Monday saw the biggest daily gain for the renminbi for more than a decade although you’d be hard-pressed to notice given the amount of negative press comment about China these days. The renminbi gained 1.2% against the dollar after the resumption in mainland trading following the Chinese new year. This is the biggest gain against the dollar since the renminbi was unpegged back in July 2005. Last week also saw China’s trade balance balloon to USD 63.29bn for the month of January, a new all-time record. At the time of writing, so far this year the renminbi has gained 1.58% against the dollar and 5.97% against sterling in total return terms. Most clients we have met with recently are shocked when they discover that the renminbi has been steadily appreciating over the past several weeks. They seem even more surprised when they realise that the renminbi has gained more than 10% against sterling over the past year, in total return terms, making the renminbi one of the best performing currencies over the past 12 months.
Less surprising is the fact that Greece is officially back in recession after announcing its second consecutive quarter of negative growth. The IMF, which is still to confirm whether it will join a third bailout, is pro-debt relief on the basis that Greece’s debt to GDP at ~175% is unsustainable. This is far too difficult for Greece to finance with yields from two years to 10 years all above 10% currently; some form of debt relief seems inevitable.
Our cut-off for investments in our funds is a net foreign liability of 50% of GDP, above which we believe that countries become increasingly vulnerable. This why we have steered clear of Greece but also avoided countries like Brazil in recent years as our projections suggested a combination of an overvalued exchange rate and a current account deficit would cause Brazil to breach the 50% threshold. This week Standard and Poor’s downgraded the country for the second time in six months, rating the country BB.
In fact, Standard and Poor's went on a bit of a downgrading rampage last week, taking the market by surprise by slicing some oil-exporting sovereign credit ratings by as much as two notches. The majority of the rating decisions were based on the agency’s revisions to oil price assumptions; of Brent crude averaging $40pb this year and $50pb by 2018. Aside from Brazil, affected countries included Kazakhstan, Oman and Saudi Arabia, amongst others.
Of the countries within which we invest, Saudi Arabia’s rating was revised to A- (rated Aa3 by Moody’s and AA by Fitch), and Oman was cut to BBB- (rated A1 by Moody’s). Aware that oil has had an impact on these countries’ balance sheets, we were not surprised by the agency's decision to downgrade. The CDS on these countries more than prices in these downgrades; for example Saudi Arabia’s 5-yr is trading at a CDS of +175, ~90bps wider since September 2014; when oil prices began their descent.
Our exposure to these two nations is via two positions in Saudi’s dominant utility company (SECO) and a holding in Lamar Funding; the state-owned funding vehicle for the country’s electricity transmission network. Rated A1/A+/AA-, the SECO 5.06% 2043 and 5.5% 2044 issues are backed by the sovereign’s ratings; as the Gulf’s largest utility firm is 81% owned by the Saudi government. These bonds continue to offer some of the most attractive risk-adjusted expected returns of ~30% (fair value), with a yield ~6% and offer plenty of cushion; roughly 5 notches, against unexpected events. The Lamar Funding 3.958% 2025 issue, rated A3/BBB/BBB+, yields an attractive 5.7% with an expected return over 15.5% and trades at 3.5 notches cheap; more than compensating for any downgrades. We are not looking to change our positioning in any of these holdings for the time being.