Month: February 2019

India’s Growing Role in the Market for Oil Imports

Every year the oil company BP presents a twenty-year outlook (Link) for global energy markets. The latest report released last week points to  the  persistently rising importance of emerging markets in  the global market for imported oil. China has had the most impact on oil markets over the past two decades, increasing its imports from a little over one million barrels per day (b/d) at the turn of the century to over nine million today. China largely replaced the  market presence of the United States, which has seen its oil imports fall from 12 million b/d in 2007 to nearly zero today. But China’s growth in demand for oil is now slowing ,and India is now rising as the primary source of marginal demand for imported oil. Unlike China, which has had a large and growing domestic production of oil, India’s high demand growth is expected to be met almost exclusively by imports. The rise of India as a major actor in the oil markets comes at a time when the U.S. has become self-sufficient in oil and Europe’s demand for imported oil is declining. The result of this is that India is set to become the major buyer of Persian Gulf oil. The following chart from the BP report illustrates India’s growing role in the market. While combined demand from China and OECD countries is slated to remain flat, India and emerging Asia and other emerging markets will experience high demand growth. India’s oil demand is expected to rise by 3.1% per year through 2040, from 5 million barrels/day to 9 million b/d. BP expects India’s oil production to decline slightly from the current 1 million b/d of production, so that demand growth will have to be supplied by imports, which will rise from 4 million b/d to about 8.2 million b/d. BP expects total global demand for oil to fall from 96 million b/d to 82 million b/d between 2017 and 2040, which means that India’s share of global oil demand will double from 5% to 10%. China’s oil demand is expected to rise from 13 million b/d to 15 million b/d, while production stays around 4 million b/d. This means Chinese imports would rise by 2 million b/d, from 9 million b/d to 11 million b/d, half as much in volumes compared to India. As India and China come to dominate the market for imported oil, both the U.S. and Europe will become less significant. The U.S. is expected to export 5 million b/d in 2040. Over this period, according to BP’s estimates, Europe’s import would fall from 11 million b/d to 7 million b/d. Where will India and China source their oil? In the chart below, the BP data points to the same primary sources that have met demand for oil imports in the past decades: Russia and the Middle East. China is already cementing its energy ties with Russia, building a series of pipelines to Siberia and importing Russian Artic liquid natural gas (LNG). India, on the other hand, has as its traditional supplier the Persian Gulf, which makes sense from a logistical point of view. Certainly, as they always have in the past, the geopolitics of oil will require that both India and China become much more involved in international politics. With the U.S. no longer importing oil from the Middle East and, perhaps, entering a period of lesser foreign-policy engagement, China and India will increasingly have to  actively defend their strategic commercial interests. We have already seen this clearly wth regards to Indian imports of Iranian oil. India  has increased its imports of Iranian oil sharply in recent years, and China and India are today Iran’s two biggest clients. Interestingly, both received waivers from the U.S. Iran sanctions and continue to buy Iranian oil. India’s dependence on oil imports with their highly volatile prices also will create greater macro-economic challenges. Growing oil imports may pressure the trade and current accounts. Unlike China, which experienced huge trade surpluses during its decades of dependence on the importation of oil and other commodities, India runs chronic current account deficits. These are likely to become more difficult to manage, leading to increased currency volatility. Trade Wars  

India Watch

  • India turns its back on Silicon Valey (Venture beat)
  • India is right to resist cancerous U.S. tech monopolies (venture beat)
  • 5 more years of Modi? (Lowy)
  • China is leading FDI in India (SCMP)
  • India curbs create chaos for Amazon and Walmart (Bloomberg)
  • India’s big upcoming election (Lowy)
  • India’s vote-buying budget (Project Syndicate)

China Watch:

  • China’s property market slowdown (WSJ)
  • Cracking China’s asset management business (Institutional Investor)
  • Haier’s turnaround of GE Appliances (Bloomberg)
  • China’s consumer is losing confidence (WSJ)
  • China real estate bubble (Nikkei)
  • Will China fail without political reform? (Project Syndicate)

China Technology  

  • China will corner the 5G market (Wired)
  • CTrip’s strategy (Mckinsey)
  • DJI’s rise (SCMP)
  • China’s decade-long Bullet-train revolution (WIC)
  • China’s lead in EVs and EV infrastructure (Columbia)
  • China’s high-flying car market (McKinsey )
  • China’s place in the autonomous vehicle revolution (McKinsey)
  • Can China become a scientific superpower? (The Economist)

