The first round of the Chilean Presidential election is due to be held on Sunday 19 November 2017 following the July primaries where the main parties elect their candidates. The incumbent President Bachelet will have served two terms in office so will no longer be eligible to run according to the Chilean Constitution but given how her approval rating has plummeted in her second term the voters look ready for a change. Not only have her attempts at pension and education reform been poorly received but voter concern has been compounded by the recent wildfires that have destroyed over half a million hectares of land.
The French presidential election is shaping up to be a bit of an odyssey with all manner of surprises and it is yet to even get to the first round of voting. A week or so ago Emmanuel Macron looked like having the best chance at facing Marine Le Pen in the second round run-off in May after François Fillon’s polling took a hit from the Penelope-gate scandal. Then, there was the story that the left candidates Benoît Hamon and Jean-Luc Mélenchon were exploring an alliance with a single candidate to represent the left but this failed leaving both facing the prospect of elimination in the first round based on their current polling-scores. But in politics a lot can change in a week.
In a report today on the public finances of EU members, the European Commission (EC) has warned Italy to tighten fiscal policy by at least 0.2% of GDP or face sanctions. This target is what Rome had promised the EC earlier this month, but obviously the Commission have yet to see enough progress. An EU official commented, ‘Unless Italy specifies its commitments properly, next week will show that they are not compliant with the debt rule.’ Given that Italy ‘should’ be reducing its deficit by 0.5% of GDP and its debt by 3.6% of GDP per annum this warning already accommodates a fair amount of leniency. With the EC forecasting Italy’s public debt rising to troubling all-time-highs of 133.3% of GDP this year it has given until April for Rome to enact the promised, but yet to be detailed, measures. Given that the EC has shown leniency (relative to its stringent austerity policies) to other members such as Greece and Portugal it seems unlikely that Italy will be fined if it does not meet this timeline, but a formal censure in May is certainly possible and would further increase negative sentiment towards a vulnerable Italy.
Late last week Moody's Investor Services raised Russia’s outlook to stable from negative adding Russia’s strategy ‘reflects an ambitious fiscal consolidation strategy incorporating conservative spending and revenue assumptions’. Russia’s Economy Minister Maxim Oreshkin, said there are ‘objective grounds’ for a ratings upgrade.
Moody’s cited an improvement in the economy as well as a fiscal consolidation strategy that should help wean the country off its dependence on oil. That means that all three major agencies have now confirmed the economy is stabilising after almost a two year long recession, the longest in almost two decades.
Ahead of Eurozone finance ministers meeting today in Brussels to discuss Greece’s progress on achieving its bailout conditions, the head of the Eurozone bailout fund Klaus Regling believes that the southern Mediterranean country will need less in the third instalment of emergency loans from international lenders than originally approved. Speaking to the German newspaper Bild Regling said ‘We already have half of the three-year programme behind us and we've paid out nearly EUR32 billion so far’ however he went on to say ‘By the programme's end in August 2018, we'll likely have paid out significantly less than the agreed highest sum of EUR86 billion.’
This week the Netherlands featured more prominently in the newswires as the country heads to the polls on 15 March for the parliamentary elections. Geert Wilders’ anti-establishment, anti-immigration, anti-euro far-right Freedom Party (PVV) has been leading in the January polls with the campaign slogan ‘Reclaim The Netherlands For Us’. Interestingly, three polls this week actually showed a decline in support for the PVV: Kantar Public/TNS TIPO showed a fall from 35 seats to 27 (out of 150 parliament seats), De Stemming showed a fall from 31 seats to 26 and I&O a decline from 26 to 20 seats. The I&O poll also put the Liberal Party (VVD), led by the current Dutch Prime Minister Mark Rutte, in first place for the first time since November 2016 with 24 seats.
As regular readers are aware we favour investment grade bonds which we deem are ‘undervalued’; thus providing attractive risk-adjusted expected returns and sufficient credit notch cushion; against any unforeseen events. We also tend to favour quasi-sovereign holdings, which are broadly state-owned, thus strategically important to the government, and trade on spreads much wider than the sovereign curve. To this effect our current exposure to sovereign and quasi-sovereign across our portfolios stands at ~80% and above.
