Monday, 23 February 2009

Emerging Market Fund Outflows Data Suggests Limited Risk-Taking. Now, Check on WSJ's Intelligent Investor Column: Money is Flowing Into EM Funds!

The beauty is in the eye of the beholder. So is sincerity. I keep on telling this girl she is gorgeous, but she doesn't believe me! I do mean it. She takes my compliments with a grain of salt -- which, funnily, in my humble view is a good policy!

Data from EFPR showed modest outflows of money from emerging market bonds and stocks during the week ended Feb. 18. Bond funds in the asset class have posted net outflows in 27 of the last 28 weeks. In the case of equities, investors pulled just under $500 million in total from global emerging markets, Asia ex-Japan, Latin America and Middle East and Africa equity funds, compared with the $400 million in inflows in the prior week. Dresdner Kleinwort explained the phenomenon this way: ''the lack of demand from real-money investors is acting as a drag for primary market activity and secondary market spreads.´´ Things make sense, at least until now.

Then, one reader kindly sends me this. It's a column by Jason Zweig of the Wall Street Journal's Intelligent Investor section. It follows:

Desperate investors do desperate things

A few months ago, most people were too terrified to do much more than wring their hands while sitting on them. But now, as the stock market takes another bullet every day and the yields on cash dwindle away, some investors seem to be flinging caution to the winds.

EPFR Global of Cambridge, Mass., reports that $2.4 billion poured into emerging-markets funds and another $3.4 billion into junk-bond funds in the first six weeks of this year, even as investors yanked $1.3 billion out of much safer balanced funds.

According to, so far in 2009 nearly half of the new money in exchange-traded funds has gone into ETFs that bet on gold, oil, real estate, emerging markets and junk bonds, often with leverage added to amplify the potential gain, or loss.

Daruma Asset Management Inc., a New York firm that invests in small companies, counts 1,240 U.S. stocks that have revenue, trade on an exchange, have a market value of less than $2 billion and were up for the month of January. The smallest 10th, so tiny that you could buy the biggest of them outright for only $14 million, were up an average of 48% in January. One, a money-losing Internet firm called Kowabunga! Inc., shot up 267% last month for no apparent reason. Kowabunga didn't respond to requests for comment.

Why are some investors turning rashly bullish during the worst bear market in decades? It is the financial equivalent of a "Hail Mary pass" -- the desperate attempt, far from the goal line and late in a losing game, to fling the football as hard and as high as you can, hoping it will somehow come down for a score and wipe out your deficit.

If you fixate on the money you already have lost, you may feel that a moderate future gain can only reduce those losses, making it hardly worth seeking at all. On the other hand, even the slightest chance of striking it rich holds out something precious: hope. That emotion can elbow aside the fact that most Hail Mary passes fail, in the stadium and stock market alike.

"When you want to recover your losses," said University of Oregon psychologist Paul Slovic, "payoffs loom larger than probabilities."

Well, yes. Money is coming in, Zweig says. It should be, I say. It would be plausible to think that some investors are betting on lottery stocks and bonds to recoup previous market losses. It would be plausible too to expect a recovery in emerging market bonds and stocks at some point ... but, take it easy. Let's see how the crisis evolves, most experts say. Stay put but ready.

Bankruptcies, Nationalisations and Recovery. Two Important Elements Should be Taken Into Account, Say Experts

Too Big To Fail? seems to be the question these days. I have been discussing this with friends from UBS, The Economist, local Colombian banks and Brazilian analysts in previous weeks. Two things have come up from those talks. One, whether a bankruptcy system is efficient enough to permit quick recovery of assets and credits and less legal uncertainty -- which we could say is a sort of destructive creation. Second, if nationalisation was used to prevent bankruptcies and economic collapse, then whether its use would be long-term beneficial for the economic health of the country and the economic system as a whole.

We talked today about the rumours involving a nationalisation of Citigroup Inc. Some people say a nationalisation of Bank of America Corp. is looming too. Are they too big to fail? Some say yes, some say no. Check this graph we extracted from a Bloomberg News story on speculation over nationalising banks:
Citigroup and rival Bank of America Corp., beaten down in New York trading last week on U.S.-takeover speculation, are among more than 20 lenders that could wind up majority-owned by the government if such conversions took place. Executives at New York-based Citigroup have discussed the change as a way to quell concerns about capital adequacy while heading off all-out nationalization, according to a person familiar with the matter.
We have extensively talked about this subject in this blog and we have tried to post comments on the subjects by the best minds. I recall having published one excellent article by Stanford University (no relation to A. Stanford, phheeww!) professor Paul Romer in which he stated that some banks should be let fail as the entire society focuses on encouraging the creation of new financial institutions with a different risk-management profile. I liked his view. But some others insist that banks (some of which were way irresponsible and too greedy in the past) should be helped -- too much to ask to angry taxpayers who are losing their jobs because of this crisis. Let's focus on the points mentioned in the previous graph, and draw our own conclusions about the feasibility of nationalisations and the necessity of implementing effective, efficient bankruptcy systems.

