The Daily Update - Asset Buffers & PAINTBRUSH

Earlier this week S&P published a report highlighting the importance of a large stock of liquid government assets in supporting a sovereign rating: ‘when government assets exceed 100% of GDP, the positive effects are visible throughout our analysis, and this is currently the case for only seven sovereigns we rate. Topping that group is Kuwait, followed by Norway and Abu Dhabi.’  The report goes on to note: ‘Our ratings on Kuwait and Abu Dhabi remained stable at 'AA' throughout the recent slump in oil prices, underlining the rating stability provided by having large liquid assets.‘

At Stratton Street we have long been proponents of the importance of net foreign assets (NFA) in screening for countries that we would like exposure to.  We favour creditor nations and those with net foreign liabilities (NFL) less than 50% of GDP. IMF research indicates NFL above this threshold are associated with increasing risk of external crises and as we have recently seen a number of debtors’ asset markets have come under pressure as the Fed continues to tighten and rein in US dollar liquidity.

Countries with net foreign assets are less reliant on foreign inflows than those with net foreign liabilities and over the longer term creditors’ currencies tend to appreciate while those of heavy debtors tend to depreciate.  Back in February 2014 Stratton Street highlighted a list of vulnerable countries with large net foreign liabilities which we collectively named as ‘PAINTBRUSH’. These countries, in no particular order of level of concern, are Poland, Australia, Indonesia, New Zealand, Turkey, Brazil, Romania, Ukraine, South Africa and Hungary. As a guide, since the end of February 2014 none of these countries’ currencies (spot rate) are showing a positive return against the US dollar: the Turkish lira is the worst performer down 66.1% closely followed by the Ukrainian Hryvnia down 64.8% and the Brazilian real down 43.5%.  The Polish Zloty is the best performer down 18.1% (spot basis). In contrast, the currencies of creditor nations such as Singapore, China, Japan and Switzerland have performed better although over this time period the US dollar index (DXY) has appreciated.

To put these moves into some form of perspective, in August 2008 the Global Financial Crisis had only just begun (Lehman’s filed for bankruptcy in September 2008) and between the end of August and the end of the year the Turkish Lira had fallen by 22.9%, the Ukrainian Hryvnia declined by 40.2%, with the Polish Zloty falling by 23.4%. Meanwhile, 10 year Treasuries declined by 160 basis point during that period, ending the year at 2.2%.

Past performance in no guide to the future, but deleveraging phases always follow a predictable pattern with the PAINTBRUSH currencies always declining more than the currencies of creditor nations. Equally, government bonds always rally in a flight to quality move so it seems more than a little surprising that the market is still running record short positions in US Treasuries. We all know about the “pain trade”, the tendency for markets to deliver the maximum amount of pain to the most investors as a popular strategy takes an unexpected twist. Maybe those investors should pay more attention to the PAINTBRUSH currencies, after all the first four letters should serve as a reminder as to what happens when a crowded trade starts to go wrong.

Please read this important information before proceeding. It contains legal and regulatory notices relevant to the information on this site.

This website provides information about Stratton Street Capital LLP ("Stratton Street"). Stratton Street is authorised and regulated by the UK's Financial Conduct Authority. The content of this website has been prepared by Stratton Street from its records and is believed to be accurate but we do not accept any liability or responsibility in respect of the information of any views expressed herein. The information, material and content provided in the pages of this website may be changed at any time by us. Information on this website may be out of date and may not be updated or removed.

The website is provided for the main purpose of providing generic information on Stratton Street and on our investment philosophy for the use of financial professionals in the United Kingdom that qualify as Professional Clients or Eligible Counterparties under the rules of the United Kingdom Financial Conduct Authority (the "FCA"). The information in this website is not intended for the use of and should not be relied on by any person who would qualify as a Retail Client. Products and services referred to on this website are offered only at times when, and in jurisdictions where, they may be lawfully offered. The information on this website is not directed to any person in the United States. The provision of the information on this website does not constitute an offer to purchase securities to any person in the United States (other than a professional fiduciary acting for the account of a non-U.S person) or to any U.S. person as such term is defined under the Securities Act of 1933, as amended.

The website is not intended to offer investors the opportunity to invest in any Alternative Investment Fund ("AIF") product. The AIFs managed by Stratton Street are not being marketed in the European Economic Area ("EEA") and any eligible potential investor from the EEA who wishes to obtain information on the AIFs will only be provided with materials upon receipt by Stratton Street of an appropriate reverse solicitation request in accordance with the requirements of the EU Alternative Investment Fund Managers Directive ("AIFMD") and national law in their home jurisdiction. By proceeding you confirm that you are not accessing this website in the context of a potential investment by an EEA investor in the AIFs managed by Stratton Street and that you have read, understood and agree to these terms.

No information contained in this website should be deemed to constitute the provision of financial, investment or other professional advice in any way. The website should not be relied upon as including sufficient information to support any investment decision. If you are in doubt as to the appropriate course of action we recommend that you consult your own independent financial adviser, stockbroker, solicitor, accountant or other professional adviser. Past performance is not necessarily a guide to the future. The value of investments and the income from them may go down as well as up. An application for any investment or service referred to on this site may only be made on the basis of the offer document, key features, prospectus or other applicable terms relating to the specific investment or service.

Where we provide hypertext links to other locations on the Internet, we do so for information purposes only. We are not responsible for the content of any other websites or pages linked to or linking to this website. We have not verified the content of any such websites. Such websites may contain products and services that are not authorised in your jurisdiction. Following links to any other websites or pages shall be at your own risk and we shall not be responsible or liable for any damages or in other way in connection with linking.

By using this site, you should be aware that we may disclose any information that we hold about you to any regulatory authority to which we are subject, or to any person legally empowered to require such information.

This website uses cookies to improve user experience, by clicking the "I Accept" button below means you consent to the use of cookies on our website.