Brazil Watch

  • Brazil’s crucial pension reform (Washington Post)
  • Brazil’s finance guru (FT)
  • The rise of evangelicals in Latin America (AQ)

EM Investor Watch

  • Make hay while the sun shines in emerging markets (FT)
  •  
  • Globalization in Transition (mckinsey)
  • World Bank Report, Global Economic Prospects (World Bank)
  • Indonesia’s economic populism (The Economist)
  • EM’s Corporate debt bomb (FT)

Tech Watch

Investing

 

Caution Remains in Order For Emerging Markets

 

Financial markets have rallied strongly since the “Christmas Eve massacre.”  Since the December bottom, the S&P 500 has rallied 17% and emerging markets are 10% higher. Wall Street has put a positive spin on Fed Chairman Jay Powell’s sudden pivot to the dovish camp, and the bet is that a soft landing for the U.S. economy will be achieved. President Trump’s eagerness to sign a trade deal with China  also has lifted spirits.

For emerging markets, however, we have mixed signals and caution is still advised.

First, it may be that Wall Street,  for the time being, has interpreted the Fed in too optimistic a manner. The Fed’s pivot may be an indication that the interest rate cycle has peaked and that the next move in interest rates is down. This would not be bullish for EM equities, which tend to do well when the economy is over-heating and the Fed is raising rates (2016-2018) but then do poorly when the cycle turns. The Fed’s own recession probability indicator has shot upwards recently, even before the very poor December retail sales numbers released this week. This rising fear of a slowdown is seen also in Duke University’s CFO survey, which has 75% of CFO’s expecting a recession by 2020. This becomes a self-fulfilling prophesy, as CFO pessimism drives down investment and hiring plans.

Second, EM assets appear to be  in overbought territory. There has been a strong inflow of funds over the past two months into the three main EM asset classes: equities, local currency bonds and dollar-denominated bonds. Bonds started to rally before equities, an indication of increasing appetite for EM yield, as expectations for U.S. rate increases collapsed. Interestingly, according to Merrill Lynch’s survey of fund managers, EM equities have gone from the most shorted to the “most crowded trade” over a three-year period. The table below shows that today is the only time over the past five years that portfolio managers have been so keen on EM equities. Portfolio manager positioning tends to be a strong contra-indicator. In March 2016, at the lowest level since the great financial crisis and right at the beginning of a powerful rally for EM equities, Merrill’s survey identified being short EM equities as their highest conviction trade for portfolio managers.

Another indication that the markets may be overbought can be see in the following chart from Goldman Sachs. The chart shows a very unusual situation where EM assets have appreciated sharply in the face of deteriorating economic conditions.

In addition to the current overbought condition of EM, there are several additional indicators that merit investor attention. These are: dollar strength, commodity weakness and global liquidity.

Historically, EM assets sustain rallies when (1) the global supply of dollars is high, (2) the dollar is trending down (weakening relative to EM currencies) and commodities are appreciating.

Not one of these indicators is currently positive.

Global Liquidity

We can look at several indicators of the supply of dollar liquidity in international markets. These are shown below.

First, global dollar liquidity as measured by U.S. M2 plus international dollar reserves. This indicator moves up in December, but remain in depressed territory.

Second, International dollar reserves, which are still trending down.

Third, Ed Yardeni’s “Implied International Capital Flows,” which is in a sharp downtrend.

Fourth CrossBorder Capital’s “Emerging Markets Liquidity Cycle” which also is in a sharp downtrend.

The Dollar Trend

The dollar continues to strengthen relative to EM currencies.

First, the EM MSCI Currency Ratio, which continues in a major downtrend. The index has ticked up recently, only because it is heavily weighted in China, where the yuan has stabilized on trade-talks optimism.

Second, both the DXY dollar index (heavily weighted to developed currencies) and the equally weighted EM index show the dollar strengthening trend to be persistent.

 

Commodities

The CRB Raw Materials index measures prices for a broad variety of industrial inputs. Historically, this index has the highest correlation with EM equities. Following a strong rebound in 2016-2018, the index has resumed the downtrend started in 2012.

In conclusion, after the recent rally in EM assets, some caution is warranted. For investor optimism to be rewarded, it is important that the three pillars of EM asset prices (global liquidity, the dollar and commodities) turn favorably. Perhaps the greatest cause for bullishness would be a conviction that China’s efforts to stimulate its economy through fiscal and monetary measures will bare fruit during the course of the year. So, investors should focus keenly on the data coming out of China.

