Monthly Archives: July 2016

The Philippines: The Rising Star for Global Demand

What country is the next China? I guess it is hard to answer given the uniqueness of China in terms of its advantage, problems and institutions. A slightly more practical question may be, what country may see rapidly growing demand for global goods and services and such demand could be too large to neglect?

To answer that question, I have done a simple filter exercise on the major emerging market countries. While a filter exercise may too easily neglect some hidden treasures, what is left is arguable a strong case.

First, I focus on emerging/developing countries with population over 50 million, except China/India with uniquely huge population (and those countries have a lot of complicated issues). A large population sets an important foundation for large domestic demand.

Second, I focus on countries with trade/current account surplus and low external debt. Persistent current account deficit prevents the country from accumulating foreign exchange reserves or net foreign assets, which leaves the country vulnerable to foreign capital outflow. Money flows out when it is needed the most (e.g. during economic downturn or in case of large external shock). That leaves out countries like Indonesia, Brazil, Egypt, Turkey and South Africa. Vietnam is also excluded due to its high external indebted and underdevelopment of domestic capital markets.

Third, I focus on countries with relatively stable political and security environment. Political, violence and security risks are usually hard to price by financial markets, given its nature of large tail risk and difficulty to hedge. That leaves out countries like Pakistan, Bangladesh, Ethiopia, DR Congo and Thailand. Mexico is somewhat concerning given its security problems.

Fourth, I focus on countries with low risk of Dutch disease. It may sound a bit controversial to avoid oil countries like Russia, Nigeria, Iran and to some extent Mexico, particularly in the case of rising oil price. However, most of those countries (barring Mexico) have undiversified manufacture bases and rely heavily on oil prices. Unless the countries are very disciplined in transforming oil revenue into productive areas, oil windfall usually exacerbates inequality and political instability.

Interestingly enough, what is left is only one country, the Philippines. Admittedly the country is not without problems, with so many of its people working abroad to earn remittance, reflecting a lack of career opportunities domestically. However, with a large population and low exposure to many risk areas that I listed above, it becomes less a surprise to see the strong growth of the Filipino economy and the rising power of its middle class.


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Shift in equity focus with limit of monetary easing and FX depreciation

Monetary easing – which results in currency depreciation and lower cost of equity – has provided support for equities of certain developed markets such as eurozone and Japan. Investors that used to invest in hedged version of the equity indices have gained decent returns.

However, such strategies may not work in the near future. For instance, in the case of Japan, the power of monetary easing has been used a lot of times, which fiscal easing and structural reform continues to disappoint. It is hard to imagine the country can significantly pull up its fiscal lever given its elevated level of fiscal debt. And monetizing its fiscal deficit belongs to un-chartered territory, which may stir even more uncertainty even if it is carefully deployed. Another example is eurozone which is experiencing mild recovery and policymakers seem not in a hurry to depreciate euro that may otherwise cause new fear of competitive FX depreciation.

More importantly, many equity markets that were relied on monetary easing to support their prices were staying at unattractive level of valuation, as the cost of equity was suppressed by the low bond yield. However, I doubt how much bond yield could go further, particularly after the Brexit vote that has already caused the market to be risk averse and poured more money into the bond market.

Therefore, rather than sticking to equities that were supported by monetary easing or benefited from FX depreciation, it is probably important to focus on those with more reasonable valuation that provides more buffer in the case where monetary easing reaches its limit or policymakers are late to respond due to various other concern/political constraint. Emerging equity may be a good choice.


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Asset allocation implication of the Brexit vote

The Leave Result of the EU referendum continues to weigh on the economy and the markets, due to the uncertainty of the protracted negotiations ahead. However, policy response is in place and will be more down the road if private sector confidence is dampened for long. To some extent, the “Leave” result should not be call a Black Swan event, as the event happens at a predetermined time with predetermined procedure. In other word, it was a known unknown. The trouble was that the markets underestimated the uncertainty of the result and did not do enough hedging against it.

Given that policy response is in place for the known unknown, one should not reduce its exposure to risky assets (e.g. equities). Given government bond yield hits new low due to the Brexit uncertainty, its expected return is deemed lower, which again supports the relative attractiveness of equities.

However, rotations among global equities should be considered. The uncertainty weighs on the UK economy and more importantly on the sustainability of the EU, exacerbated by the refugee crisis. Therefore, European equities would seem less attractive than before and  would struggle to find catalysts amid the political uncertainty, unless the ECB backs down on the political bargaining table, worries a lot about the Brexit impact on Eurozone and initiates more easing that pushes down euro. On the other hand, Asian and American equities, particularly emerging market equities may benefit from the fresh rounds of developed market monetary easing. And it is too early to say that the Brexit uncertainty would really weigh on global trade, a key macro driver of emerging equities.

Real assets, e.g. residential and commercial property, private equity, may take longer to adjust and recover than publicly traded assets. Self-fulfilling prophecy may push the price lower for longer, as many new buyers are forced to wait and see amid the political uncertainty. The culprit again is the expensiveness of those assets – and I doubt the Bank of England easing could effectively stem the price decline.

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