The epic political dramas of last week (Aunty Theresa’s Brexit plan was rejected by the House of Commons but she managed to survive a no-confidence vote by a narrow margin) strengthened the British pound, exactly as I had expected. Yet sterling has not managed to rise above 1.30 to the US dollar in the past two months and now trades at its lowest levels in the Bretton Woods era of floating exchange rate, apart from 1984 – 85, when a surge in the Reagan dollar and Arthur Scargill’s miners strike led cable to plunge to almost parity against the greenback.
I still contend that a delay in Article 50 is inevitable and will lead to a stronger sterling against both the US dollar and the Euro – at least for the proximate future. By any criteria of purchasing power parity or inflation/interest rate differentials, sterling is deeply undervalued against the US dollar, even though two-year US Treasury bond yields are significantly higher than two year UK gilts because, unlike the Powell Fed, Mark Carney’s Bank of England cannot raise its policy rate as long as Brexit lingers like a macroeconomic sword of Damocles over Britain.
It is also undeniable that the protracted, toxic politics of the Brexit has led to an increased risk premium on sterling assets as Westminster has lost its former allure of political stability. After all, the banking grandees of the City of London are as clueless about the next twist in the Brexit saga as the currency gnomes of Planet Forex and their acolytes in the Arabian desert.
It is suicidal to trade on even the most sophisticated econometric valuation model in the foreign exchange market but The Economist Big Mac index of purchasing power parity suggests the British pound is now 27% undervalued against the US dollar. This reflects the exodus of global investors from sterling and UK risk assets amid the political and economic uncertainties of Brexit, history’s most draconian economic own goal.
Sterling at 1.30 means Planet Forex disses the probability of a no deal hard Brexit, anathema to the political elites of Westminster and the financial elites of the Square Mile. The cognoscenti’s consensus in the City is for a Norwegian style Brexit. Technicals (slow stochastics) suggest sterling is overbought at 1.2990 and positioning data/FX options risk reversal all suggest traders fear downside risk. Jolly good. This only reinforces my contrarian bullish sterling call. In retrospect, 1.2700 was an ideal level to accumulate cable as the world enters “Davos week”! After all, sterling is 100 pips higher in a week in which an incumbent Tory Prime Minister suffered the most crushing defeat in a parliamentary vote in Westminster since the 1920’s.
The only rational conclusion is that the financial markets now equate a delay in the March 29 deadline to an ultimately gentler, softer Brexit. If Britain adopts the Norwegian model in its divorce from the EU, the sterling bears will be short squeezed with a vengeance as the British pound surges higher to my next near-term strategic target of 1.36. If history decrees a second referendum and no Brexit, I can envisage sterling as high as 1.45 – 1.50, a target still below its levels in the 2010 – 2016 Cameron era. Note that UK inflation has begun to accelerate to 2.1% even as High Street retail sales had the worst Christmas since 2008, when UK PLC’s biggest banking empires were technically insolvent. The protracted US Federal government shutdown, the risk of Presidential impeachment, dystopian political polarization in Washington and dovish smoke signals from the Presidents of the New York, Chicago, St. Louis and Atlanta regional Federal Reserve banks suggests that the near-term path of least resistance for cable is higher despite all the political pantomimes in the sceptered isle.
It horrified me to see 118 Conservative MP’s vote against Prime Minister May in the most important parliamentary vote since World War Two. The Tories have been divided over Europe for a generation and Europe schisms ended the political careers of Mrs. Thatcher, John Major and David Cameron. Mrs. May leads a minority government and if her government disintegrates, a general election could well follow – a scenario that could well propel Labour’s Jeremy Corbyn into 10 Downing Street. If this happens, all bets are off for sterling and the UK home price fall would morph into an ugly meltdown.
Making money in Chinese, Thai and Indian equities in 2019!
