened to about P46/USD on the back of steady capital inflows.

Final Thoughts

The Fed is unlikely to raise interest rates this year. Chair Yellen and other FOMC members have all but shouted this. Already, capital searches for higher yielding opportunities, including emerging economies and financial markets. Philippine equity performance over the last three months sits at the midpoint for emerging equities, despite a compelling economic story (DB Chart 8). To be sure, the Philippines has righted its economic house during the last six years and appears as one of the most attractive participants in the on-going foreign investor beauty pageant. With presidential elections less than three weeks away, a smooth outcome and hand-over would pave the way (hopefully) for continued economic, monetary, and structural progress made by the out-going Aquino administration. And, with a little good fortune, the Pearl of the Orient may yet be crowned belle of the ball and receive an allocation upgrade from investors.

Philippine Financials and Cash Flow Dashboard

Interest Rates / Bonds

Equities

Currencies

Emerging Countries’ Capital Flow Dashboard20160419 Table 1.jpg