What does this mean for bond investors?
It changes the countries and sectors that benefit from China's growth. In the past, countries like Australia benefitted from selling iron ore and coal to China. Increasingly, countries like Korea, selling cars and cellphones, or Malaysia, selling palm oil for food products, will benefit. That's good news for these countries' economies. Korea is our second-biggest country allocation in the global bond fund. Korea's economy is benefiting as companies are competing on the quality of their products, not price. For example, companies like Samsung and Hyundai have been able to grab market share with their products, so the strength of their currency versus competing companies in countries like Japan matters less. The economy will likely grow at 3.5% to 4%.
So people will buy "made in Korea" products because they're good, not because they're cheap. How else does Korea differ from some other emerging markets?
While some emerging markets have been hit by the Fed tapering and a possible shortage of global liquidity that could make it harder for them to finance deficits, Korea has never relied on that global liquidity. It has a record current-account surplus, which means it is exporting more than it imports. It also has very little government debt.
What attracted you to Ukraine?
It is actually a very rich country with an educated population, incredible agricultural wealth, and a manufacturing base that, with investment, could improve. There is long-term potential. The good news is it started this crisis with very solvent debt conditions—only 40% debt to GDP. That's important because it indicates a country's ability to pay back debt. [The European Union average debt/GDP was 87%.] It's been a question of accessing global capital and liquidity.
How is Ukraine handling the crisis?
A crisis is a horrible thing to waste, and Ukraine didn't waste it. The urgency let a long list of structural reforms pass that had previously run into opposition. They signed a good package with the International Monetary Fund, which unlocked other potential international assistance; now they have ample liquidity. It is also moving toward a flexible exchange rate rather than one that is pegged. That should weaken the currency, making exports more competitive, which will help its balance of what it imports versus exports. Ukraine is also freezing public wages and hiring to cut costs and reforming the way it awards government contracts to tackle corruption.
What about the political crisis?
Hopefully it can engineer changes that move Ukraine away from the tug of war—like moving away from NATO membership and giving some of its Russian-speaking states more autonomy in a decentralized, federalist system. The economy is highly integrated with those of Europe and Russia, so it's in Ukraine's best interest to deepen both relationships and, therefore, decide against joining NATO. That would allow Russia to move away from intervention, and Ukraine can then live up to its full economic potential. The high voter turnout for Petro Poroshenko [voted president-elect last month] gives him a solid mandate.
Isn't Ukraine a risky bet, even for you?
This isn't much different than others. During the financial crisis, Lithuania ran into short-term solvency challenges because it couldn't access capital markets. We were the largest investors providing them short-term liquidity. Now, Lithuania is issuing debt with very low yields, and no one even talks about it. That took about four years. Hungary also took about two to three years to pay off. We may need to be patient. It may be three years before some of these factors can move in a positive direction in Ukraine.
Let's talk about currencies. What's attractive?
We've been adding the Mexican peso. There's a lot of fear that if U.S. growth improves and interest rates go up, it's bad for Mexico. But our argument is that it's great, because Mexico has taken over the world in terms of manufacturing. Remittance flow is also highly tied to the U.S. economy.
While the Federal Reserve is finishing up its bond-buying, Japan is just beginning. What is your view of Prime Minister Shinzo Abe's reform stimulus efforts, or Abenomics?
Quantitative easing is a core part of Abenomics. It is easier to execute and the only part that has really taken hold. As long as Abe is popular, he'll rely on QE heavily. Japan has high debt levels—200% debt to GDP and an 8% fiscal deficit. In the past, Japan could fund its deficits domestically from the savings of the private sector. Now, that is no longer enough, and the government has to borrow more money from the central bank, which is printing money.
What does that mean for investors?
The yen will continue to weaken because of the BOJ money-printing, which is why we are long dollars and short yen. Capital will continue to flow abroad—anecdotally, it is already moving from Japan into Southeast Asia and Latin America.
Will the BOJ's bond-buying mitigate the effect of the Fed's tapering?
Everyone is focused on the shortage of capital globally as the Fed tapers. But they are ignoring what the BOJ is doing, which will more than offset that. They're getting the call wrong by being bearish on all emerging markets.
What does that extra money mean for emerging markets?
In 2013, the divergence in performance between the best and worst emerging market was more than 40 percentage points. We have always carefully picked countries with strong fundamentals and where we felt appropriate policy decisions were being made. Even though everyone has turned bullish recently, we would be cautious on more vulnerable places like Turkey.
What gives you the comfort to pull the trigger on an investment?
It's the feeling in the pit of your stomach when you are questioning yourself and everyone else thinks you are wrong. If we are confident in the fundamentals and the team has ripped it apart, that's usually a good check that we are doing the right thing. If it's really easy and everyone is in agreement, it's probably not.
Comments
This isn't much different than others. During the financial crisis, Lithuania ran into short-term solvency challenges because it couldn't access capital markets. We were the largest investors providing them short-term liquidity. Now, Lithuania is issuing debt with very low yields, and no one even talks about it. That took about four years. Hungary also took about two to three years to pay off. We may need to be patient. It may be three years before some of these factors can move in a positive direction in Ukraine."
.....I note that my PREMX still holds debt from The Ukraine among its top 5 positions--- but just 1.51% of total AUM. (Fund Manager is Michael Cornelius.) And the last time there was a change to the portfolio reported, PREMX had reduced its Ukrainian position.
http://portfolios.morningstar.com/fund/holdings?t=PREMX®ion=usa&culture=en-US
(More from the Hassenstab thing:) "Everyone is focused on the shortage of capital globally as the Fed tapers. But they are ignoring what the BOJ is doing, which will more than offset that. They're getting the call wrong by being bearish on all emerging markets.
What does that extra money mean for emerging markets?
In 2013, the divergence in performance between the best and worst emerging market was more than 40 percentage points. We have always carefully picked countries with strong fundamentals and where we felt appropriate policy decisions were being made. Even though everyone has turned bullish recently, we would be cautious on more vulnerable places like Turkey."
Umm, apparently Michael isn't aware that, during the past decade, 50% of the young adult population of Ukraine, between the ages of 18 and 30, has emigrated elsewhere.