If Asia is a growth warrant on the global economy, the omens look awful as the IMF just warned the financial glitterati at Davos. Asian equities were the victims of the grim macro investment themes in 2018. Four Federal Reserve interest rate hikes forced Asian central banks to raise borrowing costs to protect embattled local currencies. The Trump White House’s game of chicken on trade and tariffs with China unnerved investor confidence across the Pacific Rim. King Dollar triggered an exodus of flight capital, as did the shadow banking crackdown, forced deleveraging and economic slowdown in the Middle Kingdom. MSCI’s bellwether Asia ex-Japan index plunged by 18% in 2018, led by a 20% fall in MSCI China. In several Asian stock markets, I was stunned to see valuations a mere 8 – 10% above lows witnessed in the depths of the global financial crisis in December 2008.
Yet successful investing is not about good or bad but better or worse since a shift in the second derivative presages a turn in the financial markets. This is now happening in Asia. The Powell Fed has abandoned monetary hardball and the capital markets now expect only two Fed Funds hikes in 2019. The US dollar exhibits a loss of momentum in its bull uptrend. The smoke signals from Washington and Beijing suggest a negotiated deal to de-escalate trade tensions is imminent. The woes of the Apple iPhone suppliers and semiconductor/component vendors is priced into stock exchanges in Taiwan and South Korea. US interest rate sensitive but expensive Southeast Asian markets like Duterte’s Philippines and Jokowi’s Indonesia have lost their valuation froth.
While Chinese GDP growth fell to a 28 year lows at 6.6% in 2018, the Politburo and the People’s Bank of China have opted for monetary stimulus on the eve of the National Peoples Congress conclaves in March. Even President Xi Jinping has warned about black swans and “grey rhinos” (risks so obvious they are ignored). As a trader, I live life in the second derivative and the message from the markets is crystal clear. January 2019 is the time to go bottom fishing for value in the constellation of Asia ex-Japan equities. Where?
One, MSCI China has derated to a valuation of 10 times earnings even though earnings growth could well be 12% in 2019. The PBOC has slashed the reserve requirement ratio (RRR) for Chinese banks and thus injected monetary stimulus into the economy. The Politburo could well respond with fiscal stimulus and infrastructure spending to maintain a 6.5% GDP growth target. The sharp rise in the Chinese yuan to 6.75 as trade/tariffs threats eased in Washington seems a replay of the 2016 Shanghai accords. The time to buy China is when Beijing’s policy hits bottom – and this happened a month ago in China. Shanghai could well deliver 25% returns for US dollar investors in 2019.
Two, Thailand is my favourite stock market in Southeast Asia. Bangkok’s SET index trades at 14 times earnings and can well deliver 15% EPS growth as domestic demand/capex/FDI powers economic growth of at least 6% in GDP. The Kingdom of Siam boasts stellar macro metrics – a 9% current account surplus, the Thai baht is the most resilient Asian currency against King Dollar, rising FDI from Japan, the sheer potential of the Mekong Delta. I remember the Thai market returned a phenomenal 160% in 2003, when Thaksin’s Thai Rak Thai party first took power. Can Thailand be the money-making Goldilocks of Southeast Asia in 2019 if the military junta does not botch the election? Yes, the reason I love the major Thai banks as growth/consumption proxies.
The Nifty at 10900 leaves only modest upside for Indian equities at a time-valuations are high on MSCI India at 17.6 times earnings, a full 200 basis points above 10-year averages. It is absurd to forecast the precise result of the Indian general election, but a hung Lok Sabha seems a credible outcome. High valuations and political risk are not the only Achilles heels of the Indian stock market in 2019. There is increasing evidence in the macro data that private consumption and industrial output is decelerating and a new corporate capex cycle is iffy. Global investors are nervous after the BJP’s setbacks in the Rajasthan, Madhya Pradesh and Chhattisgarh state elections. I can envisage a Nifty correction to 9800 this spring. This could be an opportune moment to accumulate ICICI Bank (peak in non-performing loans, declines in funding costs) and Infosys, India’s preeminent IT services colossus that is beneficiary of a weaker rupee and the multiple digital transformations in Silicon Valley. May the ghost of E.M. Forster forgive me, but I expect 2019 to be a stormy passage to India.