Trade Wars

  • A look at the future of Sino-U.S. relations (Li Lu Himalaya Capital)
  • The internet has become a battleground between the U.S. and China (WSJ)
  • Senator Rubio’s report on the China threat (U.S. Senate)
  • Is China or Russia are new rival (The Atlantic)
  • China, an existential threat for the 21st century (NYT)
  • New Zealand feels China’s anger (NYT)
  • The trade war is only about theft of technology (Project Syndicate)

India Watch

  • India curbs create chaos for Amazon and Walmart (Bloomberg)
  • India’s big upcoming election (Lowy)
  • India’s vote-buying budget (Project Syndicate)
  • India looks to China to shape mobile internet (WSJ)
  • Amazon adapts to India (WSJ)
  • India’s love of mobile video (WSJ)
  • India’s potential in passive investing (S&P)
  • India’s food-delivery startup, Swiggy, backed by Tencent (SCMP)
  • Modi’s election troubles (WSJ)

China Watch:

  • Haier’s turnaround of GE Appliances (Bloomberg)
  • China’s consumer is losing confidence (WSJ)
  • China real estate bubble (Nikkei)
  • Will China fail without political reform? (Project Syndicate)
  • S&P gets go-ahead to issue China debt ratings (WIC)
  • Stable growth expected for China’s Economy (AMP Capital)
  • China’s infrastructure spending to boost economy (SCMP)
  • The new Beijing-Moscow axis (WSJ)

China Technology

  • CTrip’s strategy (Mckinsey)
  • DJI’s rise (SCMP)
  • China’s decade-long Bullet-train revolution (WIC)
  • China’s lead in EVs and EV infrastructure (Columbia)
  • China’s high-flying car market (McKinsey )
  • China’s place in the autonomous vehicle revolution (McKinsey)
  • Can China become a scientific superpower? (The Economist)

Brazil Watch

  • Brazil’s finance guru (FT)
  • The rise of evangelicals in Latin America (AQ)

EM Investor Watch

  • Globalization in Transition (mckinsey)
  • World Bank Report, Global Economic Prospects (World Bank)
  • Indonesia’s economic populism (The Economist)
  • EM’s Corporate debt bomb (FT)

Tech Watch

Investing

 

 

 

 

 

The Big Mac Index and EM Currencies

 

The Economist’s Big Mac Index looks at the dollar cost of a hamburger sold by McDonald’s restaurants in some 60 countries. The index shows a remarkable range of prices around the world. In the latest survey, the most expensive burger was found in Switzerland ($6.62) and the cheapest could be bought in Russia ($1.65).  Presumably, these hamburgers are identical, with the same combination of bread, beef patty, lettuce and sauce in every unit. The price in each country should reflect the cost of the materials, labor and rent, as well as profit margins and taxes. The index pretends to shed some light on the relative costs of doing business in different countries, and, given that it has been measured for some 30 years, it can also provide an indication of the evolution of business costs. Moreover, it can be used as a proxy to  measure the relative competitiveness of currencies around the world.

The latest January 2019 Big Mac Index data confirms that the U.S. dollar is very overvalued. The two charts below show the evolution of Big Mac prices for countries in both developed economies (Left) and Emerging economies (Right), with the dashed lines showing the averages. In both cases, the dollar shows the most strength in nearly 30 years.

The two charts below, from Yardeni.com, confirm this dollar overvaluation trend for both developed and EM countries.  These charts measure the currency evolution of MSCI Indices (MSCI All Coubtry World ex U.S. for developed markets and MSCI EM fr Emerging Markets) relative to the USD. The overvaluation of the U.S. dollar relative to EM is key to the EM investment thesis, as when this trend turns it will provide a powerful boost for EM assets.

The next two charts show, first, the top twenty most overvalued currencies according to the Big Mac Index and, second, the cheapest 20 currencies (the numbers refer to the price in each country relative to the U.S. price).  Noteworthy overvalued Big Mac currencies for EM countries are Brazil, Colombia and Chile, all in Latin America. On the cheap side, India, Mexico, Indonesia, South Africa, Taiwan, Malaysia, Argentina, Turkey and Russia stand out.

The data is detailed below for the primary EM countries of interest to investors.

It is important to view the data in a country-specific historical context to understand what the data means. We look below at several specific cases.

Brazil

The two charts below show The Economist data since 2000 (left) and the Real Broad Effective Exchange-RBEE (right) as measured by the Bank for International Settlements  (BIS). The first thing to note is that the current relatively high valuation of the Brazilian real is not an anomaly. Except for a brief period in 2015, one has to go back to 2000-2004 to find a “cheap” real. The current “weakness” of the real appears largely explained by the strength of the dollar, which has appreciated against almost all currencies over the past eight years. The data is confirmed by the BIS RBEE data which shows the BRL to be about in line with its 25-year average. The BRL probably has some moderate potential for appreciation only if the economy experiences a robust economic recovery.

