Like David Cameron’s Brexit referendum, Theresa May gambled her political career on her decision to hold a snap election to consolidate the Tory majority in the House of Commons. With 318 seats, Mrs May’s gamble backfired and the Tories are now forced to negotiate a coalition with the sectarian Irish Unionists (‘Ulster says no. Never, never, never!’) to cobble together the next British government. Mrs May remains Prime Minister for now, but her leadership is neither strong nor stable since the Tories do regicide with alarming ruthlessness – Mrs Thatcher, Edward Heath, William Hague, Iain Duncan Smith, Michael Howard were ousted in my own life. Mrs May will go down in history as the most inept Tory PM since Sir Anthony Eden (Suez) or even Lord North (who lost the American colonies for Mad King George).
The financial markets fallout from the UK election is self-evident. The risk premium on sterling rises and it would not surprise me to see cable fall back to April 8 levels of 1.25, when Mrs May called the election. Yet Labour’s surge (in Kensington and Chelsea – hello?) also shows that the electorate has rejected fiscal austerity. This means a steeper sterling yield curve and soft Brexit will be the twin macroeconomic scenarios this autumn.
This, ipso facto, is an argument for another major sterling rally sometime this autumn. I never trade binary geopolitical events and even decamped to Evelyn Waugh’s city of dreaming spires, Charles Ryder’s city of aquatint to monitor the election, barely escaping the horror of London Bridge and the Borough Market terrorist outrage last Saturday night. I will not take a long position in sterling just yet as the storm and fury in Westminster, Brussels and even Threadneedle Street will continue to pressure the quid. I also expect sterling to depreciate against the euro. I expect the gilt yield curve to steepen as long dated HM Treasury debt yields rise while market rates fall. The fall in sterling also increases the inflation risk premium on long gilts. A weaker sterling is bullish for FTSE100 exporters. The FTSE250, the sceptred isle’s domestic midcaps, will fall, with homebuilder shares the biggest losers. British consumer midcaps are a compelling short.
Emerging markets have been the winner asset class of 2017, up 17% on the MSCI EM index fund (EEM). The softness in the US Dollar Index, the fall in US Treasury yields, fund inflows into developing world bonds and cheap valuations (ex India and Mexico) have trumped America First protectionism, geopolitical trauma in Ukraine, North Korea and the Middle East. In essence, after five years of dismal underperformance relative to Wall Street or Japanese equities, emerging markets have rallied with a vengeance since last summer, reassured by the easy money policies by the Bank of Japan, ECB, the People’s Bank of China and Bank Rossiya. As asset volatility on Wall Street tanked, risk assets surged. If Morgan Stanley adds Chinese A shares to its indices, the Middle Kingdom could constitute almost 40% of the index fund EEM’s assets. Specific macro ideas? I believe the Chinese yuan is a buy at 6.85 for a 6.50 target as Xi Jinping’s Politburo no longer wants capital flight. Now that Russian consumer inflation has fallen to the Moscow central bank’s 4% target, a new round of rate cuts is inevitable, given rouble strength. This is an argument to buy long duration Russian Eurobond and Sberbank, Russia’s ‘too big to fail’ retail bank, founded in the reign of Tsar Alexander at a time when Abraham Lincoln lived in the White House.
I passionately believe in Japan’s Sony turnaround, mainly due to restructuring in its Hollywood studios and its exciting new ventures, in gaming, e-sports, music, video content and self-driving car Camera chips. I had gone gaga on Alibaba ADR in New York when the shares were 100. Now that the easy money in Jack Ma’s magic kingdom been made relative to my target, I would switch into Chinese financial shares, notably China Life and Hong Kong’s AIA, which is really emerging Asia’s insurance franchise. I am not interested in Latin American markets as valuations are now iffy at 14.6 times forward earnings (a 20% premium to emerging Asia and EMEA) in this province of MSCI emerging markets even as elections loom in Mexico, Chile, Columbia and Argentina (midterms). Mexico? Avoid since Trump will maul NAFTA. The Mexican dictator Porfirio Diaz was right when he lamented, “Pobre (poor) Mexico. So far from God, so close to the United States” – and to Donald J Trump, Big Boss of Gringolandia.
