A Contrarian Bet Against the Rising Sun

Amidst the rapid decrease of the Japanese Yen since Shinzo Abe won election as Japan’s next prime minister in December 2012, the fundamentals concerning how the depreciation would impact global markets practically have been forgotten.

Attention of market participants has been fixated on Abe-rhetoric, which has driven the yen down 7.2% since December 2012 without any quantitative easing from Japan’s Central Bank thus far. In fact, Abe’s rhetoric has transformed market sentiment more successfully than Japan’s last US$100billion attempt to drive the Yen down in November 2011. Furthermore, market participants see the near future outlook for the Yen weighing towards further weakening due to:

Will the Sun continue to rise this year?

1. Japan Central Bank’s likely stance to utilize monetary easing until an inflation target of at least 2% is achieved;

2. The delay in increasing the consumption tax will add pressure on Japan’s fiscal position and weigh on the yen; and

3. Rumours of a ratings downgrade would likely increase sales of Japanese government bonds and capital outflows, which would depreciate the yen.

However, an examination of the fundamentals suggests that Japan’s devaluation of the Yen will not be allowed to go so far, for both political and economic reasons. Politically, Shinzo Abe’s rhetoric and ultra-nationalism has provoked neighbouring countries China, South Korea and Taiwan. Japan and South Korea’s relations soured over Japan’s decision to celebrate Takeshima Day in February 2013, a celebration concerning the Takeshima Islands or Dodko (as they are known in South Korea), as well as continued issues regarding Japan’s refusal to acknowledge its misuse of Korean comfort women. Japan’s relations have soured with China and Taiwan over its decision to nationalize the disputed Senkaku Japanese) or Diaoyu (Chinese) islands last year. Then there is the added competitiveness between China and Japan as to who is the giant in Asia and the stage is set for political confrontations. On the economic side of the coin, Japan’s major trading partners – China, South Korea, Taiwan, Hong Kong, and Saudi Arabia – all have something to lose in a global marketplace with a weaker Yen. A weaker Yen directly affects these countries’ imports and exports. Furthermore, these countries all compete with each other in global markets. For example, a cheaper yen can slow these countries’ export growth to key markets such as the USA and Eurozone. When one combines the political will of these countries when confronted by Japan along with the economic detriments for them of a weaker Yen, there is incentive to negate Japan’s efforts.

The next question then is do these countries – specifically China, South Korea, Taiwan, Hong Kong, and Saudi Arabia – have the means to resist Japan’s efforts to weaken the Yen. International capital reserves allow governments to manipulate exchange rates – either to provide their country with a more favourable economic environment or to buy domestic currency to protect their country from “hot money”. On the one hand, Japan has the second largest international capital reserves in the world at US$1,321,000 million. However, just considering China’s reserves alone, nearly double Japan’s at US$2,453,550 million, suggests the means to counter Japan’s Central Bank. In addition, Saudi Arabia have the fourth largest reserves (US$418,000 million), Taiwan have the sixth largest (US$360,230 million), South Korea have the eighth largest (US$316,000 million), and Hong Kong have the tenth largest (US$295,000 million). Combined, this is a potent arsenal to arrest Japan’s depreciating yen. My proposition is that they won’t let the repercussions of a weaker Yen last long and therefore a contrarian bet against the Japanese Yen is an attractive play.

The recent slight increase in the Yen’s value to 91.60 against the USD, from a low of 94.99, may just be a market correction. However, it may also signal testing of Japan’s strength and commitment to intervene to weaken the Yen. Once the Japanese Central Bank is installed with a governor conducive to Shinzo Abe’s vision of a weaker Yen and they begin a concerted campaign of unlimited quantitative easing, we may see a concerted effort from China, perhaps with implicit cooperation from other affected states such as South Korea, Hong Kong, Saudi Arabia and Taiwan, to combat their attempts. Although they may be unlikely allies, these countries could be united by a common cause – game theory suggests that cooperation would save them more of their individual capital reserves than if they acted alone. Therefore, be a surfer, watch the ocean, and figure out where the big waves are breaking. And adjust accordingly. 

Emerging Market Infrastructure: BTS Group Holdings

Bangkok Mass Transit Systems Plc (BTSC), the $1.3billion skytrain operator in Bangkok, is a subsidiary of BTS Group Holdings. BTS Group Holdings offers safe and excellent exposure to emerging market infrastructure. In fact, I would venture that, as the only privately owned mass train service worldwide, it offers unique exposure to megacity infrastructure.

