FT had an analysis last week about Emerging Market’s “original sin”–inability to raise debt in its own currency, something that is going away. I won’t summarize the finding as most people know the story of Thailand and Argentina. But, what I found interesting (though obvious) are the multiple factors that contribute to stability of a country’debt. They key factors are Debt/GDP (duh), the currency the debt is raised in (the point of the article), whether the debt is long-dated or short-dated (short-dated bonds means that the country needs to roll over its debt more frequently and hence every raise becomes important), whether it is held by domestic investors or foreign (a big factor in why JGB trade has failed so far, as Japan’s debt/GDP has gone past 225%), and whether the domestic debt market is developed. I will add more factors as I learn more.
I read the net inflows in the periphery improved significantly in the last quarters of 2012, €93bn in total, compared to €189bn and €97bn in 2007 and 2008, respectively, which surely sends a strong message. But, this is still dwarfed by the total outflows since 2009, €119 in 2009 and about €300bn each in 2011 and 2012 (Jan-Dec). This is good news given that the yields had been pushed down before because of troika’s actions and the ECM OMT, but now they’re being pushed down by inflows from private investors. Hopefully, this will last and we can be done with multiple article proclaiming the death of EU. Now, only if the rising unemployment rates in the periphery can be addressed. I am reading Krugman’s End This Depression Now!, and about to get in the chapters that details the steps that governments should take.
I read about how Utilities’ yield has stopped tracking the 10-yr Treasury for the last 10 years, a relationship that held pretty well for the best part since late ’70s. This actually correlated pretty well with the Fed model, in fact, where earnings yield tracked the 10-yr Treasury very well for the said time period, except to break down in early aughites. This can probably be tracked to one of the Fed’s dual mandates–ensuring near full-employment. The recovery post the docom bubble was a jobless one, which forced the Fed to keep rates lower than what they would have had otherwise, breaking the Fed model. Also, interesting is that in the last 3 recessions, Utilities outperform during the months leading into economic downturn, and then during recoveries, and one is paid to trade in these names, and not to own them.
GMO released a white paper this past week talking about the upcoming credit crisis in China. Very interesting, though if you have read the dense but phenomenal book Red Capitalism, there isn’t a whole lot of news in there, except perhaps the fact that debt related to development of high speed railways is not in the official debt/GDP calculation. This very week, Michael Hasenstab of Franklin Templeton and latest unlikley celebrity in Ireland, posits the opposite view about China and though agrees that there may be some over-development, things are basically fine. How this turns out will surely be a spectacle to watch; hopefully, it’s not ugly. On an unrelated note, it is kind of awesome that Hasenstab has a PhD in philosophy.
To close out this post, which is already heavily weighted toward debt/GDP discussions, here’s the news that may finally make the JGB trade work – http://www.bloomberg.com/news/2013-02-03/japan-pension-fund-s-bonds-too-many-if-abe-succeeds-mitani-says.html
Prasad Capital 