Contrarian Signals (Or Why Romania May Be the World’s Best Performing Market This Year)

In my research and investing I stress three things: people, structure and value.  I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below fair value if not outright cheap.  This post is mostly about valuation and how bankers and financial experts take away the punch bowl just when an investment becomes attractive.  

I've written before how doing the opposite of what large financial institutions are doing and recommending can lead to higher returns (see here). This post is in the same vein . 

The reason I think Romania has a good chance of being one of, if not the best, performing stock markets this year is that the broker I use to access Eastern European stocks informed me that it will stop service there.  Earlier this year I had to transfer or sell all my Romanian shares.  To me, my broker’s closing operations is a large buy signal. 

The broker is ultimately owned by a large Belgian bank.  It’s likely that back in their corporate headquarters the stuffy-suited managers decided that all group companies would stop offering their clients access to Romanian equities.

This could likely be a very logical decision as it sounds like they have few clients trading Romania equities. My Prague-based account manager noted that I was one of four.

However, it is also short-sighted as there are many positives.  Romania has one of Europe’s fastest growing economies at 4.6% last year.  The country appears to be serious about political reform.   Its stock market is also one of the world’s better performing ones, having increased by close to 16% year-to-date. Despite the increase, many of its large cap stocks pay good dividends with yields north of 6%. 

While logical, it still stinks.  It took a long time to find a broker who provided access to most Eastern European markets and took US citizens as clients.  Part of the onboarding process was flying to the Czech Republic to sign account opening forms in person. (It was actually not much of a burden - Prague in June is actually quite nice.  But I’m still angry about it).

The situation reminds me of other instances where bank and financial product withdrawals and shutdowns turned into good contrarian signals. History doesn’t repeat, but it can rhyme, to paraphrase a famous quote. 

Consider the following:

• Brazil – the EGShares Brazil Infrastructure ETF (BRXX) was closed and delisted at the end of October 2015.  At the time headline news in Brazil was pretty abysmal.  However Brazilian equities were starting to flash buy signals based on my screens.  Stocks in the BRXX were the least expensive among the handful of Brazilian ETFs.  Since its delisting, its top ten holdings have increased by an average of 64% in USD.  Many had good dividend yields which would have likely pushed total returns closer to 70%.  Not as good as the Bovespa’s 84% during the same time period, but not too shabby. (ETFs are like mutual funds that track a specific index or strategy and can be bought and sold like stocks.  More information is can be found here).
• Greece - in 2012 HSBC sold its Greek securities business.  This was at the same time that I wanted to buy Greek shares, as they were trading at valuations similar to Korean stocks at the depths of the 1997/98 Asian financial crisis.  The bank that I’ve had an account with for almost 30 years took away a service just when I wanted to use it.  Over the next two years the headline Athex index rose by close to 200%.
• Russia – in mid-December 2014 when the Ruble was floated and Russian securities and its currency plummeted, my European broker decided to suspend dealing in Moscow listed shares.  I was locked-out just when I wanted to buy.  Many share prices of quality companies I earmarked to buy are since up 2-3 times in USD.
• South-East Asia – around 2001 HSBC closed and/or vastly curtailed its research operations in South-East Asia.  It was during this time that many of those markets started a multi-year bull run.  Since then, Indonesia’s and Thailand’s headline indexes are up by over 12x and 5x respectively in USD.

To be honest I really don’t know if Romania will do well this year.  Nobody does.  As I wrote in a previous post, the country’s stocks seem to be perennially cheap (see here).  Like all articles on investments, consider this article as an idea and interesting information, rather than advice. 

In addition to Romania, other Eastern European stock markets look attractive with several among the world’s best performing so far this year.  Czech stocks are some of the world’s least expensive. Polish stocks seem to be rebounding from political uncertainty since Poland’s late 2015 change in government.  And there’s even life in Ukrainian stocks as that country’s economy starts to stabilize.  Its GDP grew by 2.3% in 2016, rebounding from a 15% decline in the previous two-years. 

