“SURVIVAL THE NEW SUCCESS” AT EMTA WINTER FORUM “Survival has become the new success,” Joyce Chang (JPMorgan) observed dryly as she opened the Forum’s Sell-Side panel. Chang warned that “economic conditions will continue to deteriorate across the board,” and EM growth levels would be lower than during the 1997-98 crisis. She added that JPMorgan has been focusing on EM corporate rollovers as it tries to identify the biggest risk facing the asset class, with sovereigns remaining in comparatively “robust” conditions. Finally, Chang advised that, while her firm forecasts a tightening of the EMBI in 2009, it is underweight EM debt relative to US high-grade and high-yield paper, as the same yield can be obtained in the US high-grade market with lower risk. Kasper Bartholdy (Credit Suisse) agreed with Chang that, in the current environment, the argument for EM debt was difficult to make. All the same, he did see value in weaker EM sovereign credits, even compared to their G-3 high yield counterparts. Asked for a rationalization of current EM cross-country spreads, and specifically why Russian 5-year paper is trading 300 basis points wider than its Turkish counterpart, Bartholdy reiterated a point made at EMTA’s Annual Meeting that such differences appear to be based on domestic bank funding needs rather than financing gaps at the sovereign balance of payments level. This analysis works well for most countries, with the exceptions of Argentina and Venezuela, where political risk and other factors appear to be greater factors, according to Bartholdy. Bartholdy doesn’t anticipate a sovereign payment problem in 2009, although “clearly there is quite a high probability that there will be some defaults” in 2010. (He specified that no country has a greater than 50% probability of defaulting in 2009 although statistically, with several countries in the 10-40% range of defaulting, the combined probability that “at least one of them will default is very substantial.”) “It will take a very long time for EM corporates to re-access the markets,” opined Dresdner Kleinwort’s Arnab Das. Das seconded Bartholdy’s prediction that there would not be a sovereign default—at least “of any meaningful country”—in 2009 while underscoring that the probability rises “substantially” in 2010. On the big picture, he expressed concern that “there is an element of risk to the entire EM thesis—globalization, the Washington Consensus, the flow of capital to the developing world, liberal open markets and convergence.” There is “at least a material risk” of increased protectionism as a result of the current crisis; while “the culture of bailing out” in the developed countries will lead to the crowding out of EM countries. While Das did not expect the traditional argument for EM investment to be entirely debunked, he cautioned that such a scenario could be ruled out. Phil Poole of HSBC argued that “we are coming out of a massive financial bubble…effectively, EM and other asset prices were pumped up way too high relative to their underlying income streams, and the only way we get to a new equilibrium is to see massive wealth destruction.” Poole saw more potential profits going short EM debt than buying it while this wealth destruction is played out. Tim Ash (Royal Bank of Scotland) commented that public sector debt-to-GDP ratios for Eastern European countries was “relatively modest” and that even with a big hit to the banking system, debt levels would still be sustainable (even Ukraine’s debt to GDP ratio should still be 50%, he reasoned). On the other hand, Ash described himself as “staggered” by the decrease in demand in some emerging European exports. Asked to opine on Turkey, Ash proclaimed that the country’s performance over the year has been better than one could have expected. He credited this to a couple of factors including the benefits of lower energy costs as well as, technically, the fact that skeptical foreign investors generally avoided the credit last year. Turning to FX, the panel concurred that fixed exchange rate regimes in Eastern Europe would be greatly strained. Poole viewed the Turkish lira as also being vulnerable as a result of rate cutting. Chang offered her opinion that competitive devaluations were not likely in Asia as “the issue is not a pricing problem, but rather a lack of demand.” Turning to trade recommendations, Bartholdy reiterated Credit Suisse’s overweights on Argentine and Venezuelan sovereign debt and underweights on Brazil and Colombia. Bartholdy also recommended the Chilean peso and Turkish inflation-linked bonds (although he admitted he was not championing these as vigorously as in the past). Das would shy away from corporate debt even at current reduced levels. He predicted EM currencies will generally depreciate vs. the dollar. Poole also favored shorting Asian currencies vs. the dollar, while also suggesting shorting EM equities based upon his expectation of below expectation growth. Ash was intrigued by the risk-reward ratio for Ukraine and advised a short on fixed-rate regimes vs. their floating-rate counterparts. Chang spoke positively on Russian sovereign and quasi-sovereign debt. She also drew attention to the heavy election cycle coming up in emerging countries and “politics still matters.” During the discussion, a slide revealing forecasts for key economic variables from panel firms was displayed. Royal Bank of Scotland’s forecasts were generally among the most bearish, while JPMorgan’s forecasts were comparatively more optimistic. EMTA members may click here to access this slide. Investor Panel Critical of G-7 Leadership “Until we can clean up what is essentially an insolvent G-7 banking system, I don’t think we can make any