On the Case for EM Local Currency Bonds; A China Breakout?; Buffet on Investing; High Protein Diet and Cancer Risk?!

From: aditya rana
Date: Sat, Aug 23, 2014 at 1:09 PM
Subject: On the Case for EM Local Currency Bonds; A China Breakout?; Buffet on Investing; High Protein Diet and Cancer Risk?!


Emerging markets equities have made a strong comeback in 2014, having outperformed developed markets led by India (up 25%), Indonesia (up 21%) and Brazil (up 13%). This stands in stark contrast to their significant underperformance during the past three years, which set the stage for outperformance by EM equities in the years ahead as articulated by the well known fundamental value research manager Research Affiliates ($169 BN managed) earlier in the summer (and presented in my June 6 newsletter). What about the outlook for EM bonds? They recently made the case for EM local currency sovereign bonds being one of the most compelling investment opportunities in markets today. To summarise:

-The investment case for bonds issued by EM sovereigns in their local currencies is predicated on four underlying factors: 1) high real yields, 2) positive expected currency appreciation, 3) declining currency volatility, and, 4) strengthening credit quality.

High real yields:

-EM sovereign real bond yields (ranging from 1% to 6%) are attractive not only relative to developed markets (ranging from -1.5% to -.5% – see chart below) but also when compared to their historical averages.

-The JPM global EM sovereign local currency bond index is currently yielding just under 7% (see chart below), and the difference between the index yield and short-term UST yields is well above its historical average of 5.2% (following the "taper tantrum" of 2013) , almost reaching its all-time high set during the 2008 crisis. There are no other asset classes today which present comparable valuations, and the potential upside is significant (like it was in late 2008/early 2009).

Currency appreciation:

-The currency exposures have the potential to boost the long term return as EM currencies are likely to appreciate versus DM currencies due to the differences in productivity growth between the developed and the EM world.

-The expected real return on local currency EM bonds is the real yield on the bonds, less defaults plus any changes in the real exchange rate. One of the key factors driving relative movements in the real exchange rate is the differences in the productivity growth rates of the two countries. This follows from the fact that not all goods in an economy are tradable, and the economy with higher productivity drives higher inflation resulting in appreciation of the real exchange rate.

-For example, given that cars are freely tradable, a sports car in the U.S. costing $100,000 would cost roughly 1.3 million pesos in Mexico at an exchange rate of 13 pesos to the dollar. However, hospital services in these two countries are not really tradable, and a emergency hospital procedure in the U.S. might cost half a sports car while in Mexico is might only cost a tenth of a sports car.

-Higher productivity growth rates in EM drive higher wage growth resulting in higher inflation in non-tradable goods. This leads to an increase in the EM consumption basket relative to the DM consumption basket, resulting in an appreciating real exchange rate. This relationship between productivity (as measured by real per capita GDP growth rate) and the real exchange rate is known as the Balassa-Samuelson effect.

-The expected real exchange rate appreciation on a basket of EM countries is 0.5% per annum, which is small compared to the real yield on EM bonds, but still adds (rather than subtract) to the long term real return.

Currency volatility:

-While currency volatility for EM currencies has historically been higher than that for developed currencies (reaching highs during the ’97 Asian Crisis and the rouble devaluation in ’98), volatilities have declined dramatically since then (see chart below). For example, the volatility of the Mexican peso versus the dollar over the last five years has been the same as the Norwegian Krone to the dollar (12.3%) and the most vulnerable of the "fragile five", the South African rand, has had only marginally higher volatility than that of the Australian dollar (15.2% vs 14.9%).

-While adding any foreign currency exposure to an international portfolio does add risk, over the last five years the currency risk associated with an EM bond portfolio has not been any greater than the risk arising from a DM basket. This convergence of risks is expected to continue.

-Credit Quality:

-The credit quality of EM sovereign issuers has strengthened dramatically over the years, with the average credit quality rising from BBB+ to A – over the last fifteen years, and with it the size of the local currency debt market has expanded to more than $1 trillion (and external currency debt has gone from $200 million to $500 million).

-Despite the swift rise in debt issuance, EM countries have not experienced a rise in debt/GDP ratios as their economies have grown even faster. While budget deficits remain (on average) a bit higher than those for developed countries, they are in a declining trend. This has lead to increased savings, reflected in rising foreign exchange reserves which now are close to the amount of external debt issued.

-While current account deficits have proven to be stubbornly high in some countries, they have also decreased on average. It is clear that the fiscal stability of EM countries has improved significantly over the last fifteen years, and their credit quality appears to be stronger than many developed countries due to lower debt burdens, lower deficits (in some cases) and higher FX reserves.

Interesting piece of analysis which makes a persuasive case for investing in EM local currency sovereign bonds. It is important to focus on the real returns on capital (to preserve purchasing power), and EM local currency sovereign bonds offer one of the most compelling investments as they offer attractive real returns. They can be accessed via a variety of funds, etfs as well as single issues (i.e Brazilian real and Turkish lira bonds).

China to breakout?:

The Chinese stock market has begun to show signs of life in the last two months, on the back of better than expected growth indicators, the introduction of policy easing measures and the October launch of the "through-train" providing investors in China and Hong Kong access to each other’s market.