An efficient bankruptcy regime often has a positive impact on a broad, solid economic recovery. Colombian central banker Fernando Tenjo, during his years as a research fellow at Universidad de los Andes, did extensive work on this. I always believed he was named to the central bank board in 2000 to help his colleagues understand the impact of this very microeconomic issue (bankruptcies and corporate finance) in monetary policy and help them implement policies to address that issue. At the time Colombia was undergoing its worst recession in seven decades, following the collapse of its housing market, a plunge in the peso that closed access to borrowing for the government and companies, and the impact of precedent international crises (the Asian currency devaluation, the Russian default and the fall of Long Term Capital Management.) At the time, the Andrés Pastrana administration proposed a thorough revision of the local bankruptcy law that ended up being very important in helping the country pull out of the recession. Tenjo understood that monetary policy should focus heavily on helping companies restructure debts while providing them with a stable macro environment, I recalled he told me around 2001 in an interview. The
Banco de la República
was aggressive cutting rates but was also quick in supplying companis and individuals with more dollars. For the past six years Colombia enjoyed a period of growth only comparable to the marihuana-led bonanza of the mid 1970s, or the coffee years boom in the 1950s. So, the bankruptcy overhaul helped on the recovery. Although illegal money keeps coming into the country, anyone sees there has been a flourishing of business activities -- investment has tripled under the current Alvaro Uribe administration. Thus, good bankruptcy laws helped speed up the corporate recovery while instilling confidence on investors.

Bankers at Dresdner Kleinwort say a stricter, more lender-friendly bankruptcy code with only weak punitive elements for the debtor leads to a larger number of bankruptcies, but also to a faster recovery afterwards. Interesting finding: ''In many countries -- including the U.S., which has generally been seen as the gold standard in the last century, and has historically been the one to recover fastest from recessions -- changes have been made to the bankruptcy code over the last few years, which will now face their first true test. Our preferred recovery play in this cycle remains the US: it is most likely to reach the peak in bankruptcy filings first, but most likely also to recover first,´´ the bank wrote in a report. But why that? An efficient bankruptcy recovery system. Thus, heavy state intervention should hamper this systemic advantage this time around.

Finally, if the number of moribund companies that are dependant on life support from their governments keeps increasing, recovery will falter or even fade at some point.
A recent report by Ernst & Young mentions the study case of Europe -- entire sectors were massively nationalised in the late 1970s there. With the exception of the U.K., where former Prime Minister Margaret Thatcher got rid of pachyderm-like state companies and reduced the size of government to a very small and healthy level, growth in European nations lagged behind that of the U.S. for years! Therefore, it may happen that state intervention, namely massive U.S. nationalisations of banks, autmoakers and other industries, end up only hurting economic recovery and hindering asset price and credit recovery. So, those thinking that nationalising these companies (Citi et alter) is gthe answer to prevent a collapse of capitalism should go back to their texts and revise their position.

IADB May Report $1 Billion Loss in Investment Portfolio. Another Victim of the Sub-Prime Debacle

The way the IADB bankers announce their screw-ups is quite peculiar: ''The financial crisis has driven down market prices of several types of assets worldwide and the IADB has not been immune to its effects. As part of its liquidity policy, the bank maintains a liquid investment portfolio that covers on average 18 months of loan disbursements, debt service and other liabilities.´´ Too much of that.

Then, they say: ''For 2008, the IADB expects to report a net investment loss of approximately $1 billion on the portfolio. The results were mostly unrealized and were recognized in compliance with mark-to-market accounting rules. The realized losses were $71 million for the year.´´ Last year, such net investment loss had been worth $300 million more or less (it was quite a long time ago, so that it is why I can't recall the exact number.)

