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Investing Insights Weekly

Current Issues

  • Argentina Pins Hopes on Default Overtime to Win Against Creditors

    Rudy Martin Investing InsightsThe debt restructuring issue will not be resolved within U.S. courts or this year.

    Anyone betting on Argentina's ability to run the debt default clock into overtime and achieve a favorable resolution to its debt predicament in 2014 is likely to be disappointed. Renegotiating $15-20 Billion of debt is not something that can be done quickly.

    In soccer, a match almost never lasts only 90 minutes. That is because unscheduled stoppage or injury time can be added at the officials' discretion to the end of each half of play.

    The court battle between Argentina and 'los fondos buitres', the vulture funds, it is clear there has been significant injury on both sides. With the second-highest inflation rate in the Americas, an economy in recession and still suffering from the massive currency devaluation this year, Argentina did not come to this match in its best condition. It has every incentive to get this debt restructure case behind it as soon as possible.

    The game changer yesterday would have been the granting of a stay from the judge's last ruling to avoid a selective default. This stay was actually something the funds were more than willing to provide - for a fee.

    Normally, a country the size of Argentina's would reach into its foreign reserves of $29 billion, create some new bonds to pay off the old debt and be done with this $1.3 billion nuisance suit. The challenge here, according to the Argentine administration, is that paying 1% of the debt holders could cause 100% of the monolithic settlement for their 2001 default to tumble, crushing the economy in the process. Therefore, the only immediate exit strategy that Argentina offered was an immediate participation in the 2010 deal - a 300% profit. This was an offer investor-plaintiffs could afford to refuse and did turn down.

    The response from Standard and Poor's was equally negative. At approximately 4:38 PM in New York, credit rating agency Standard & Poor’s lowered Argentina’s foreign currency rating to SD, or selective default, for missing a $539 million interest payment on its Discount bonds maturing in 2033, after a 30-day grace period expired.

    Today, the sun will rise over Argentina for the eight time in default status.

    Now, in fairness to our Latin American neighbors, it is important to point out that the U.S. government has a history of defaulting also. In November of 1814, a few months after the British sacked Washington DC, during the War of 1812, the Treasury was unable to move enough precious metals to service its debt. Again, a second default happened in the spring of 1979 under Jimmy Carter, when the debt ceiling was $800 billion of debt. That $120 million of missed payment, a back office glitch, cost billions of extra interest expense on the entire debt outstanding as interest rates rose.

    The reason this Argentina story is of such interest now is that a victory for the holdouts could strengthen creditors’ rights in other markets. This could make governments think twice before taking on debt that may turn out to be unsustainable. In effect, a small group of litigious hedge funds may also have ushered in a new more stringent era in debt markets that could frustrate a country’s efforts to get back on its feet after an economic crisis.

    In their own defense, the Argentina holdouts assert that they do not go after countries that cannot afford to pay their debts. Governments that renege on their obligations are also often corrupt. They note that Vice President Amado Boudou of Argentina is involved in a corruption case for allegedly receiving bribes and conducting business incompatible with public office. He was once considered a likely successor to Cristina Fernández de Kirchner.

    In the meantime, the interest in Argentine equities is overdone. Mercadolibre (NasdaqGS:MELI), Banco Macro (NYSE:BMA), Cresud (NasdaqGS:CRESY). Petrobras Argentina (NYSE:PZE) and Telecom Argentina (NYSE:TEO) are all likely to give back yesterday's gains.

    My take on all this is that defaults are not predictable but they make for very predictable political theater.

    Stay tuned for more Argentine defiance of U.S. courts and some very predictable damage to Argentina's creditors and investors - whoever they are.

    Until next time ... Happy Trading!!

    Rudy Martin

    For the complete issue, including current recommendations, download the pdf.

  • 2014 Earnings Growth in Critical Care Zone

    Rudy Martin Investing InsightsEconomic doldrums are setting in as stock market hits new highs.

    Fear is rising as measured by the VIX, a popular measure of the market's implied volatility. What fuels this is a tepid earnings reports season. With few signs of improvement in the overall 3% top-line revenue growth rate this quarter, stock market valuations are stretching to their limits.

    Fortunately, reported earnings for large capitalization stocks are growing at a 5.5% clip. It seems the cost-cutting initiatives to maintain earnings growth rates and profit margins are working for now. Especially so in the Capital Markets industry that is reporting the highest earnings growth at 22% this quarter.

    Yet, the implications of overall economic lackluster top-line growth are clear.

    The margin for corporate management error is shrinking. The conference board survey of CEO confidence assessment of current economic conditions was considerably less favorable. Now, 46 percent claim conditions weakened compared to six months ago, down from 54 percent in the first quarter.