There are however a number of corporate issues we favour; here the quality of credit and spread cushion are crucial. One example could be a holding in AAA rated Microsoft 4.2% 2035 which is currently trading at a spread over 115bps over US Treasuries (“UST”); similar AAA bonds trade at only ~45bps over. Currently offering an attractive expected return and yield at ~13%, with 5.5 notches of credit cushion, we calculate the bond's expected capital gain, were it to reach fair value, at over 10 points.
There have been a number of interesting corporate issues out this week, some of which have looked relatively attractive, while others have not offered enough in terms of spread cushion. Today’s offering from Kuwait Projects (KIPCO) is a perfect example. Rated BBB- (one notch above junk) the 10-year issue, is currently being offered at a yield of 4.75%; which would be a welcome holding in most portfolios. However, using our proprietary Relative Value Model, we calculate the expected return stands at a mere 2.6%; as it trades only 32bps wider than similar securities. Although we have been long term holders of the major investment holding company in the past, and the Kuwaiti ruling family indirectly owned a large stake in the company, this issue offers very little in terms of cushion, with less than one notch of credit protection.
Ahli Bank Qatar, another corporate new issue to the market priced today at +163bps over UST, which is relatively attractive given similarly rated A2 bonds with a duration around 4.5 years trade at ~91bps. The expected return and yield is calculated at 6.6%, with 3.3 notches protection. Although this bond offers far more spread cushion than the KIPCO issue and a higher credit rating, we would not look to hold it as we have chosen to not hold GCC banks at the moment, and Ahli Bank is tiny (~3% market share in terms of assets), with little to no guaranteed government support.
We look to maintain our portfolios’ credit quality at a weighted average single A rating, and continue to search for value opportunities. We avoid taking any unnecessary risks when building our portfolios by: undertaking sufficient credit analysis and evading the ‘search for yield’ trap.
Yesterday’s hawkish testimony from Fed Chair Janet Yellen sent the Dow and SP500 to new all-time-highs along with a rally in the dollar and global equity markets and pushed Treasury yields back above 2.5%. Markets seem to have focused on her reference to the recent improving economic data - drawing a consensus that a June (or even the possibility of March) rate rise may be on the table. However Yellen also stressed caution over the uncertain economic picture; notably the risks and ‘considerable uncertainty’ associated with the current administration’s plan to boost growth through further unsustainable fiscal stimulus. In contrast she stressed ‘the importance of improving the pace of longer-run economic growth’.
The risks of a hard/soft landing in China have subsided as the strong economic data releases of January continue to support the country’s improving economic outlook. Exports, measured in US dollars jumped 16.7% yoy, from 3.1% in December and beat market calls for 10%, meanwhile imports remained robust at 7.9%, beating the market consensus once again. Inflation figures also surprised on the upside; PPI surged 6.9% to the highest level since March 2011 while CPI rose 2.5%, from 2.1% in December. ‘Seasonal factors’ could have contributed to the encouraging trade data; boosted by the timing of the week-long Lunar New Year beginning in January.
Over the weekend the Swiss public rejected plans to overhaul their corporate tax structure, in the process giving the Swiss government a renewed headache on how to abolish ultra-low tax rates for multinational companies without causing a huge exodus. The government has already stated its commitment to abolish the preferential tax rates that cantons give to multinational companies; which have been set up as holding and domiciliary companies as they fall foul of OECD tax rules. Companies with this status account for over half of all the research and development spending in Switzerland as well as employing over 150,000 people. This equates to approximately half of all the corporate tax revenue the Swiss government receives.
The French Presidential election has been grabbing the headlines as the Penelope-gate scandal looks to have crushed Francois Fillon’s chances, instead propelling Emmanuel Macron as the likely runner against Marine Le Pen in the second round run-off. But even in Germany the elections may well be shaping up to be a close race, although it is still early days as German voters do not go to the polls until 24 September 2017.
Concerns have escalated in the commodity space this morning as Iron Ore in particular could see a dramatic fall in value after it’s nearly 60% rise in price since mid-October last year.