	Index	% Change Year-To-Date (USD)
Romania	BET	14.7
Poland	WIG	19.4
Czech Republic	PX	8.7
Ukraine	UX	17.5

Bankers and their management are not known as visionaries.  They are known to stop lending and pull products when the market or economy is faltering and their clients need them the most.  This has happened before and it will happen again.  To me these are good, qualitative contrarian signals that are not easily programmable by the quants and algos.  Let’s call it ‘qualitative alpha’ or, my favorite, ‘Research Alpha’ (see here).

It doesn't look like I'll be part of the Romanian party unfortunately, but I hope there are some readers who can make some decent money on this.  Buy me a bottle of wine if you do. One from Transylvania will do nicely.

BRICs, PITs, and PIGS: Go Ugly

In my research and investing I stress three things: people, structure and value.  I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below fair value if not outright cheap. 

This blog is mostly about valuation and yet another example of how investing in beaten down, unpopular and ugly markets can lead to better returns. 

Usually valuations are low in markets that are not very attractive.   But who knows when the news can get even worse? Uncertainty and negative news flow keep most of us out of markets just when we should be buying. 

And it can take even greater will power to stay invested when nobody around you sees your point of view, friends and peers are calling you crazy, and well-educated, respected and slick investment bank analysts and traders are negative.    

It is psychologically easier to invest in markets when there is a lot of good news and the future looks very bright.  The problem is that these markets tend to be expensive and future returns tend not to be as good.

To contrast these two points let’s look at two acronyms that surfaced about the same time.

BRIC stands for Brazil, Russia, India and China. The acronym is attributed to Jim O’Neill in a paper he wrote for Goldman Sachs in November 2001 (found here).  In it he argued that these four countries should be included in high-level government groupings such as the “G7” because their size and growth would make them increasingly influential.

The acronym came out not long after the tech crash. Wall Street was ripe for a new story and over the next few years the term became more popular.  Goldman Sachs and many others launched BRIC funds and ETFs.  There are now over 200 of them according to a very expensive database.

The term took on a life of its own.  Leaders of the four appear to like the grouping.  Just a few months ago they and South Africa formally launched the BRICS Development Bank (link here).

About the same time BRICs was coined, traders and analysts who survived the late 1990s Asian financial crisis were referring to the ASEAN countries as PITs.  The term stood for Philippines, Indonesia and Thailand.  These were three of the hardest hit economies and markets.  Unlike BRICs I don’t think anybody has come forward to claim responsibility for it.  Calling your home market a degrading term soon after clients lost money would not likely make one popular.

Investing in the four BRIC countries when the phrase was coined until now would have generated decent returns.  The four countries' headline indexes are up an average of 302% since late 2001 for a CAGR of 10.5% (this and other return figures in this article are based on the average return of each country's headline index, in USD, dividends not included). 

In contrast, and despite the acronym’s negative connotation, one would have done considerably better by investing in the three PITs markets.  An equally weighted investment in the three grew by 675% over the same time period, which means the PITs investor would have made more than double the money of the BRIC investor.  Even the worst PIT outperformed the best BRIC.  Thailand, the worst performing PITs country, rose by 629%, a bit more than India, the best performing BRIC country, which increased by 611% from November 2001 to November 2015. 

In addition to being weary of investment fads, investors should also be skeptical of what the big banks are pushing. In July 2006 Goldman Sachs launched its BRIC fund.  From launch to close, the fund’s performance was just under 20%.  Over the same time period the three PITs indexes increased on average by 157%, meaning that one would have made almost eight times more money by investing in the markets that were unloved rather than the ones that the big banks were marketing.

Are PIGS Today’s PITs?

PIGS stands for Portugal, Italy, Greece, and Spain.  These are some the world’s worst performing economies and equity markets since the 2008 global financial crisis.  Like PITs it is not a flattering grouping and member countries have reportedly renounced the term (link here).

I suspect PIGS could be an up-to-date version of PITs.  The origins of both are the same and they describe markets that are having problems and are out of favor.  

Also like PITs the countries in the grouping are geographically close and have a lot in common in terms of economic integration, language, and culture. This is a stronger grouping than the BRICs. Except for the large country size, I don’t really see much that binds them like the PITs and PIGS.

Back to BRICs

Ironically now may be a good time to consider investing in BRIC equities. 