BTSC has been in operation since 1999, and having paid down the majority of the debt that hampered its profitability in the first 9 years of operation, BTS Group Holdings has recorded profitability since 2009. In fact in 2012, BTS Group Holdings recorded a profit of approximately £42.1million. The company’s EBITDA represents roughly 60% of its total revenue and roughly THB5.5million per day. BTSC operates Bangkok’s skytrain under a concession awarded by the Bangkok Metropolitan Administration. This concession was extended by 13 years after the original concession expires in 2029. As of February 2013, the Skytrain serves around 650,000 passengers daily along a system consisting of 32 stations along two lines. Equally, BTSC has obtained excellent fixed assets from two companies with a proven track record of durable trains. German engineering powerhouse Siemens AG manufactures trains not only for the BTSC but also for Nuremberg, Melbourne, Shanghai, Oslo, Guangzhou and Vienna’s train systems. BTSC have also sourced trains from Chinese enterprise Changchun Railway Vehicles Company Ltd, a subsidiary of China CNR Corporation. Changchun’s clients include 11 major cities in Mainland China (Beijing, Shanghai, Guangzhou included), Sydney’s Cityrail, Tehran’s metro, Hong Kong’s MTR, Rio De Janeiro’s metro, Pyongyang’s metro, Mecca Metro, and Singapore’s downtown line.

BTS Group’s short-term future looks rosy. It has a solid foundation in terms of its popularity, fixed assets and profitability. Furthermore, it is considering raising fares for commuters from May 2013 in response to the increase of the minimum wage and the fuel charge tariff in Thailand. The company is looking to pass on the higher costs of labour ,electricity and maintenance onto commuters as these three operating costs account for approximately 75% of the company’s expenses. The need to make provisions for possible energy shortages in Thailand starting in April this year increases the likelihood of a fare rise. Moreover, a fare rise is not likely to meet much resistance as it would be the first since 2005. At the same time, BTSC projects 196million journeys on the skytrain this year, roughly a 8% increase on the previous year. With further investment in developing more stations to extend the skytrain lines as well as develop real estate surrounding stations, there is much going for the company. From March, BTS Group is seeking to offer an infrastructure fund aimed at raising THB50-60million and plans to hold roadshows in the USA, UK, Hong Kong and Singapore. Additionally, a subsidiary of BTSC, Bangkok Smart Card System Co, has jointly launched with Thailand’s biggest bank Bangkok Bank, the Smart Rabbit Card. This debit and credit card affords greater convenience by allowing cardholders to pay for goods and services as well as skytrain fares. Therefore, a fare rise combined with the likely success of BTS Group’s Mass Transit infrastructure fund, continued investment in development of more stations, and a more flexible Smart Rabbit Card contribute to a positive outlook for BTS Group’s share price and dividends. Being a major constituent of the SET, Bangkok’s stock exchange, the sixth fastest-growing stock exchange in the world in 2012 with a 50.21% growth rate, also doesn’t hurt.

Sky high earnings

Outlook for the next 5-10 years is also bright. All current skytrain station platforms are built to accommodate trains of six cars, but currently only trains of three or four cars are in operation. There is therefore potential to increase the number of passengers on trains, perhaps partially during peak times. In addition, Western Bangkok is devoid of any train system and further development in this tourist hotspot (Wat Pho, Royal Palace, Wat Arun, among others are located here) could be a key growth area for BTS Group. The major hindrance to such development is regulatory consent. Although with an estimated net worth of $800million, founder and CEO Keeree Kanjanapas’ influence with various elements of Thai government and Hong Kong connections are good indicators that he would be able to push through such a development.

BTS Group’s current share price stands at THB8.15. To take advantage of the short-term developments, look to buy at THB8.00 and sell around the end of June where the summer season higher passenger totals and greater international awareness of BTS Group should see the price surge to around THB11.40. For the longer term, the outlook is positive and the dividends aren’t bad either – the dividend yield is 3.3%. 

Buying into Securitisations

Securitisations are making a comeback and presenting an excellent investment opportunity along the way. With the EU examining ways to recover from the financial crisis and banks (such as Societe Generale) looking at novel methods to decrease their counterparty risk, securitisations are looking attractive to buy for investors due to the low yield environment driven by excessive quantitative easing in Europe, USA and Japan.

2008: bankers handling CDS² 

This interest may be at odds with the negative sentiment culminating in the financial crisis of 2008 when the US mortgage market exposed the dangers of packaging and reselling large volumes of dodgy Alt-A (borrowers with patchy record of repayment) and sub-prime (borrowers with No Income No Jobs or Assets) loans.

However there is an added factor that makes securitisations attractive, besides obtaining a higher interest for buying into the new raft of securitisations. It is looking likely that the European Central Bank will guarantee, at least implicitly, certain securitisations. Having initiated the Outright Monetary Transactions (OMT) scheme to successfully support the periphery Eurozone countries and given €1,019billion in low-interest loans to banks across the EU, the ECB  has demonstrated its commitment to finding a long-lasting solution to the economic depression in Southern Europe. Therefore, a commitment from the ECB to guarantee, in some way, securitisations would add to their appeal.

Traditionally in continental Europe banks are the providers of credit to European business. Yet the financial crisis resulted in banks withdrawing lending to European businesses and households, with amplified effects in eurozone periphery countries like Spain, Italy and Greece. For example, by December 2012 outstanding bank loans to Spanish businesses had dropped by 25% from January 2009. The void created by European banks unwilling to lend is already partly being filled by European corporate debt markets, which remain underdeveloped by USA standards. In the USA it is capital markets, not banks, which are the major sources of credit for American businesses. However there is a divergence in European capital markets, with companies raising funds from them being predominantly from Northern Eurozone countries such as Germany, France, and the Netherlands. For these countries, they not only can obtain cheap bank loans but the yields on their corporate bonds are low. Conversely, companies from Southern Eurozone countries face much higher bank interest rates and only the largest companies can access capital markets.

