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Winter Forum – March 6, 2012

EU’s “Can Kicked Down the Road”?

EMTA’s Winter Forum was held in London on March 6, 2012.  Once again, JPMorgan hosted the event in their Great Hall, which was attended by over 150 market participants.

Joyce Chang (JPMorgan) led the event’s discussion of sell-side analysts.  Chang began the session by noting that economic forecasts for 2012, as shown on a slide projected at the event, were in a narrow range, with the greatest variation in estimates on US GDP growth and G-3 FX specifically the USD/EUR and USD/JPY rates.  (The slide of economic forecasts is available on the EMTA website at

Chang further observed that the current economic forecasts were much more positive than those offered at the December 1, 2011 EMTA Annual Meeting, and sought explanations for the change in tone.  Credit Suisse’s Kasper Bartholdy found this rational and attributed it to ECB action that had led to sharply reduced concerns of a sovereign default by Italy or Spain, and thus decreased Eurozone risks in general, although the upcoming French elections and Greece’s potential Eurozone exit could lead to market volatility.  The fact that aggressive G4 central bank monetary support has generated traction in financial markets also had led to the adoption of a less pessimistic outlook.

Arnab Das (Roubini Global Economics) concurred that “catastrophic” risk had declined in recent months, but added, “let’s call a spade a spade; eventually Greece will exit the Eurozone.” EM players should know better than anyone, Das argued, that official denials of a devaluation were almost inevitably followed by a devaluation.  The only question that remained was whether enough time had been bought to mitigate the effects of a Greek default.

David Lubin (Citi) rejected a suggestion that a potential Greek default had become a “non-event,” and refused to rule out Portugal and Ireland as additional debt restructuring candidates.  Chang summarized speaker comments that, at best, “the can has been kicked down the road, but the crisis is not over.”

Discussing China’s impact on global growth, Lubin stressed that “China is absolutely fundamental...and any Chinese shock would translate into a decrease in risk appetite.”  Chinese authorities were mistaken to believe they could squeeze the property sector without affecting the rest of the economy, according to Lubin, who asserted that officials would be subject to the same pressures and incentives as their democratic counterparts in order to ensure a smooth leadership transition.  Das revealed that his forecast for Chinese growth was 4-6% in 2013, notably below street consensus.

On additional risks for 2012, Standard Bank’s Stephen Bailey-Smith expressed his belief that the downside risk to growth is already priced in to the market, and that the DM linkages to frontier markets were mainly realized through commodities.  Bailey-Smith observed that frontier markets have underperformed since the global financial crisis began in 2008.

Several panellists concurred that attacks on Iran were not a base case, and that recent US and Israeli comments indicated a decreased chance of a military intervention.  Lubin suggested that the uptick in oil pricing could be due to “over-worrying,” while increased demand from Japan and China provided fundamental support of oil pricing.  Bailey-Smith noted his forecast for oil (WTI) in 2012 was $105.

Reviewing specific countries, Lubin noted that the IMF and EU had ample reasons to negotiate aggressively with Hungary, especially in light of the potential increased contributions to the IMF from Gulf countries, etc, which would be monitoring developments.  Bailey Smith expected a reversal of the rand’s appreciation, forecasting ZAR at 8.20/8.30 by year end.  Das judged the Russian elections a “non-event,” while warning if the status quo in Russia did not change, investment in the country would remain little short of an oil play.

The panel ended with trading recommendations.  Lubin saw rates declining throughout the EM world, with the notable exception of South Africa.  He added that that the recent run in EM equities still had room to continue.  Bartholdy and Das voiced optimism that EM sovereign bonds would catch up (in terms of spread compression) after lagging other assets.  Bartholdy also recommended Russian OFZs, Argentine GDP warrants, and the RUB, PLN and MXN.

Bailey-Smith acknowledged that his recommendation of Egypt was a contrarian view, while Nigeria remained a top selection.  He saw opportunities in Kenya and Uganda, and spoke constructively on Cote d’Ivoire (“they will make the June coupon payment, and there are positive structural changes taking place in the country.”) Chang highlighted her overweight EMBI recommendation.  She favored Venezuela, while also seeing opportunities in Belize (even in a restructuring) and also spoke positively on the CNY and MXN.

The event’s Investor Panel followed, moderated by Kevin Daly of Aberdeen Asset Management.  Jerome Booth (Ashmore Investment Management) continued his impassioned championing of the asset class.  “Investors remain massively under-allocated to EM; there is much further compression to come in spreads on both sovereign and corporate debt, and any drop in asset pricing should be viewed as a buying opportunity,” he proclaimed.

La Francaise AM’s Tom Fallon concurred in the positive view of EM.  Gene Frieda (Moore Capital) noted that a lot of tail risks had been removed from the market, while suggesting that a going into risk-off mode in the 2H was probably wise.

The effects of the Greek exchange were discussed.  Moore polled attendees if they would buy post-exchange Greece, but a show of hands revealed no takers.  “Greece is fundamentally irrelevant, the 120% debt/GDP ratio [post-exchange] is a joke, and Greece will default again,” stressed Booth.  The traditional goal of a restructuring--a boosting of private sector confidence--would not occur in this case, but that was of no importance to pension funds investing in EM, Booth argued.  Other panelists agreed that market concerns should be limited to the potential for a Eurozone break up, and several predicted a short-term (if not short-lived) relief rally once the exchange was completed.

While recent US macro data had led to increasing investor confidence, Booth expressed scepticism.  “The reality is that there is still a lot of deleveraging that must take place in the US and UK; there are several more years of slow growth in the US ahead of us...and we are probably doing the best that can be expected, simply because there has not been a blow up,” he stated.  John Carlson of Fidelity Investment Management adopted a more optimistic tone, “I think that US growth will be steady and will gain traction, although I am not predicting 4% growth,” he noted.

The panel concurred that the chances of a hard landing in China were vastly exaggerated, with Fallon reminding attendees of the vast resources at Beijing’s disposal.  Booth suggested that the Chinese hard-landing story was mostly an excuse employed by those wishing to avoid allocations to EM.  Daly disagreed with Das’ earlier prediction of much slower-than-expected Chinese growth, agreeing with Fallon that the government “clearly has the ability to stimulate the economy if needed.”

At 900-1000 bps over USTs, Venezuelan debt had room to rally, especially in a year of firm oil pricing, opined Fallon.  He warned investors however that, following market speculation on a potential leadership change, the country’s history of democratic governments was limited, and that investors should in any case wish for a continuation of the Chavez government’s record of servicing external debt in any future administration.  Daly predicted the credit could trade through Argentina under a new leader.  Carlson labelled Venezuela a top recommendation.

The effects of the Volcker Rule and Basel III were also discussed.  Fallon commented that larger firms would feel the liquidity contraction more than smaller funds, while Carlson predicted that EM corporate debt would increasingly be a buy-and-hold game.  Traders would be hurt more by the reforms than investors, Booth stated, highlighting that EM banks would likely gain market share from traditional EM sell-side firms, which was “a healthy development.”

On trading recommendations, Frieda observed that the 4Q 2011 sell-off was almost perfectly mirrored in the Q1 2012 rally.  “There has been almost no differentiation in credits, so the macro trends are the most important factors,” he commented, pointing out that the anticipated easing of rates in China in Q2 could be a market mover.  Frieda would short India and Turkey and was not convinced that Hungary was “on the path to redemption.”

Fallon recommended Argentina and Russia.  He also favored the ZAR (while cautioning “we always get ZAR wrong at the EMTA meetings”).  Daly joined Fallon and Carlson as members of the MXN fan club, with Daly also recommending Nigerian T-bills.