– According to Bank of America Merrill Lynch, China is on the verge of breaking out from its pattern of consolidation. The stock index is in the midst of transitioning into an upward trend as it ends the 4-year downtrend (see chart below). China can be accessed via funds, ETFs as well as single stocks traded in Hong Kong.

Buffet on investing:

Came across this great Buffet excerpt from a 2011 interview he gave in India:

-"The good news I can tell you is that to be a great investor you don’t have to have a terrific IQ. If you’ve got 160 IQ, sell 30 points to somebody else because you won’t need it in investing. What you do need is the right temperament. You need to be able to detach yourself from the views of others or the opinions of others.

-You need to be able to look at the facts about a business, about an industry, and evaluate a business unaffected by what other people think. That is very difficult for most people. What happens is people start listening to everybody talk on television or whatever it may be or read the paper, and they take what is a fundamental advantage and turn it into a disadvantage.

-You have to come to your own conclusions, and you have to do it based on facts that are available. If you don’t have enough facts to reach a conclusion, you forget it. You go on to the next one. You have to also have the willingness to walk away from things that other people think are very simple. A lot of people don’t have that. I don’t know why it is.

-Most people have, sometimes, a herd mentality which can, under certain circumstances, develop into delusional behavior. You saw that in the Internet craze and so on."

Great piece of advice. Pascal said it best: “All men’s miseries derive from not being able to sit in a quiet room alone.”

High-Protein Diets And Cancer Risk:

Came across this interesting article which should clarify some of the prevailing confusion about the need for high protein diets:

Alice G. Walton, Forbes. 3/04/2014

-Despite the popularity of protein-rich diets like Atkins and Paleo, new research suggests that it may be wise to steer the opposite way, especially when it comes to cancer risk.

-In the new study, middle-aged people who ate protein-heavy diets had a markedly increased risk of dying from cancer compared to their low-protein counterparts. Protein from animal sources – meat and dairy – was what largely produced the risk, whereas plant-derived proteins seemed to be “safer.” And the rules seem to be different for people over the age of 65.

-“There’s a misconception that because we all eat, understanding nutrition is simple,” said study author Valter Longo, director of the Longevity Institute at the University of Southern California. “But the question is not whether a certain diet allows you to do well for three days, but can it help you survive to be 100?”

-In the new study, the team followed over 6,300 adults over the age of 50, to see what effect high-, medium-, and low-protein diets had on longevity. A high-protein diet was defined as 20% of one’s daily calories coming from protein, a moderate-protein diet is made up of 10-19% calories from protein, and a low-protein diet consists of less than 10% protein. People in the study ate, on average, 16% protein, with two-thirds coming from animal sources – pretty typical of an American diet, the authors say.

-The findings were intriguing: People from ages 50-65 who ate high-protein diets were four times more likely to die of cancer – this is in the ballpark of smoking risk, say the authors – compared to people who ate low-protein diets. Even those who ate moderate-protein diets were three times as likely to die from cancer. And people who ate high-protein diets were 75% more likely to die from any cause, including three times as likely to die from diabetes. The team calculated that reducing protein intake from moderate to low would reduce the risk of death by 21%.

-Interestingly, when the source of the protein was taken into consideration, things changed a bit. When animal-derived sources taken out of the mix, the mortality risk was significantly reduced: In other words, plant-based protein did not seem to present the same kind of problem as protein from animal sources.

-“The majority of Americans are eating about twice as much proteins as they should, and it seems that the best change would be to lower the daily intake of all proteins but especially animal-derived proteins,” said Longo. “But don’t get extreme in cutting out protein; you can go from protected to malnourished very quickly.”

-Why the protein-cancer connection? Protein intake influences the levels of the growth hormone IGF-I, which not only affects the growth of healthy cells, but can also encourage cancer cell growth. In fact, in the current study, the team found that for every 10 ng/ml increase in IGF-I, people who ate high-protein diets were 9% more likely to die from cancer than those on a low-protein diet.

-This growth hormone mechanism seems to be the reason that calorie-restricted diets have been shown to increase longevity in certain species, including, possibly, humans.

However, IGF-I levels decline over the years, especially after age 65, which is part of the reason that people lose muscle tone and become frailer with age. And the current study bore this out, too: When the team looked at people above the age of 65, people who ate more protein had a reduced risk of death.

– The protein issue is therefore complex, and will require some more research.

But the recommendations arising from the current study, says Longo, line up with those from the World Health Organization and the Institute of Medicine. Longo says that generally people should stick with “plant based proteins and/or stay as close as possible to 0.36 grams of protein per pound of body weight per day. This is about 54 grams of protein per day for a 150-pound person. However, going lower than that can be detrimental.”

So, it may be wise to watch your protein intake, at least in middle age. And at any age, eating a plant-based diet is probably smart, as study after study shows the near-indisputable health benefits of doing so.

-“Almost everyone is going to have a cancer cell or pre-cancer cell in them at some point,” says Longo. “The question is: Does it progress? Turns out one of the major factors in determining if it does is protein intake.”

So do try and stick with a mainly plant-based diet – it does provide adequate amounts of protein without the risks associated with high protein intake!




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