Russia has some of the world’s least expensive large companies and very impressive management.  Brazil is starting to look interesting with its currency down some 40% in the last two years.  There are some exciting and inexpensive companies in China and at 7x PE the Hang Seng China Enterprise Index does not seem very expensive. Weren’t US equities trading at the same level in the early 1980s just before that market’s long bull run?

There’s also a good contrarian signal.  Goldman Sachs recently closed the above mentioned BRIC fund.  Big banks have a habit of closing operations and products just when things start turning around. HSBC closed its South East Asian equity research offices in 2001 – just before those markets went on a multi-year bull run. Goldman’s closing of its BRIC’s fund may be a similar signal (more here). 

Go Ugly

This short piece is meant to show that going against the grain and doing what is uncomfortable and unconventional many times leads to higher returns.  The best place to find value is typically in ugly geographies and sectors.   

Are there other places that appear to be ugly and warrant catchy phrases such as PIGS?

How about “RUKs”, for Russia, Ukraine and Kazakhstan, three ex-Soviet countries whose currencies have fallen and have some of the highest interest rates in the world.   Or “PCB”, for Peru, Columbia and Brazil, three of the worst performing equity markets this year for US-dollar investors  Or “JOBQES”, for Jordan, Oman, Bahrain, Qatar, Egypt and Saudi Arabia which are among the world’s least expensive equity markets likely due Middle East uncertainty.  Or "GETOUt" for gold, energy, telcos, oil and utilities, five out-of-favor sectors that dominate my global value screens.

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Making Ugly Fun

"Average investors are fortunate if they can avoid pitfalls, whereas superior investors look to take advantage of them", wrote Howard Marks in his very good book, The Most Important Thing.

Psychologically it is hard to put one's hard-earned money into unattractive and out-of-favor stocks and markets.   It's not easy or very enjoyable to try and catch a falling knife.  But buying quality companies at knock-down prices is likely a good way to limit downside and hopefully generate superior long-term returns. 

To help ease the way, I silently sing the chorus of a song from my youth.  Perhaps it will help you also.  It's sexist, corny and elementary, but with a catchy pop-hook its also very memorable, so make sure to click on the link below.  I've changed some lyrics in the second version to make it a little more investment specific.  

If you want to be happy for the rest of your life,

Never make a pretty woman your wife,

So from my personal point of view,

Get an ugly girl to marry you.

-----------------------

If you want to be happy for the rest of your time,

Never make a pretty stock your life,

So from my personal point of view,
Get an ugly market to carry you.

"If You Want to Be Happy", by Jimmy Soul (link here), 

(Based on "Ugly Woman", by Roaring Lion (link here)  

Bangkok - Changing and Staying the Same

Thailand is, and is not, changing.

That is my impression after a three-day trip to Bangkok to celebrate a friends 50th.  My first trip to Thailand was in 1986 and I've been going back every one-to-three years since.  This was my first time to Thailand in almost exactly two years when I was doing on-the-ground research for Inside Corporate ASEAN. My list of publications can be found here: http://michaelmcgaughy.blogspot.hk/2012/02/publication-list.html

Changing.  Bangkok for the first time feels like a real, first-world cosmopolitan city.  In the past it has always stuck me as a sprawling city in a developing country.  This time the night drive into the city from the airport yielded an urbane skyline, fast expressways and drivers that (mostly) stayed in their lanes. Later in the weekend a crowded BTS and fashionable shopping mall added to this feeling. Dinner, drinks and a terrace view of a concrete jungle reinforced it.

Staying the Same.  However in some ways Bangkok has not changed.

1. Traffic is still dreadful. It took 1.25 hours to go a few kilometers on a rainy Friday night.   
2. Politics remains rumour-driven.  My host informed me a few hours after I arrived that he received an SMS/Text stating that there will be a military coup in a few days. (another friend said this is not a rare message to receive)
3. Thais continue to start interesting consumer products. This is the country that gave us Red Bull.  

The last point is actually the purpose of this post.

The product is called G&G Body Deodorant.  It is for both underarms and feet. Basically a combination of Sure and Odor Eaters.

From a chemist's standpoint this combination may be very logical.  However from my consumer mindset it seems odd. Something that is meant to be spread on my feet does not seem like something that is also meant to spread on my armpits.

