10/19/2015

FortressSaysEmergingMarketsBearSlumptoRival1997BloombergBusiness

FortressSaysEmergingMarketsBear
SlumptoRival1997
SuzyWaite
October6,201512:00AMSGT UpdatedonOctober6,201511:57AMSGT

Hedgefundsees`contractionarycycle'foratleast18months
FortressConvexAsiafundledbyDredgerose3.2%inAugust
FortressInvestmentGroupLLCtoldinvestorsthattheemergingmarketsareatabeginningofabear
marketthatcouldrivaltheAsianfinancialcrisisof1997.
Theselloffinemergingmarkets,whichbeganinJune,hasledtoacreditcontractionthatwilllastuntil
atleastMarch2017,accordingtoalettertoinvestorsinFortressConvexAsiaFundLtd.,signedby
SingaporebasedChiefInvestmentOfficerDavidDredge,andfundcomanagersNicholasHeaneyand
AndyWong.Fortresssaiditusedpasteconomiccyclesasaguideinevaluatingthecurrentmarket.
Ourviewisthatweareinthebeginningstagesofthenextcontractionarycycle,andthiscycle,similar
to19971998,iscommencingontheemergingmarketsideoftheglobalimbalance,Fortresswrotein
theinvestorletterdatedSept.30.Webelievewearethreeweeksintowhatislikelyan18plusmonth
contractionaryperiod,usingpastcyclesasaguide.
Fortressisntaloneamonghedgefundmanagersseeingmorepainaheadfortheemergingmarkets.Ray
BakhramovofForumAssetManagement,whosehedgefundhassurged107percentthisyear,sees
tumultinemergingmarketscontinuingforyearsandpointedtohistoricalanalogiesbetweenthecurrent
environmentandtheAsianfinancialcrisisthatstartedin1997.RayDaliosBridgewaterAssociateshas
saidtheimpactofemergingmarketlossesislikelytobemorewidespreadthaninthecrisesofthe1980s
and1990sbecauseinvestorshavemoremoneyinvestedindevelopingmarkets.

BuckingSlump
DredgejoinedFortressin2011toheadagroupthattradesinstrumentsdesignedtothriveinvolatile
marketsandprotectinvestorsfromunusualmarketmovesknownastailrisks.Hedeclinedtocomment
onhisletterorstrategy.Fortress,basedinNewYork,managesabout$72billioninassetsandwasthe
firstprivateequityandhedgefundmanagertosellsharestothepublic.
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FortresssAsiafocusedfundgained3.2percentinAugust,bringingitsyeartodatereturnsto1.4
percent,accordingtotheinvestorletter.Thefundproducedgainsasotherstrategies,suchasitsmacro
fundrunbyMichaelNovogratz,tumbled4.3percentlastmonththroughSept.25.Thedeclinein
Septemberbringsthemacrofundsyeartodatelossesto17.2percent.
SignsofslowinggrowthinChinaandtheprospectofrisinginterestratesspurredmarketlossesand
volatilityacrossregionsinthethirdquarter.TheShanghaiCompositeIndexfell29percentinthethird
quarter,themostworldwide,andtheyuanweakened2.4percentafterauthoritiesdevaluedthecurrency
inAugust.

SharpCorrelations
FortresscitedsharpcorrelationsbetweenAsiaandmarketssuchasBrazil,wherethecurrencyhas
tumbledamidapoliticalstalemate,aplungeincommoditiespricesandtheworstrecessioninaquarter
century.TherealsunktoarecordlowinSeptemberafterStandard&Poorscutthenationsratingto
junk.ReverberationsfromslumpingcommoditieshavealsohurtRussia,whichisstrugglingwitha
recessionandarublethatweakened15percentinthethirdquarter.
TheBloombergCommodityIndexhaditsworstquarterlylossinthethreemonthsendedSept.30.The
economicslowdowninChina,theworldsbiggestconsumerofgrains,energyandmetals,makesthe
outlookforrawmaterialsevenmorebleak.
Notallmanagersarebearishontheemergingmarkets.FranklinResourcesInc.sMichaelHasenstab,
manageroftheTempletonGlobalBondFund,saidinaninterviewpostedonYouTubeonMondaythat
theselloffinemergingmarketassetshasopenedupinvestmentopportunitiesnotseenfordecades.The
SanMateo,CaliforniabasedmoneymanagersaidhesbuyingtheMexicanpeso,Malaysianringgitand
Indonesianrupiah.