    Corporate boards are less confident too. Stock buyback announcements in the second quarter are on track to be the lowest in seven quarters. According to Trimtabs, buybacks in June sunk to just $11.5 billion, the lowest level since May 2012.

    There is a real possibility of a growth slowdown in the next quarterly earnings numbers as costs start to rise against these flat revenue numbers. Negative earnings guidance for the third quarter could become the norm for large U.S. companies.

    The frequently cited causes were weather and lower order activity.

    Remember that U.S. durable goods orders dropped 1.0% in May. A pullback in military spending dragged down overall orders for big-ticket items from U.S. factories.

    In addition, do not hold your breath waiting for the consumer to bail out the economy. On a national accounts basis, low savings and higher debt could further depress the consumer's ability to revive the U.S economy.

    Low interest rates are still creating distortions.

    While we have seen a pickup in housing, previously owned U.S. homes sales increasing in May to the highest level this year, the higher confidence is not translating to consumer sales at Coach (COH) or Pepsi (NYSE:PEP) or Coca-Cola (NYSE:COKE) and a growing list of no growth companies.

    Rudy Martin Investing InsightsThe winners according to Factset, are companies in the Materials (+7.5%), Financials (+7.5%), and Health Care (+7.0%). These sectors are reporting the largest upside aggregate differences between actual earnings and estimated earnings. In the Materials sector, Alcoa (NYSE:AA)(+45%) has reported the highest positive earnings surprise. In the Financials sector, Morgan Stanley (NYSE:MS)(+65%) and Goldman Sachs (+34%) have reported the largest upside earnings surprises. In the Health Care sector, UnitedHealth Group (+13%) has reported actual EPS above the mean EPS estimate by the widest margin.

    The value is also in high growth regions internationally. If counted as separate economies, eight of the top 30 Countries would be provinces of China. The average international beverage stock posted growth more like Fomento (NYSE:FMX) with an 8% increase in sales last year.

    My take on this is that there are still a few U.S. stocks worth buying with the emphasis on few.

    A drop in U.S. unemployment to 6.1 percent in June increases the likelihood of the Fed raising interest rates. Read my comments about the Fed tapering from the past issue.

    Happy Trading!!

    Rudy Martin

    For the complete issue, including current recommendations, download the pdf.

  • US Fed Tapering Road Has No Off-Ramp

    Rudy Martin Investing InsightsThe economy is stuck in low interest rate mode and investors are betting against the US Fed.

    For those who grew up with the science fiction TV series, The Twilight Zone, it's easy to imagine how trying to solve someone else's problem transforms you into the problem itself.

    The U.S. Federal Reserve is stuck in a Twilight Zone episode.

    Fed Chair Yellen has been spending face time this week in the Senate Banking Committee testifying that significant slack remains in the U.S. labor market with employment-related data below the Central Bank's goal. At the same time, she has been giving hedged assurances that October 2014 could bring the end of the bond purchases program and usher in an extended period of low interest rate maintenance. Of course, she also notes that any rate action would be data-dependent, especially considering current weak employment and productivity measures.

    'The Perils of The Feds Rules' leads to the unintended outcome state where the nominal interest rate and inflation rate are below target and the economy is in a liquidity trap.

    Go ask a banker for a loan and see how liquid the financial system is - not.

    From the savers and investor's perspective, there is a lot of money at stake guessing the 'off-ramp' date -- the date at which the U.S. monetary authority begins to drive its policy rate back to normal - whatever that looks like now.

    MutualFunds Flow

    And investors are already betting against the Fed being able to do anything about rates in the near-term. They are moving away from U.S. equities, pulling $6.3 billion out of U.S. funds in the first six months of this year. That money is flowing into bonds or higher return world equities.

    Corporate investors are also moving their capital abroad. Larry Ludlow's Congressional rant this week contains comments about this and a few other pearls:

    • On the inflation front, the Fed should declare victory and go home.
    • The zero Federal Reserve target rate, at five years plus after the financial meltdown, is too low and is contributing to a distortion of risk assessment in the financial markets.

    Is there anything the U.S. monetary authority can do here to talk up inflation?

    If you heard Yellen talking down valuations for social media and biotech stock, then you might think the Fed is still trying to curb enthusiasm for equities. This may be the point the market hears - the Fed's inability to control the interest rate shock in equities, the impact on total savings and capital formation and host of other issues - including creating real jobs and real demand for capital.

    Speaking of being stuck...