It was the only option at the supermarket so I gave it a try.  After a few days in a not-so-hot-Bangkok I found that it worked well.

At least for my upper body.  I still have not tried it on my feet.

The second picture is also from the trip.  It shows the King of Thailand getting haircut from his mother.  In Thailand virtually every retail business and office has a picture of the the king or other members of the royal family centrally displayed.  This was hanging at the Nonglingchee barber shop I tried. Very appropriate.

Negative Local Press

Last week's HK local press had a lot of negative headlines.

This is in-line with several smaller and value oriented fund managers I know who invest in small and mid-cap Asian stocks. As expected several of them are seeing more buying opportunities, and/or running high net exposures (i.e. buy when others are fearful, sell when others are greedy).
Below are some SCMP (www.scmp.com) headlines found in last Monday's edition:

• "Warning on Risk of Property Bubble - Hong Kong's Finance Chief says the price of flats has not fallen to a satisfactory level - but he does not say what they should be, or if there will be more cooling measures"
• "Currencies - Fears Capital is Fleeing Mainland - Foreign exchange purchases enter negative territory for the first time in four years"
• "Global economic conditions remain grim, and ensuring economic recovery is the priority", China Vice-Premier Wang Qishan 
• Asia - "Regional Tale of Gloom and Doom - Economic data tells a story of weak growth, and expectations are that things will only get worse (See below) 
• "Like a Ton of Bricks - Hong Kong Property Prices Could Be Poised For A Large Fall In Value" - (28 Nov 2011 SCMP

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Regional tale of gloom and doom
Economic data tells a story of weak growth, and expectations are that things will only get worse
Agencies in Tokyo, Seoul, Bangkok and Singapore Nov 22, 2011
Economic data from Japan, South Korea, Thailand and Singapore point to a global economy that may be weakening more sharply than expected. "Things are going to get worse before they get better," said Vishnu Varathan, a Mizuho Corporate Bank economist in Singapore. "Export growth will slow across Asia and we may see financial shocks coming through. Asian policymakers are going to become stimulatory all over again." A record of the Bank of Japan's October 27 meeting released yesterday showed that one board member favoured adding 10 trillion yen (HK$1.01 trilllion) in asset purchases, and Chinese Vice-Premier Wang Qishan said his nation must adopt a more "forward looking" and flexible monetary policy. Separate data showed that Japan's exports fell at the fastest pace in five months in the year to October as a strong yen and sputtering global growth weighed on the recuperating economy. Although Japan's economy expanded 1.5 per cent in the previous quarter, rebounding from recession triggered by the March earthquake and nuclear crisis, it is expected to slow sharply in October-December. Severe floods in Thailand, a major manufacturing base for many Japanese exporters, are expected to add to global headwinds faced by the world's third-biggest economy. Japan's exports fell 3.7 per cent last month from a year earlier, far more than a 0.3 per cent dip forecast, and follows the central bank's warning that government debt woes in Europe were already hurting Japan and emerging economies. The October fall was the biggest drop since a 10.3 per cent fall in May, with shipments of semiconductors and other electronic goods falling due to strength in the yen. South Korean customs agency data showed yesterday that exports grew just 2 per cent in the first 20 days of this month from a year ago, while imports rose 3 per cent. In Bangkok, the government yesterday said it had cut its forecast for economic growth this year to 1.5 per cent because of the floods. The flooding in Thailand has also disrupted supply chains of Japanese car and electronics companies. Toyota, Asia's largest carmaker, reported that its profit fell 19 per cent in the third quarter. Singapore yesterday lowered its forecast for non-oil domestic exports, estimating overseas shipments to rise 2 per cent to 3 per cent this year, lower than a forecast of 6 per cent to 7 per cent. The government also said the economy could contract in the fourth quarter and growth next year was likely to slow due to the weakness in the Western economies. "This [2012] forecast is based on current known external weaknesses. Should a recession or a full-blown financial crisis in the advanced economies occur, growth could come in lower," said Ow Foong Pheng, permanent secretary at Singapore's Ministry of Trade and Industry. Reuters, Bloomberg