IMF Revelations: The End of European Dominance & The Rise of Emerging Markets?

As “super-injunctions” are labelled “pointless” by the rise of ‘new’ social media sites, the world seems a smaller place for those wanting to hide potential transgressions.  Indeed, such accusations can have broad ramifications as the head of the International Monetary Fund this week steps down from his leadership position. Could this trigger the end of European dominance at the IMF and even pave the way for Emerging Market leaders to acquire a more appropriate size of the power pie?

Jurisdiction Arbitrage: The Super-Injunction Flaw

Last week, an anonymous twitter user exploited a ‘jurisdiction arbitrage’ to name celebrities whose identities are being protected by a series of ‘gagging-orders’. The Twitter site is based in the US and therefore “outside the jurisdiction of the British courts”. Furthermore, not only would the user himself be “difficult to trace” but the number of other users who forwarded on the names and could be charged represented a “mass defiance” and “unlikely” any of them would be pursued. Therefore potential wrong-doers can, for the moment at least, be named and shamed in some form of media. Just how dangerous can these revelations be?

Revelations at The IMF

This week legalities are once again in the headlines as Dominique Strauss-Kahn, (now the former) head of the International Monetary Fund, stands accused of politically damaging indiscretions. Regardless of the outcome of the case, the political impact has been made and focus is on identifying his potential successor.

The European Bias

Historically the IMF Managing Director has been European and the World Bank President American but nowhere in the “Articles of Agreement’ is this mentioned. So where did this bias come from? It dates back to the Bretton Woods conference, where the fund was formed and this informal agreement struck. In the aftermath of World War II, European economic stability played a large part in the health of the world’s economy and voting power reflected the balance of power. The US has a 16.7% share, Germany 5.9% and the UK & France 4.9% each; leaving the ‘door open’ for ‘behind the scenes’ negotiations. Unsurprisingly, since this time, there have been 10 Managing Directors, all of them European.

Flaws of a European Successor

Proponents of a continuation of European dominance point to the IMF’s crucial role in stemming the European Sovereign Debt crisis. A German government spokesman, Christoph Steegmans, maintains that the leader needs to understand “Europe’s particularities”. Interesting then that there has been no talk of electing an official from the Middle East as Egypt requests a $4bn loan to ‘fill its budget gap’. With all the turmoil, doesn’t a leader need to understand the ‘particularities’ of this region too? Instead, focus is on German candidates (including Axel Weber, the former head of the Central Bank who recently withdrew from the race to succeed Trichet as head of the ECB). A favourite amongst pundits is French finance Minister Christine Lagarde. Bank of Canada Governor, Mark Carney has even been given odds of 10-to-1 by a British bookmaker. Gordon Brown’s name has even been thrown into the ring but was quickly opposed by our PM Cameron due to the record budget deficit which continued to build during his tenure. Here lies the crux of the issue, since the EU and ECB have yet to solve the debt crisis, is it time for someone else to have a go?

Opportunity for Developing Markets

The economic balance of power is changing. China has overtaken Japan as the second largest economy and it has been argued that it will surpass the US’s share of global GDP in a decade. Back in 1973, the developing nations asserted more of their power as a group led by Indonesia and Iran vetoed the nomination of a Dutch candidate (seen as too closely aligned to the interests of wealthy nations). With this in mind, candidates from South Africa, Turkey, Singapore, Indonesia, Mexico and a Chinese official who advises the IMF already have been mentioned in the press. Brazil too has contributed to the discussion, as their Finance Minister argues for a “new criteria”. Indeed changes to IMF governance were decided in 2008 and last year, shifting 5.3% of the voting share to emerging markets. Although nothing has yet taken effect. However, with the increased contribution of funding coming from these regions and the negativity within these countries expressed against too much focus on the developed world, change is warranted.

Investment Conclusion

As ever, economic issues can often lie opposed to equity market movement. But changes (or continuation) of dominance could affect short-term sentiment for various country’s financial markets. Exploit any over-reaction in the short-term whilst remaining focused on quality in the longer-term. The shift of economic power is well underway, let’s see if the political powers play catch up….

Is There Hope From Emerging Markets – Are we being too G8-centric? Radio Clip

“Risk of acronym over-exuberancea pithy abbreviation does not necessarily equate to a profitable investment!” (Me!)

Click the image below to here my views on Emerging Markets (and the global economic outlook). It was broadcasted just the other week on “The N@ked Short Club” on Resonance FM – (2m+ listeners and growing!). Follow-on comment from Mike Gasior, CEO of AFS.

The Long-Term Case Summarised

  • Strength of balance sheets (10% D / GDP vs. 400% in UK)
  • High levels of savings to deploy rather than build (33% vs 17% of GDP)
  • FX reserves (75% of global forex)
  • Wider range of policy tools available

Most crucially

  1. The growth of emerging consumer class: an estimated 1bn are to join by 2030 , with the Chinese middle class to exceed the US population within a few yrs
  2. We have seen resolve: Industrial Production is above its pre-crisis peaks in emerging Asia and there are increasing levels of intra-regional trade (see chart below) – leading to countries becoming more insulated from pullbacks in demand from developed markets
  • From export-led to domestic-demand (and neighbor-demand) led
  • In just 14 years, Emerging Market exports to other developing countries (light blue) increased by 10%.

Although valuation and reputation concerns remain

Source: Automatic Trend Lines by the Ramp Pattern Recognition Program. MSCI EM has risen 135% above March low although still below previous peak for those who believe the long term trend is up.

A word of warning

  • As ever, DIFFERENTIATE between markets – they aren’t all as strong.
  • And market RISK OF CONTAGION remains – if international investors get spooked, they will  take risk off the table across the board regardless of fundamentals
  • INVEST IN QUALITY – should add value over longer-term.

We have had the “BRICs” (Brazil, Russia, India and China) and the calls just keep coming. Now the term “Chindonesia” (China, India and Indonesia) has been coined or even the “Civets” (not just cat-like mammals from Africa and Asia but Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa). But as my above quote states, there is a risk of acronym over-exuberance – a pithy abbreviation does not necessarily equate to a profitable investment! Often there are discrepancies between international investor excitement and the fundamentals of the economy and sentiment on the ground.

Specific Stock Example

Avoid anything with “Chinese Consumer” in the name, a beneficiary of this “over-exuberance” and have potentially, in some cases, become over-priced. Instead look for more indirect access to value and growth.

One such example – to be taken within the context of an admission of having spent little time evaluating the fundamentals sufficiently, is Want Want China Holdings, listed on the Hong Kong Stock Exchange – maker of rice cakes and flavoured milk in China as well as snack foods. Has rallied 24% YTD to a PE, according to Reuters, of around 33x, above that of its sector. A different angle is Olam International, listed in Singapore, – global leader in supply chain management of agriculture products and food ingredients, which has underperformed Want Want by almost 7% YTD and cheaper than the sector average (PE 19x).