    One of my favorite movies on this topic is Casablanca, a 1942 American romantic drama film starring Humphrey Bogart and Ingrid Bergman. Despite its dated film noir genre and expressionist lighting techniques, the film's top expressions serve as a mini-manual for investing in today's market and waiting for an exit opportunity.

    '…Here's looking at you, kid.'

    This phrase is a play on the card game of poker, when the face cards (Joker, Queen, and King) are all looking at you: good news if you hold them. Therefore, when I lay my cards down and repeat this phrase, well... you have just lost the hand.

    It is very clear that a rise in interest rates will trounce returns on long-only bond funds and equities. Therefore, you had better have something better in your hand if you expect to win the investing game.

    'I’m shocked...shocked... to find that gambling is going on here!'

    This is actually one of the funnier parts of the movie, when authorities claim a violation of law while acknowledging some complicity in the activity. It also reminds me of the U.S. government's long-term support for mortgage lending and its position reversal after the failure of Fannie Mae and Freddie Mac.

    Fortunately, today not all fixed income dollars flow into long bond or mortgage funds. Some investors are allocating into strategic fixed income portfolios. These higher-risk, sophisticated multi-strategy, multi-asset class portfolios utilize a variety of techniques, such as options and shorting interest rates to generate a stream of income.

    For example, read this week's earnings release from Blackrock (NYSE:BLK), the world's largest asset manager with $4.7 trillion in assets under management. Fueled by a solid $38 billion of net inflows for the quarter, it easily beat earnings estimates. For the quarter, retail investors segment contributed $13.1 billion of net inflows. The investor appetite for efficient-beta and outcome-oriented strategies added $3 billion into Strategic Income Opportunities, an alternative credit focus fund, and $1 billion into Multi-asset Income, a tactical allocation fund. Blackrock also noted the success in gathering assets via their relationship with Fidelity Investments.

    Note that mentioning these funds is not a recommendation - just an illustration of a trend occurring in the investment world. Please read our full disclosures online.

    …'Round up the usual suspects.'

    The U.S. government appetite for sanctions and settlements is overwhelming.

    As I was writing this piece, Obama went on television announcing yet another set of sanctions against Russian nationals and corporations. Russia saw nearly $75 billion in capital flight in the first half of the year as investors and ordinary Russians ditched the ruble en masse following sanctions imposed by the West on Moscow over its involvement in Ukraine. I will follow up on this in next week's issue.

    Back in the financial services sector, between this year and last year, the U.S. government is likely to rake in almost $100 billion for settlements from large banks globally.

    With that as a trend backdrop, the $13 billion JPMorgan (NYSE:JPM) agreed to pay in November of 2013 overshadows the announced Citigroup's (NYSE:C) $7 billion settlement. It also outranks what the government is trying to extract from Bank of America (NYSE:BAC).

    Fortunately, bad news is good news - when it removes uncertainty.

    In the case of JPM, the company reported a solid quarter this week with solid net interest margins, improving credit ratios, declining delinquencies, and even a surge in average deposit balances. In addition, commercial real estate lending stood out with a 27 percent increase.

    More positively, JPM's assets under management now total $1.7 trillion, up 16% from a year ago. The head of the asset management operation noted at a CNBC conference that the net inflows are favoring the longer-term strategic investment products versus the shorter-term liquidity products with about $50 billion in new assets coming year to date.

    This again reinforces the point made earlier about investors positioning themselves for an eventual move in interest rates by accepting more risk and considering multiple, alternative investing strategies.

    The only cloud in JPM's earnings was a drop-off in mortgage lending.

    JPMorgan originated only $17 billion of consumer mortgages in the second quarter, a plunge from nearly $50 billion in the same period in 2013. One of the main reasons for the decline is that the bank is making fewer Federal Housing Administration loans after agreeing to pay a penalty of $614 million early this year to the Justice Department over accusations that it had submitted noncompliant mortgages into the F.H.A. program over several years.

    According to JPM's Mr. Dimon about the FHA mortgages, 'We are thoroughly; thoroughly confused about how we got treated ...That penalty has made JPMorgan cautious about making such mortgages'.

    Low rates don't help either.

    Since 1985 the 30-year mortgage rates have been in a fairly steady downtrend as the chart above shows.

    Granted banks make a spread over their cost of funds so the level is normally not so important as the rate of change and predictability of interest rates. Bankers are afraid to make the first move as they will need a) a higher base rate to cover there additional costs of business and b) relative predictability of rate levels.

    My take on this is that the U.S. banks will not loosen the lending spigot until overall lending demand drives interest rates permanently higher. The well-documented problem with low interest rates is that once you get there, the probability of staying there increases - just like The Twilight Zone.