CreditContraction
Centralbanks,havingspenttrillionsofdollarsinprogramsknownasquantitativeeasing,orQE,arenow
intheirlastroundsofbondbuying,whichhistoricallyissignofabearmarket,accordingtotheFortress
letter.
Theoutflowsandongoingcredittighteningamongdevelopingcountries"isnotjustanotherpullback
thecontractionofcreditinemergingmarketsishappening,"thefirmwroteintheletter.
Thenext18monthsto24monthswillbewild,particularlywiththeupcomingU.S.election,Fortress
said,anddiversificationacrossassetclassesiskey.
Nowisthetimetobehedged.
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Capitaloutflowsfromemergingmarketsareontracktoexceedinflowsthisyearforthefirsttimein27
years,accordingtotheInstituteofInternationalFinance.Investorswillpullanestimated$540billion
fromdevelopingcountriesthisyear,theIIFsaid,afterdevelopingnationstockslost$4.3trillionin
marketvalueinthethirdquarter.Anestimated$141.66billionleftChinainAugust,exceedingthe
previousrecordof$124.62billioninJuly,datacompiledbyBloombergshow.
TheriskofmoreoutflowsfromEMcountries,risingmarketratesandfallingforeignexchangereserves
becamemorerealinAugust,Fortresswroteintheletter.Asaresult,wethinkthevolatilityregimeof
thepastsevenyearshaschanged.

EmergingMarketsFortressInvestmentGroupLLCBearMarketDevelopingCountriesChina
CurrencySingaporeAndyWongStandard&Poor'sEnvironment

China'sSellingTonsofU.S.Debt.
AmericansCouldn'tCareLess.
DanielKruger

TheRealDFK
October19,20155:00AMSGT

U.S.fundsarebuyingrecordamountsatTreasuryauctions
Surgeindemandkeepsfundingcostslow,raisesdoubtonrates
ForallthedirewarningsoverChinasretreatfromU.S.governmentdebt,thereisonesimplefactthatis
beingoverlooked:Americandemandisasrobustasever.
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NotonlyaredomesticmutualfundsbuyingrecordamountsofTreasuriesatauctionsthisyear,U.S.
investorsarealsoincreasingtheirshareofthe$12.9trillionmarketforthefirsttimesince2012,data
compiledbyBloombergshow.

ThebuyinghasbeencrucialinkeepingalidonAmericasfinancingcostsasChinathelargestforeign
creditorwithabout$1.4trillionofU.S.governmentdebtparesitsstakeforthefirsttimesinceatleast
2001.YieldsonbenchmarkTreasurieshavesurprisedalmosteveryonebyfallingthisyear,dipping
below2percentlastweek.
ItsnotthescenariothatdoomsayerspredictedwouldleavetheU.S.vulnerabletoChinaswhims.But
thefactthatAmericansarepouringintoTreasuriesmaypointtoadeeperconcern:theworldslargest
economy,plaguedbylacklusterwagegrowthandalmostnoinflation,justisntstrongenoughforthe
FederalReservetoraiseinterestrates.
Asyoudevelopamorepessimisticviewonglobalgrowth,inflation,andrates,assetmanagersare
goingtobuyTreasuriesinthatenvironment,saidBrandonSwensen,thecoheadofU.S.fixedincome
atRBCGlobalAssetManagement,whichoversees$35billion.

OverseasCreditors
OverseascreditorshaveplayedakeyroleinfinancingAmericasdebtasthenationborrowedheavilyto
pulltheeconomyoutofrecession.Since2008,foreignershavemorethandoubledtheirTreasury
investmentsandnowownabout$6.1trillion.
Chinahasledtheway,funnelinghundredsofbillionsintoTreasuriesastheAsiannationboomedandit
boughtdollarstolimitthegainsinitscurrency.
Nowthatschanging.Thisyearalone,Chinasholdingshavefallenabout$200billionasitraisesmoney
insupportofitsflaggingeconomyandstockmarket.Ifthepatternholds,itwouldbethefirsttimethat
ChinahaspulledbackfromTreasuriesonanannualbasis.ThetallyincludesBelgium,whichanalysts
sayishometoChinesecustodialaccounts.