This divergence has led to discussions among EU policy officials about using securitisation as a method to get credit flowing again in the Eurozone by packaging loans to small and medium-sized enterprises in the periphery and selling them to global investors. The ECB want to effectively play the role of banks in supplying funding for SMEs as well as the role of markets in providing the mechanisms for sufficient liquidity in the securitisation asset class.

There are several reasons to invest in these SME loan securitisations:

1. Higher interest rate than other asset classes;

2. Supported by the ECB;

3. Before the financial crisis, Europe had a burgeoning market for SME loan securitisations. For example, in 2006 there were 34 issues worth €46billion in total, with 15 issues originating from Spain. Therefore there is a track record of success in this asset class;

4. Global regulators in the USA and EU have approved residential mortgage-backed securities as a product banks can utilize when constructing liquidity buffers, which is a sign of support for securitisations;

5. SME loan-backed securitisations have a low default record; and

6. The ECB has launched the European DataWarehouse to bring transparency to the pools of loans underpinning asset-backed securities and restore confidence in the market. A second initiative aimed at increasing transparency in the securitisation market is the Prime Collateralised Securities initiative, which awards kitemarks to high quality asset-backed securities (including SME loan-backed securitisations). These initiatives should address some of the issues with SME loan-backed securitisations, such as problems standardising these small business loans and worries about the ease of buying and selling such securities.

A Bet Against the Kiwi

If one believes in the theory of purchasing power parity, then we should sell the New Zealand dollar with a view to realizing gains in Q3 2013. The NZD is significantly overvalued compared with its economic fundamentals, as was confirmed by the New Zealand Central Bank Governor Graeme Wheeler last week. Having surged since the beginning of 2013 due to reports of a healthy New Zealand economy and a change in its trade balance from a deficit of around NZ$500million to a surplus of NZ$500million, the NZD is at a potential cross-roads. With the NZD trading at 0.8397 to the USD at last sight, several factors suggest that it is time to sell the Kiwi with a view to realizing gains in Q3 2013.

1.The rising value of the NZD has made New Zealand’s exports less competitive, which should prove unhelpful for the NZD. Expect New Zealand’s terms of trade to deteriorate in the coming months.

2. US, EU and Japanese central banks have effectively printed money, lowering their exchange rates in a bid to stimulate their economies through an increase in exports. This has resulted in a surge in the NZD so far this year. The announcement that the US Federal Reserve is uncertain about continuing its unlimited quantitative easing program slightly decreased the NZD. However the impending statement from US Federal Reserve Chairman Ben Bernanke will offer greater clarity as to the strength of the division in the Fed Committee concerning the scale of quantitative easing that was highlighted in the FOMC minutes released last week. This will have a knock-on effect on global currencies due to the risk-on risk-off effect, with an ambiguous statement from Bernanke increasing the strength of the USD and being counterproductive to the NZD.

3. Strength in the AUD supported by demand among sovereign wealth funds for its bonds as well as continued FDI flow into the Australian mining industry will draw funds away from the NZD into the ‘hotter’ AUD.

4. This week sees the result of the Italian election, which may not be a clear-cut result and therefore would dampen the outlook for EU recovery and result in a retreat to haven currencies such as the USD and away from risk-appetite linked currencies such as the NZD.

5. NZD has advanced against the Yen as reports suggest that Asian Development Bank chief Haruhiko Kuroda is Prime Minister Shinzo Abe’s preference to be Governor of the Bank of Japan as he shares his desire to stimulate the economy through weakening the JPY.

6. There is a substantial amount of speculative longs in the NZD/USD, which confronted with this week’s event risk, may result in a sharp sell-off of NZD vis-à-vis other currencies.

7. NZ Central Bank Governor Wheeler has provided clarity on the conditions where the Central Bank would intervene to artificially bring down the NZD. His criteria for intervention stated last week were:

1. Is the exchange rate at an exceptional level?

2. Is this exceptional level justified?

3. Would intervention be consistent with the current monetary policy?

4. Is intervention likely to succeed?

Markets reacted to news that the Central Bank was not considering intervening by selling the NZD in the immediate aftermath of his statement. This is a signal that markets feel the NZD is currently overvalued, but a fix will have to wait for stimulus from market forces.

However, New Zealand’s size and limited funds confers special constraints on its ability to quickly influence its currency. Other developed countries with significant size can cut interest rates or directly intervene in its currency markets. New Zealand’s only options are longer-term, which is not necessarily a bad thing. Traders should look out for New Zealand government action to improve productivity, reduce foreign borrowing, cut fiscal imbalances as currently NZ Government’s future expenditures do not match their future revenue streams, and clarify distortions in their citizen’s saving and investment incentives. If such action is forthcoming, a long term view on the NZD’s depreciation would be favourable.