    Happy Trading!!

    Rudy Martin

    For the complete issue, including current recommendations, download the pdf.

  • Not Just Another Anti-dollar Alliance - The BRICS Bank

    Rudy Martin Investing InsightsA new trade-stabilizing tool underscores real risk of long-term U.S. dollar dominance.

    The World Cup home crowd's pain stopped in Brazil after the humiliating 7-1 defeat by Germany. Last week's article pointed to Brazil special advantages against regional rivals. Clearly, that was not the case against a Europe-based contender last night.

    Fortunately, for local fans, Brazil goes up against the U.S. on another field next week - and this time with some real power players. The world scale team is lead by China with India, Russia and South Africa as key participants as well.

    In a few days, the Sixth BRICS Summit will put the final changes on a new financial architecture in response to an overdollared global economy.

    The plan combines a monetary stabilization fund called Contingent Reserve Arrangement (CRA) with a development bank called BRICS Development Bank.

    The CRA will have a total of $100 billion in capital - $41 billion from China, $18 billion each from Brazil, India and Russia, and $5 billion from South Africa. The BRICS Development Bank will begin operation with capital of $50 billion dollars, with contributions of $10 billion and guarantees of $40 billion from each of its members. The bank will be able to expand to $100 billion dollars within two years, and to $200 billion in five years; it will have capacity to finance up to $350 billion.

    Normally, the United States is a member of, and a major donor to, each major multilateral development bank.

    However, the BRICS Bank is not just another development bank. It is an anti-dollar alliance to wean the world off overreliance on the dollars - overdollaring.

    The concept of overdollaring

    Let's borrow a concept from the technology area, overclocking, and apply it to the U.S. dollar to explain our current monetary predicament.

    Overdollaring is the process of making a currency or other component operate in international trade other than that for which the source currency is denoted for (hence the name 'overdollaring'). Prime examples of this are oil and other commodities. Net exchange rates and transactions costs and conditions may also be changed (lowered in favor of the buyer), which can increase the pace at which trades flow. Most overdollaring techniques increase commodity consumption, generating more inflation, which effects must be dispersed if the source economy is to remain operational.

    Basically, it's been a historical mistake to use a country or single currency as the central measure to control anything on a global basis. Advocates of digital global currencies can quickly validate this.

    Here are some current example and issues of overdollaring.

    The Export-Import Bank . Proponents of extending the bank's mandate cite this as a way to rebalance the rules of international trade against unfair subsidies. Opponents claim it acts like a piggy-bank for corporate welfare and lobbyists. While it can win some votes and influence in Washington, ultimately this is another tool to extend the dominance of the dollar globally.

    Global bank settlements . It seems like the U.S. government went to war against the large global banks attaching terms and conditions to individuals and entities from the prohibited destination country as part of its investigations. The response from abroad was overwhelmingly negative after BNP Paribas was slapped with a record $9 billion fine and a 1-year dollar trading ban. Bank of France's Governor Christian Noyer recently said, 'Trade between China and Europe -- do it in euros, do it in renminbi, stop doing it in dollars. This is an affair that will leave marks.' Michel Sapin, the French finance minister, more clearly called for a rebalancing of the currencies used for global payments, saying the BNP Paribas case should 'make us realize the necessity of using a variety of currencies.'

    FACTA . The US Foreign Account Tax Compliance Act (FATCA) comes into full force on July 1, 2015. The newest extension of overdollaring will add significant new reporting requirement costs for financial entities across the globe. Many offshore-based investors, as well as those in the U.S. who invest abroad worry that when this comes into full force on July 1, 2015 some financial institutions might opt out of dollar-denominated transactions or not accept U.S. accounts.

    The trade-offs are increasing economic consumption and inflation versus the source economic system becoming unstable if the currency is overdollared too much. There is also the risk of damage due to excessive inflation or debt generation. In extreme cases, costly and complex exchange rate devaluations, defaults or savings liquidations are required. There is a loss of trust too.

    Don't blame it all on the dollar!!

    Other countries need to start to plot out long-term strategies to find replacements to the greenback as the world’s de facto currency.

    China is already the prime mover on this. By 2015, about 30% of China’s cross-border trade will be settled in the renminbi, also called the 'redback'.

    Over the past few months, Chinese officials have been reportedly meeting and consulting with several Asia-Pacific nations to set up the still tentatively named Asian Infrastructure Investment Bank (AIIB). The AIIB is an open and inclusive platform that focuses on infrastructure and welcomes not just nations from Asia (except Japan of course), but others as well, including the United States and European countries.