Stock Pick: the bullish case for Singapore and Indonesian banks
I have admired Singapore for its fairytale rise from a somnolent British colony on the southern tip of Malaya to its role as the financial, aviation, retail and technology hub of Southeast Asia. In the past decade, I have happily braved the perennial afternoon rain and monsoon humidity, the crowds at Changi and the retail razzmatazz on Orchard Road to invest in pre-IPO deals in Singapore industrial property and office REITs. With a per capita income of $50,000, an Anglo-Saxon legal pedigree, a famously uncorrupt government led by the son of the legendary Lee Kwan Yew, a magnet for the world’s smart money flows, minimal inflation, the most credible central bank (MAS) and currency (Sing dollar) in Southeast Asia, Singapore is the world’s most successful and best managed city-state, a AAA sovereign credit, a modern Titian’s Venice or Rembrandt’s Amsterdam (though we don’t do art, la!).
Singapore’s recent export surge mean the Lion City could well see 3% GDP growth in the next twelve months. The Singapore dollar is now once again undervalued as King Dollar swoons. Money supply and bank loan growth has accelerated, a bullish omen for the Straits Times index. Banking profits and net interest margins have begun to rise. China and India’s stellar growth has powered an uptick in Asian trade volumes, whose leveraged proxy is the Straits Times index even as its market breath and momentum rises.
Singapore’s Straits Times index and country index fund (symbol EWS) has risen 14% in 2017 as the Monetary Authority of Singapore (MAS) has opted for easy money to combat deflation risk and boost economic growth. The MAS also tracks central bank easing in China, Indonesia, Taiwan and even India in the past twelve months.
DBS Group, the flagship Temasek owned bank that is the largest financial institution in Southeast Asia, has been my favourite Singapore money center bank investment since July 2016. Piyush Gupta has transformed DBS’s bottom line via cost cutting as net interest margins and loan yields fatten. DBS and United Overseas Bank (UOB) are both ideal proxies for Singapore’s economic, earnings and stock buyback cycle. Singapore banks have also built large fee generating wealth management businesses and have largely written off busted oil, gas and commodities loans. A steeper US Treasury yield curve will be bullish for net interest margins and EPS growth in DBS, UOB and OCBC, which has also bought its own undervalued shares. Singapore banks also offer some of Southeast Asia finance’s highest free cash flow yield, at 10–12%.
Indonesia’s reformist President Joko Widodo, the recent tax amnesty and surge in private wealth creation also makes me bullish on Indonesian banks. In 1998, Indonesia’s banking system was bankrupt as Jakarta was forced to negotiate an emergency lifeline from the IMF, mobs attacked Chinese owned businesses in Java and President Suharto’s 34-year-old kleptocratic dictatorship imploded. Now Indonesia is the world’s most robust Muslim majority parliamentary democracy, a colossus of 260 million people whose middle class will happily throng four star hotels of Makkah.
Indonesia’s largest retail and consumer bank is Bank of Central Asia. The 8% fall in Bank of Central Asia (BCA) shares was due to a cut in its MSCI Indonesia index weighing, not any slip up in its operating profits. Digital/consumer banking will power BCA earnings growth in the next three years. True, BCA is expensive at 17 times forward earnings but high growth consumer banks in consensus darling emerging markets like India and Indonesia are never cheap. Bank Rakyat, which boards the largest branch/mobile banking network in Indonesia could well be an alternative to Bank of Central Asia. Bank Rakyat, which boasts the largest branch/mobile banking network in Indonesia, could well be an alternative to Bank of Central Asia. Bank Rakyat trades at a modest 12 times forward earnings even though it has grown its deposit base faster than either BCA or Bank Mandiri.
I have never invested in Malaysia, as so many Gulf investors have lost fortunes in the KL property market and Bursa. As crude oil plunges to $48, it makes even less sense to invest in Southeast Asia’s only oil and LNG exporter. Najib Razzak’s political woes, the free fall in the ringgit and the 1MDB sovereign wealth scandal further erode the investment case for Malaysia – at least for now. Thailand has been a far more profitable emerging market country pick than Malaysia, let by the 25% sizzle in Krung Thai Bank and Bangkok Bank.