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ThePeoplesBankofChinadirectedquestionsonitsTreasuryholdingstotheStateAdministrationof
ForeignExchange,whichdidntreplytoafaxseekingcomment.
TheChinesepullbackhasledsometoraisetroublingquestionsabouttheU.S.sabilitytoborrowand
refinanceitsobligationsatultralowratesyearafteryear.Itsalsoreignitedlongheldconcerns,made
overtheyearsbybothRepublicanandDemocraticpoliticians,thatChinasownershipofU.S.debtisa
threattoAmericasindependence.

HomegrownBuyers
HomegrowndemandforTreasuriessuggeststheresnoreasontopanic.
Americanfundshavepurchased42percentofthe$1.6trillionofnotesandbondssoldatauctionsthis
year,thehighestsincetheTreasurydepartmentbeganbreakingoutthedatafiveyearsago.Asrecently
as2011,theyboughtaslittleas18percentatauctions.
Asagroup,U.S.investorsofalltypeshavealsosteppeduptheirholdingsofTreasuriessincetheyfellto
alowinmid2014.In2015,thatsharehasclimbed2.1percentagepointsto33.1percentoftheU.S.
governmentdebtmarket.
Thatmightnotsoundlikemuch,buttheannualincreasewhichhaspushedupAmericansholdingsto
arecord$4.3trillionwouldbethefirstsince2012.

MisplacedWorries
TheworriesaboutChinasellingaremisplaced,saidDavidAder,theheadofU.S.governmentbond
strategyatCRTCapitalGroupLLC.Thiswasoneofthegreatfearsofthebondmarket,andits
happeningandwetookitinstride.
WhiletheappetiteamongAmericansfortheworldshavenassethaskeptthegovernmentsfinancing
costslow,whatsworrisomeiswhatitsuggestsaboutthehealthoftheU.S.economy,accordingto
GeorgeGoncalves,theheadofinterestratestrategyatNomuraHoldingsInc.,oneof22dealersthatare
obligedtobidatTreasuryauctions.
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Lowerforlonger?

Sure,theU.S.iscreatingjobs,butaraftofdisappointingindicators,fromretailsalestomanufacturing,
suggestsconsumersarescalingbackjustasoverseasdemandweakens.
AndwagesarestagnatingformanyAmericans.Sincetherecessionended,averagehourlyearningshave
increasedlessthaninanyexpansionsincethe1960s.Withouthigherwagestospurspending,inflation
hasremainedstubbornlylow.

PricePressures
TheauctiondatashowsthatU.S.fundstargeted30yearbondsmostvulnerabletorisinggrowthand
inflationthemostamonginterestbearingTreasuries.Thatcomesastradersarepricinginthe
likelihoodthatinflationwillremainbelowtheFeds2percentgoaloverthecomingdecade.
EconomistsinaBloombergsurveynowseea15percentchancetheU.S.willslideintoarecessionin
thenext12months,thehighesttotalsince2013.
InvestorsintheU.S.aremakingadecisionbasedontheiroutlookanditsareflectionoftheeconomy
aswellastheirriskaversion,NomurasGoncalvessaid.

ItalsosuggeststheFedpolicymakersmaywanttorethinktheirassumptionsabouttheneedtoraise
interestratesanytimesoon.WhileFedChairJanetYellenhassaidshestillseestheeconomygrowing
enoughforthecentralbanktoraiseratesbyyearend,tradersareskeptical.Theyseeonlya32percent
chanceofarateincreasebyDecember,whiletheoddsofaMarchriseareatlittlemorethanacoinflip.6/7

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FortressSaysEmergingMarketsBearSlumptoRival1997BloombergBusiness

chanceofarateincreasebyDecember,whiletheoddsofaMarchriseareatlittlemorethanacoinflip.
SomeFedofficialsarecomingaroundtothatview.GovernorsLaelBrainardandDanielTarulloboth
indicatedthismonththeFedshouldwaituntilclearersignsofinflationemerge.
TheresnopressingreasonfortheFedtohikeratesandthereareclearrisksagainstaglobalbackdrop
thatssofragile,saidRobertTipp,thechiefinvestmentstrategistatPrudentialFinancialsfixedincome
unit,whichoversees$533billion.

ChinaU.S.DebtU.S.GovernmentDebtMutualFundsInterestRatesWageGrowthFederal
ReserveEnvironmentRoyalBankofCanadaBonds

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