South Korea

South Korea appears as the second most expensive EM currency relative to the USD in Big Mac terms. The history shows that the USD price of the South Korea Big Mac has been stable over the past ten years, so the overvaluation of the won is due largely to other currencies becoming cheaper relative to the dollar. This is confirmed by the BIS RBEE which shows the won having appreciated significantly over the past decade. The strength of the won should present a headwind for investors in coming years.

Turkey

By any measure, the Turkish Lira is very undervalued.  The Big Mac Index shows Turkey at record-lows both relative to its history and compared to other countries. The is confirms by the RBEE which shows Turkey starting to rebound from near record-low levels. For an investor in Turkish assets, the very cheap lira should provide a strong boost to total dollar returns when the economy recovers over 2020-2022.

Russia

Russia provides an interesting contrast to Turkey. Though the Russia Big Mac is very cheap, it is only marginally cheaper than it has been for the past 20 years both relative to the USD and to other countries. The BIS RBEE shows that the ruble is only cheap relative to the peek of the 2008-2012 commodity boom but not relative to history. This points to relatively poor upside for the ruble, unless, of course, oil prices rally strongly.

India

India shows a significant relative appreciation in the Big Mac data for the past ten years, and its Big Mac has been increasing in price relative to other countries. This is confirmed by the BIS RBEE data which shows the rupee at a moderately high level on a historical basis. The rupee is likely to trade increasingly in line with oil prices as the country has become the biggest importer of oil in the world. Currency strength is not likely to be a boost to investor performance from current levels, unless oil prices collapse.

China

China’s place in the Big Mac Index has been gradually rising, and the price of a Big Mac in China relative to other countries has increased significantly over the past ten years. This is confirmed by the BIS RBEE which shows the consistent appreciation of the yuan over the past 15 years. The yuan has stabilized over the past 4-5 years and the future path of the yuan is not clear.

 

Trade Wars

India Watch

  • India looks to China to shape mobile internet (WSJ)
  • Amazon adapts to India (WSJ)
  • India’s love of mobile video (WSJ)
  • India’s potential in passive investing (S&P)
  • India’s food-delivery startup, Swiggy, backed by Tencent (SCMP)
  • Modi’s election troubles (WSJ)

China Watch:

  • Will China fail without political reform? (Project Syndicate)
  • S&P gets go-ahead to issue China debt ratings (WIC)
  • Stable growth expected for China’s Economy (AMP Capital)
  • China’s infrastructure spending to boost economy (SCMP)
  • The new Beijing-Moscow axis (WSJ)
  • Russia-China entente worries Washington (WSJ)
  • What next for China’s development model (Project Syndicate)
  • An entrepreneur’s tale of adaptation (NYT)
  • China boosts new airport spending (Caixing)
  • An analysis of nightlight points to overstated Chinese GDP (JHU)
  • China’s slowdown (CFE)
  • China’s GDP (Carnegie Pettis)

China Technology Watch

  • CTrip’s strategy (Mckinsey)
  • DJI’s rise (SCMP)
  • China’s decade-long Bullet-train revolution (WIC)
  • China’s lead in EVs and EV infrastructure (Columbia)
  • China’s high-flying car market (McKinsey )
  • China’s place in the autonomous vehicle revolution (McKinsey)
  • Can China become a scientific superpower? (The Economist)
  • The quantum arms race (tech review)
  • Baidu CEO says winter is coming (SCMP)
  • Zoomlion’s international ambitions (FT)
  • Ping An goes digital (Mckinsey)
  • China’s bet on AI chips (Tech Review)
  • China’s 5G push (tech review)

Brazil Watch

  • John Bolton’s Troika of Tyranny (The Hill)
  • The rise of evangelicals in Latin America (AQ)

EM Investor Watch

  • Globalization in Transition (mckinsey)
  • World Bank Report, Global Economic Prospects (World Bank)  
  • Indonesia’s economic populism (The Economist)
  • EM’s Corporate debt bomb (FT)
  • Holding’s digital transformation (Mckinsey)
  • Lowy Institute Asia Power Index (Lowy
  • In pursuit of prosperity (Mckinsey)
  • What drives the Russian state? (Carnegie)
  • Russia’s big infrastructure bet (WSJ)

Tech Watch

Investing