Monday, July 28, 2014
On the 17th of May we published a note titled, “Time for Emerging Markets?” here is an excerpt that missive:
“What we really think is happening is that those EM markets that were strongly correlated to the commodity cycle (particularly as producers) have lagged versus their peers and dragged the MSCI emerging Markets Index down versus the S&P 500. For EEM to begin outperforming we would need to see a rebound in raw materials demand from:
- A rebound in the Chinese economy (China is in a debt crisis – unlikely)
- inflation concerns picking up due to US growth (US Treasuries are saying no)
- Or our least favorite but seemingly most likely – War!”
Of the 3 root causes above we were likely wrong about a rebound in the Chinese economy – at least that’s what the iShares FTSE China 25 indicated with a breakout last week (blue line in chart below):
Figure 1 – iShares FTSE China 25 breaking out
We suspect that the breakout is a result of the loosening of monetary conditions by Chinese central bank planners, allowing even more credit to flow into that economy. China’s economy has been the setting for mal-investment on an unprecedented scale, the result of which will be one of the most spectacular economic busts ever recorded or, more likely, very many years — perhaps even decades — of lacklustre performance. But for now let the good times roll…
Regarding resurfacing inflation concerns in the US, we note that high yield bonds have continued their underperformance relative to US Treasuries since Q4 of 2013. This is an indication of slower growth or heightened risk aversion – not conditions for higher inflation expectations.
Unfortunately we were prescient about our comments on War. While Israel and Gaza are front page news as is the downing of Malaysian Jet MH17 there are other news worthy items, of significant consequence, which have not yet entered mainstream conscience. For example the Washington Post reports on June 30th – In Baghdad, we could see the fall of Saigon all over again.
The Islamic State (first ISIL, then ISIS), run by Iraqi jihadist Abu Bakr al-Baghdadi, is actually already at the western gates of Baghdad, cleverly infiltrating from the Sunni western neighborhoods. Abu Bakr al-Baghdadi has claimed to be the caliph of the Islamic State. So a shocking headline “Baghdad Falls,” might be a trigger for a stock market decline.
In a world where Twitter now has a bigger market cap than old-line blue chip Coca-Cola and a building at One Wall Street in New York sells for $585 million – over half a billion dollars, for a building, investors may be forgiven for wondering if anything of value exists anywhere, anymore.
Our analysis indicates that such value may exist in the metals complex (including precious metals) as well as emerging markets, especially those that are commodity producers such as Brazil.
Figure 2 – Industrial Metals etf
Figure 3 – Ishares MSCI Brazil
P.S. the one way we would be comfortable investing in China today would through a long/short approach – our assessment is that there will be both winners and losers in this, the Chinese Century.
Chief Investment Officer
Advisory Services offered through Atlanta Capital Group.
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