progress in any area of the world,” stressed David Dowsett (BlueBay Asset Management). EM can emerge at a higher rate of growth than developed countries; however, this must be preceded by investor confidence in a G-7 recovery plan, which is problematic because “no one knows what the sizes of the losses are.” “I think the developed world is clueless,” summarized Fidelity’s John Carlson, who criticized the G-7 for not “being bold enough or inclusive enough.” Fear has taken over but he agreed with other investor speakers that opportunities exist in the emerging world. “They’ve been through this many times before,” he explained. Francis Beddington of Insparo Asset Management emphasized that “we have to face the fact that we will have permanently lower G-7 growth; half the growth in the US was based on leverage.” Beddington pointed out that EM growth would henceforth be more impressive on a relative basis. “The problem in the G-7 is that there is too much talking and not enough listening,” Carlson concluded, and suggested that much could be learned from EM politicians and ministers who have had lots of experience with financial crises. Carlson was skeptical that developed country leaders could resolve the current crisis in the foreseeable future, “because the problem is being solved by the same people who created it.” Dowsett concurred. He acknowledged that he wasn’t sure if nationalization of the US banking system would prove a solution to current malaise. In fact, it was questionable whether anyone could really argue with certainty that bank nationalization would work because of the unique nature of the current crisis, according to Dowsett. Carlson saw three potential outcomes to the current economic state: (1) “The Good” – inflation; (2) “The Bad” – little happens over the next year while anxiety mounts; and (3) “The Ugly” – more deflation. Carlson added that bankers’ salaries should not be capped, but bankers should be required to spend their earnings. Brett Diment of Aberdeen Asset Management believed that the widening of the EMBI was nearing an end as leverage has disappeared and forced selling was close to being completed. Ukraine and Venezuela were appetizing at current levels, he reasoned. According to Diment, fund managers should focus more on larger EM economies where Central Banks were not managing the FX regime too aggressively, such as Brazil, Turkey and Malaysia. Finally, he would “keep it simple” and focus on sovereign debt and well-supported corporate bonds. “It is hard to see Ukraine defaulting, but I wouldn’t rule it out,” Dowsett declared, although he viewed Eastern Europe, including Russia, as his least favorite region. Dowsett liked Argentina and believed their financing for 2009-10 was secured. Corporates maturing in the next year would be more interesting than Brazil A bonds, he added. Carlson seconded Dowsett’s selection of Argentina (“if anyone knows how to inflate their way out, it’s the Argentines…experience counts for a lot in this market!”) He also spoke positively on Venezuela, short-dated Ukrainian bonds and—since he “never sells short a country with nuclear weapons”—also Russia and Pakistan. Beddington selected Ivory Coast as a likely outperformer, citing London Club progress. He stressed that, in general, investors need to do detailed credit analysis in selecting their assets. Booth’s first priority would be to buy “quality assets from distressed sellers.” He contributed the panel’s third buy opinion on Argentina, while expressing a bearish outlook on EM currencies in the short term. The panel took a number of audience questions. In response to a query on how nationalization of banks would affect EM liquidity conditions, Beddington replied he would “prefer to lose a Merrill Lynch than some of my EM banks which are key counterparties for me.” He highlighted the return of some boutique investment bankers as well as new emerging brokers. Dowsett believed that the CDS market’s previous liquidity “won’t be coming back.” Local counterparties make more sense for local trades, and “there are enough enterprising people out there” to fill the gap in liquidity for sovereign and corporate external debt. Diment predicted that the profits being made by the current wide bid-offer spreads would eventually lure major banks back into the external debt markets. Prompted for their most out-of-consensus forecast for the coming year, Carlson had to assure the audience he was not joking when he predicted a 50% rally in world-wide equity markets, based on history and psychology. Diment expected January 2010 industrial production numbers will rise by at least 20% around the globe because of low comparisons. Dowsett feared “major discontinuities in China on a social level” as workers in coastal export zones return to their villages. “Oil will trade comfortably above $50 for most of the year,” was Beddington’s contribution. The Forum concluded with a cocktail reception. EMTA’s next Forum in London will be its 12th Annual Summer Forum on June 25, 2009.
"I cannot quite remember an EMTA session where the overwhelming mood was so downbeat,” wrote one EMTA Winter Forum participant in a report to clients following the February 24 event. The Forum, which was hosted by JPMorgan in London, attracted over 150 EM professionals who listened as speakers “generally struggled to see the silver lining.”
”It feels to me like we are in December 1998—we are still seeing the downdraft and we don’t know when the fog is going to clear,” affirmed Jerome Booth of Ashmore Investment Management in introducing the Forum’s investor panel. Booth sharply rebuked Washington for its lack of “sensible” policies yet asserted that “there is lots of value out there” in EM.