The main reason for this is a huge jump in stockpiles especially in China. Inventories at China’s ports jumped 123.5 million tons last week taking them to about 75% of the ports holding capacity. To put that into perspective it is reported that a further 20 million tons would bring capacity to 90%. The reason cited for this is a massive over calculation in demand by producers combined with suppliers taking advantage of the jump in prices in the fourth quarter of last year.
Greek 2 year bonds touched yields of 9.5% yesterday on the back of a disenchanting report from the IMF which has revived a dispute between the IMF and EU creditors. Europe and markets generally have continued to assume that the IMF would eventually join the third bailout programme for Greece which for the last three years has fallen solely to the European Stability Mechanism (ESM). The IMF was meant to have decided on their participation by end 2016 but continue to abstain whilst arguing for a 1.5% primary surplus – rather than an “unrealistic” 3.5% target by 2018 as demanded by the European Commission – which would necessitate significant debt relief from other Eurozone countries.
China’s fx reserves fell to, a still very substantial, USD 2.9982tn in January. Although the largest reserves globally, the dip through the psychological USD 3tn threshold has shaken some market players, despite the same commentators saying that the country’s reserves were too large back when they stood at ~USD 4tn! What the reserves are made of only Chinese officials know, however the drop in reserves, albeit attributable to renminbi protection, is also caused by huge currency swings, or fx valuations. Since June last year, sterling alone has fallen 12.6% against the onshore renminbi, and 16.5% against the dollar, at time of writing.
In the fast moving world of the US legal system, Trump’s Justice Department's request for an immediate reinstatement of the executive order to ban travellers and refugees from seven predominantly Muslim countries was denied by the federal appeals court yesterday. The request for the reinstatement came after Seattle Judge James Robart temporally halted Trump’s immigration order stating that the ruling would cause ‘immediate and irreparable injury’. Later Robart wrote, ‘The executive order adversely affects the state’s residents in areas of employment, education, business, family relations and freedom to travel’, adding ‘These harms are significant and ongoing’.
Today’s January non-farm payroll release showed 227,000 jobs added which was above expectations of 180,000 jobs created although the prior month’s reading was revised up by only 1,000 jobs to 157,000. The unemployment rate edged higher to 4.8% from December’s reading of 4.7% along with the participation rate which increased to 62.9%. Importantly, average hourly earnings grew 2.5% yoy, down from the previous month’s figure of 2.9% yoy, and below expectations of 2.8% yoy.
By the way, today is Groundhog Day.
As Trump voiced his concerns over the apparent ‘bunch of bad hombres down’ in Mexico, the less sensational Fed voted unanimously to keep rates on hold and gave little indication of a hike at the next meeting in March. Comments included ‘some further strengthening’ in the labour market, increasing inflation, albeit still below the central bank’s target, and ‘soft’ business sentiment.
Consider two countries: one with high public debt and Net Foreign Liabilities rated Baa2 versus one without Net Foreign Liabilities rated Ba1. History has shown that high levels of indebtedness greatly increase financial risks to creditors as investor sentiment becomes more volatile and repayment costs balloon. We believe the risks of this greatly increase when Net Foreign Liabilities exceed 50% of GDP and are typically unsustainable beyond 100% of GDP. Yet there are numerous examples across the world where countries with high levels of indebtedness are rated higher than net foreign creditors or countries with appropriate and sustainable levels of debt. Why is this?
As President Trump continues to settle into the role, with confusion and sackings domestically, one of the international situations which we still have no information on is the policy in regard the Russian sanctions. Trump has spoken to President Putin but according to reports the sanctions were not discussed.
Strikes us that it would not be in Mr. Putin’s best interests to rush to have sanctions lifted as this would cause a further rally in the rouble; which has been a key weapon in Russia’s armoury to survive the fall in the price of crude over the last few years.
According to a draft report issued by the International Monetary Fund (IMF), Greece’s government debt could soar to 275% of its gross domestic product (GDP) by 2060, at which time its financing needs will be a massive 62% of GDP, although these figures are disputed by the Greek government's own estimates. Greece believes debt at present is a mere 180% of GDP.
The IMF reports that Greece’s debt and financing needs will be ‘explosive’ in the coming decades unless they can renegotiate the bailout programme with the EU to lighten the load.