Currencies: what next for the US Dollar Index and gold?
The US Dollar Index (DXY/Dixie to the FX cognoscenti) has fallen from 102 in February to 97 as I write, thanks to disappointment over recent US economic data momentum, the subsequent fall in the ten year US Treasury note yield to 2.15% and political angst on Trump’s pro-growth legislative agenda amid the darkening shadows of Comeygate. In fact the US dollar’s 1.5% fall against the Japanese yen to 109.80 reflects the capital market consensus that the Yellen Fed will slow down its pace of interest rate hikes even as the FOMC meets in its June conclave next week. The big miss on May non-farm payrolls, the soft services ISM and the credit woes in the used car market (the new subprime?) could well have an impact on Fed’s statement even if the FOMC engineers another 25-basis point rate hike. After all, 138,000 new jobs does not add up to a 3% GDP growth economy that Trump and his acolytes have trumpeted (sorry, awful pun!) as their policy target.
It is also significant that the headline CPI in May has slowed to 2.2, down from March’s 2.4% rise. So I must calibrate my Fed call. The June FOMC will see a rate hike but Dr. Yellen will play down expectations for a September rate hike while she tracks the labour market, the high drama in Congress, PCE inflation, the death rattle of Trump’s legislative agenda and geopolitical events in North Korea, Russia and the Arab world.
Dollar-yen was the ultimate Trumpkins trade for me as the Japanese yen tanked to 118.65 in the five weeks after the election as Wall Street hailed the false dawn of a billionaire property developer/snake oil salesman as the leader of the Free World. Yet Trump has been the biggest disaster in US Presidential history, with 34% approval ratings that even Richard Nixon (‘I am not a crook’) would have scoffed at. The 50 million angry, America First xenophobes in the US who voted for him in the November election were fooled into electing a President whose policies benefit the financial elite of Wall Street, not the working-class stiffs, the proverbial Joe and Jane Sixpack Middle America. When the financial markets lost its confidence in Trumpkin’s legislative prospects, the ten-year US Treasury note yield fell from 2.5% to 2.13% (a bear steepening of the yield curve in Bondspeak) and the US Dollar Index fell to seven month lows. Comeygate? The Volatility Index dropped below 10 while the fired FBI Director testified to hostile senators.
As expected, Mario Draghi kept the ECB policy rate unchanged even if his statement was a tad less hawkish relative to consensus while Trump’s latest assault on Dodd Frank slammed the euro. As a leak proved, the ECB has downgraded its inflation forecast, despite the clear acceleration in momentum in Eurozone growth (on Planet Forex, we live in a world of second derivative deltas, theta curves and four-dimensional chess!). Four hour charts on the euro (forgive me, but I also do 100 year macro retrospectives on European history) tell me that the euro failed at its bearish 20 day moving average. This means the euro is now headed to 1.10 unless it recovers to 1.1240, where the ‘trend is my friend’ neurological programming will force me to again go long euro for a May 2016 target of 1.16. Like Janet Yellen, I too am data dependent, though unlike her (sadly) I have no advance knowledge or insider edge on the data flow. I will spare my valued readers the Ichimoku cloud rhapsodies!
Gold’s rise to $1266 an ounce (note my silver trade idea as the white metal rose to $17.65 spot. So voila! S for Shanghai, L for London, V for Venice spells SLV!) is nothing more than a corollary of Dixie weakness and the horrific terrorist attacks in the Manchester Arena, London Bridge, Notre Dame, Baghdad and Kabul. Gold is also a cheap hedge against a political meltdown in the Trump White House and a potential policy U turn by the Yellen Fed if wars and rumours of wars pan out. CFTC positioning data notes the smart money has dramatically increased its net longs in gold and silver futures. The world’s largest gold bullion index fund (the Fort Knox/King Midas of our times, symbol GLD) has increased to 851 metric tons. Monsieur Auric, Lord Keynes’s barbarous relic, is in a bull market. If Aunty Janet goes lovey-dovey at the June FOMC, real rates get more negative and gold rises to $1400!
Image (c) iStock