Ah! and they finish it with style:
''The results have not materially affected the bank’s lending or operational capacity.´´ It might be partially true -- they will surely finance a fewer number of projects across the region this year than they did in 2008. On the other hand, the IADB said it boosted loan and credit guarantee approvals by 18 percent last year to $11.2 billion, citing renewed demand for financing in Latin America and the Caribbean amid the global crisis. Disbursements totaled $7.6 billion, or about $500 million more than in 2008.

S&P Expects Further Slowdown in U.S. Credit. Spooky? Yes! Worrisome? Yes!

Standard and Poor's is betting on a further credit contraction in total credit available in the U.S. in the coming months. ''The popular belief is that U.S. banks have been unwilling or unable to lend due to capital constraints or a desire to avoid risk, leading to a credit crunch. But the data on credit outstanding in the U.S. has so far only tenuously supported the idea that the U.S. has indeed experienced such contraction in credit,´´ wrote S&P analyst Tanya Azarchs. ''While the amount of borrowing by the various sectors of the economy has continued to grow, albeit unusually slowly, there are early indications that a further slowdown is becoming apparent,´´ Azarchs wrote.

Her comments come as talk of a wave of U.S. nationalisations is gaining momentum. Many people argue a nationalisation is desirable for it may help kick start lending more rapidly. No evidence about it is conclusive. But the political response might have more effect on the industry than real capital support by the state -- which may not necessarily end the ills of the banking sector. Banks have to fail, consolidation should be allowed to operate freely, and new, non-state banks should be permitted to pop up. We have discussed this issue in the blog extensively, but there are aspects of it that must be better spelled out. In
the past nine months, loan growth has come at a slower pace than ever. That is worrisome. But the more worrisome thing for banks, in theory, is the prospect of further loan losses. This has been retarding lending, says S&P. Ninety-two percent of the sample of bankers interviewed for the Federal Reserve's Jan. 2009 Senior Loan Officer Opinion Survey found the increase in losses was an important factor behind the tightening of lending terms. The same survey found that capital problems aren't necessarily a key reason behind a retrenchment in lending. ''Loans are being replaced as they mature, but little net new growth is occurring. That could mean that the slowdown in lending is just an opening act, and a true credit crunch may yet take the stage,´´ Azarchs said. So, hold tight ... this might get worse.

Itau Eyes Citigroup Mexican Unit, According to LatinFinance. Citi's Stake in Brazilian Credit Card Company Up for Sale

Setubal (left) the day he announced the takeover
of Unibanco. He must be pleased to be well
placed at this moment, sitting on a pile of cash
and ready to buy rivals at large discounts

In a brief titled ''Itaú Eyes Mexico Opportunity´´ -- and which was kindly ceded to this blog by a good source, -- magazine LatinFinance got one nice scoop. It is the first vehicle in Latin America directly linking Brazilian giant Itaú to a possible acquisition of Citigroup's Banamex unit in Mexico. Speculation over the sale of this big jewel in Citigroup's crown was resurrected last week as shares of the New York-based bank tumbled on rumours of nationalisation. ''Besides a possible bid from local money, bankers in Mexico wonder whether a large Brazilian institution might make a play. Chief among potential suitors is Itaú, which recently jumped into the big league of global banks through its merger with Unibanco,´´ says LatinFinance.

LatinFinance reporters went beyond this -- they are less powerful than Reuters or Bloomberg or even Valor Econômico, but often scoop them. Itaú CEO Roberto Setúbal told the magazine's daily newsletter that Latin America should present the bank with opportunities: ''Mexico is the second largest economy in Latin America, and it is politically and economically stable. I personally like Mexico, and think it’s very attractive,´´ Setúbal told LF. He is already on the lookout for opportunities: ''Banamex and Banorte are attractive assets, but it doesn’t appear to us that they are for sale,´´ Setubal said, adding that he doesn't see cultural and linguistic barriers preventing Itau’s entry into Mexico. Banamex could cost potential acquirers less than $7 billion.

On the other hand, Reuters reporter Elzio Trindade Barreto Jr. (long name, longer than mine, isn't it?) reported on Friday
Citigroup's plans to sell its 17 percent stake in Brazilian credit card company Redecard; Barreto obtained the scoop after sources with direct knowledge of the plans briefed him on the bank's plans. Citigroup would potentially raise 3.1 billion reais from such sale. We have insisted in this blog, based on the assertions of knowledgeable sources, that Citi is considering selling some core units of its Brazilian business -- which may fetch the ailing bank billions of much-needed dollars. The first move would be selling most of the stake in Redecard. One unit Citigroup may possibly try to sell afterwards would be its consumer-financing unit, one person with knowledge of the bank told this blog.