    With both the AIIB and BRICS Bank, China takes on a more central financing role that is independent of the current financial bureaucracy.

    You don't have to be a sport fan to appreciate what happens after a humiliating defeat. What follows is a general loss of trust from supporters and a big loss of self-confidence for the team.

    The United States government may just end up hurting itself with its tactics while it has the dominant position. Ahead there could be a serious tumble in the value of the US dollar, more wealth contraction, higher inflation via import prices, and less US wealth available to support US debt.

    My take on this is that if you are concerned the U.S. won't be economically dominant in five years, start adding international equities in your portfolio now and support a return to a sound dollar.


    Happy Trading!!

    Rudy Martin

    For the complete issue, including current recommendations, download the pdf.

  • Brazil vs Colombia Investor Game

    Rudy Martin Investing InsightsBetting on a World Cup game and investing in stocks have a couple of things in common - win or lose, it's the odds premium that matters.

    Brazil is under pressure to produce results.

    First, let's talk about economic strength.

    Brazilian government officials are expected to continue guarding the target inflation rate of 6.5 percent. With the actual May numbers rising to over 6 percent in May, Brazil is going to have a tough time defending that goal. Normally, the Central Bank's quick fix government fiscal footwork could kick up interest rates to fend off the advance. Unfortunately, there's nothing normal about interest rates that are already at 11 percent.

    According to an IMF survey, Brazil's interest rates are at least 2 percent higher than a comparable emerging economic benchmark due to low domestic savings rates and other structural reasons. So this higher cost of doing business in Brazil limits the Central Bankers game play options. And the higher interest rates also affect other country stats too. In Q1 2014, Brazil's GDP growth score increased only 1.9 percent. Odds-making rating agencies look at Brazil's progressively weaker growth numbers over the three preceding quarters and say Brazil's not junk, but it's not great either.

    Colombia, in contrast, posted a GDP annual growth rate of 6 percent in Q1 2014, the highest it's been since Q4 of 2012. This gives Colombia plenty of flexibility to maneuver on the field as it demonstrated just a few weeks ago by raising its benchmark interest rates to 4 percent, easily ahead of the country's 2.5 percent annual inflation rate. It's no surprise that rating agencies have positive outlooks and credit upgrades in mind for Colombia.

    Next, take two groups of country-specific stocks iShares MSCI Brazil Index (EWZ) versus the Global X FTSE Colombia 20 ETF (GXG) as team proxies.

    Fundamentally, Brazil has the advantage on size and breath with a $4.7 billion market value and 78 securities. In the past the Petrobras (PBR) and Vale (VALE) players dominated the EWZ and if you add up both the common and preferred issues these two names still represent 19% of the portfolio. Bottom line here is that Brazil still depends on energy and materials to perform.

    Technically, the smaller $111 market value, more concentrated 26 issues, Colombian ETF has shown some real endurance. The key players come from the financial services sector, lead by a 13% holding in BanColombia SA (CIB). These comprise 29% of the portfolio and with rising interest rates could swiftly run the ball away from Brazil.

    While there are several ways to look at these two, one that yields quick results is a U.S. dollar price-equivalent technical comparison of the ETFs. It's actually just the price of one ETF divided by the other.


    The odds in the above weekly price ratio chart favor investing in Colombia which looks poised for a relative performance breakout.

    But don't place your bet yet.

    Our final step is to review assumptions, including the cost of a selling short Brazil.

    There are a lot of estimates that go into this and the biggest one is about the Brazilian currency exchange rate or the premium paid to move in and out of the US dollar. In this case, Brazil's Central Bank has a big say in what you pay.

    Twenty years ago, after decades of financial turmoil, Brazil introduced its current currency, the real, marking a turning point in the country's fight against hyperinflation. Now the Brazilian real has strengthened against the US dollar to the tune of around 7.5 percent in the early part of 2014, a world-beating advance that is the highest gain of 31 major currencies.

    Last week, Brazil’s Central Bank extended its daily support for the currency for at least another six months to curb inflation. More importantly, it can count on $388 billion in foreign currency reserves to back this up. While normal market forces would have pushed the Brazilian real lower, this intervention puts that currency out of its normal trend for the near-term.

    For the rest of the year, traders will continue buying the Brazilian real when it falls, knowing that the central bank will support the currency. In effect the odds have been moved in Brazil's favor with the Central Bank altering the premium on this bet.

    My take on this is that this creates some Brazilian stock buying opportunities as well as our model portfolios show.

    Happy Trading!!

    Rudy Martin

    For the complete issue, including current recommendations, download the pdf.