What is investor sentiment on Saudi Arabia at the moment?
The petroleum fund is still going to increase its Saudi exposure to the benchmarking, which is upcoming. The JP Morgan Bond Index is coming. I’m on the record last time we spoke saying that I think it’s deeply interesting that you can have a dollar-denominated linked economy with debt issuance which trades at 140-150 basis points above US, and probably with better collateral in terms of oil. The positive thing is all the domestic factors—the inclusions. The VAT creates a credible revenue increase. What’s less transparent and less obvious to me is dealing with the state-owned enterprises doesn’t seem to be a priority, and doesn’t seem to be in the top three in terms of the hand-over to the private sector. I’ve repeated that over the past 10 years.
The visa situation has some changes in the UAE with a 10-year investor visa, but five to ten years doesn’t go far enough. If you want me to be productive in the GCC, I’d assume you’d want me to be here for the rest of my life, right? Why time limit my investment? If I’m doing something wrong you can always cancel the visa. I don’t understand the rationale. The paperwork, the access to market competition is still the downside, but the net-flow in terms of foreign direct investment I don’t think is changing. For all that goes on in Saudi Arabia, I think at the end of the day, it’s more important, the MSCI inclusion and the JP Morgan Bond Index are the bigger story for investors. You have to really argue hard why you’d underweight something that has a yield carry of 130 to 150 basis points over. A fund manager is going to say that they are not in the game of politics, they do what the benchmark tells them.
I think this region could really regain some of its traction, but it should not be based on oil, it should be based on oil generating enough proceeds to invest in the future of the world, to be more productive. We need a productivity focus, as that’s what drives the world, in my opinion. And they are trying, with their investments in AI and other future tech.
Does the Bolsonaro election in Brazil make that market more interesting to investors?
A lot of people say there’s 20 to 30 per cent upside, but I would rather be buying South Africa and China than buying into a populist president in a country, which doesn’t have a great record of actually implementing a lot of the rhetoric that they promise. Will there be a relief rally? Absolutely, but he’s a populist. Populists have the problem of when they go into the actual parliament and need to do the dirty job, it’s very difficult for them. In my experience, presidents who have less of an agenda are more efficient in getting an agenda done. This sounds counter intuitive, but if you start a negotiation by dictating everything you want it’s very unlikely that you will get it. If you start with a blank sheet and discuss what’s best for Brazil, which will be a different story.
We had similar sense of joy when Timur came in and it was supposed to be a big change as well.
What’s the best way to enter South Africa?
The currency is extremely liquid, though volatile, so that would be an easy one. But if you look at the listing on the Johannesburg Stock Exchange, there is a huge amount of global stock. You can buy Naspers, you can get all of its African business for free. The banks are dirt cheap—they’re down 30 to 40 per cent from their peak. If you read the newspapers in South Africa, it’s very negative, but local politics have already become a power-sharing base. There’s an election coming next year, with a president and leading candidate in Ramaphosa who is trying to do market reform being a Marxist, which in political theory could be argued is the right person to get that enacted, though it will create turmoil. The nervousness is about land reform, his talk which is trying to keep things stable until the election, but what he’s actually doing at the government level is nothing but impressive.
As an emerging market investor, you have to look at the strength of the constitution, and there are fewer countries with a stronger constitution than South Africa, so your day in court will come if you have an investment in South Africa that goes bad. There’s quite high confidence there. First I will wait for the currency to do some of the work for me, but I’m very tempted to buy direct equity exposure.
What thoughts do you have on the US market at the moment for investors?
For Saxo’s research what we’ve really been trying to tell clients is how out priced the US stock market was relative to the rest of the world. The whole narrative around stock markets has only changed after the US market came down, because if you exclude it, we’ve been in a negative market all year. We’ve found it kind of odd that the world has been so focused on the US stock market, particularly because we believe we can explain the US stock market. The repatriation and the tax discount that was made this year made US corporations close to $4 trillion to on-shore US markets, and of that they used $1 trillion to buy back their own stocks reducing the float. If the market doesn’t go up then, it’s never going to go up. It’s a unique story.
In terms of the underlying economics, we focus on the four horsemen: the quantity of money, which is collapsing, the price of money, which is going up led by the Federal Reserve, The price of energy, which is up massively, and productivity which is also negative. The four components are all negative. Sometimes this negative is met with fiscal expansion and tax cuts, but as you know that’s already the case in the US and has been spent.
We think there’s a cyclical change in growth from the US towards Asia, which will support emerging markets and make the dollar somewhat weaker. There is hope at the end of the rainbow, but the first catalyst will be another three to five per cent down on the stock market, forcing the hands of the Fed.
So you think the US market is still overvalued?
I can put it mathematically. At the start of October, it was three points in standard deviation expensive, and at the end of October it’s still 2.1 standard deviation expensive to the rest of the world. There’s still quite some room. The number one advice we’ve been giving clients is, if you have US exposure, please, at a bare minimum, reduce that exposure to the US and replace it with MSCI and emerging markets, in particular China and India. In portfolio construction, you can reduce your volatility for the same amount of risk.
If you believe that the buy-back programme, which I do, has been the prominent source of outperformance, then next year, when that disappears, you’re losing a lot of momentum that was there in 2018. Investors will have worse conditioning, less credit cake to eat from, and even the velocity of money is decreasing still.
Is China the right place for investors to look in Q4?
China is dirt-cheap for investors. Whether it’s a value trap is the real story. The way I like to phrase it is that, I’m certain that the US has peaked both in growth and performance. What the perfect timing is to enter emerging markets is another story, as you have to time the strength of the dollar with the credit transmission in China to make it work. The hole in China is much bigger than reported. In order for this to work, they need to fill up the hole to get to a positive number, but what we’re clearly seeing is a ramp up in non-commercial lending, so clearly China wants to do that. I will look at that in Q1 or Q2 next year for entering emerging markets.
Additionally, I like gold in this environment and all scenarios point to the strength of gold. A year ago, people were still looking at cryptocurrency but I think they’ve given up on that, so the opportunities have all but disappeared in that space.