Uncertainty Shifting Foreign Investment

By Peter Pham - May 29, 2012 | Tickers: VNM, GLD, BNO, WMT | 0 Comments

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With the fantasy of the rally in U.S. equities having met the reality of what’s left of the functioning economy around the world, as always the really telling economic indicators lag behind the effects of them.  If the U.S. economy was truly beginning a new boom phase and the debt situation in the Euro-zone periphery was contained in a meaningful way then the flow of investment funds into the high growth areas of the world would not be slowing down year over year.

The truth is that the equity rally in the first quarter was a liquidity driven phenomenon engineered by the Federal Reserve to accomplish two goals:

1. To de-fuse the building wave of anti-government sentiment and manage the headlines coming into an election year
2. Provide the funds necessary to turn the Greek bond default in early March into a non-event.

The Fed was successful in achieving both goals.  The consequence was to ignite a commodities rally in oil and gold.  Brent crude, traded as the U.S. Brent Crude ETF (NYSEMKT: BNO) and the driver of U.S. gasoline prices, soared to $125 per barrel while the SDPR gold trust (NYSEMKT: GLD) made another attempt at $174 per share, or $1800 per ounce gold. 

No Coincidences

I operate under the assumption that there are no coincidences in politics and financial markets.  Shifts in Federal Reserve policy under Ben Bernanke have been swift and violent.  February 29^th’s FOMC statement was nothing special, but the market’s reaction to it was and we have been caught in that policy regime since then.  Commodities and equities down, Bonds up as capital seeks cover against a rapidly deflating U.S. monetary base, which the Fed has the most control over.

At that point they had ring-fenced Greece having supplied the market with what was needed to keep the banks afloat for the next few months until the next crisis would emerge and face the reality of the slowing global economy, which some of the economic

Foreign Investment Indications

Foreign direct investment flows into emerging markets are an excellent indicator to sniff out possible dislocations in the market.  So far in 2012 China and Vietnam have seen foreign investment drop year over year.  China’s foreign investment is down 2.4% through April, an extension of China managing their property bubble.  The Market Vectors Vietnam ETF (NYSEMKT: VNM) has risen 27% this year while Vietnam has seen a 25% drop over last year’s FDI inflows through May 20^th with most of that loss being seen in real estate investment.  Both China and Vietnam have serious real estate problems clogging up their banking systems.  Unlike the U.S. though, they still have policy room with which to maneuver.

Since the Fed changed course in March, many of the emerging market currencies have been sold on fears of a global slowdown.  This has been particularly difficult for India as the Rupee has dropped nearly 20% versus the U.S. dollar in three months.  What it has done, however is spark a large inflow of foreign capital deals to be finalized.  Through the end of March India has seen according to Commerce Minister Anand Sharma $50 billion in foreign investment, a record amount.  India’s current account deficit is large enough that net investment has to rise to stave off further deterioration of the Rupee.

In order to continue to attract foreign investors, however, these countries have all had to liberalize their rules for foreign ownership in one way or another.

• China now allows up to 49% Foreign ownership of financial institutions, from 33%.
• India now allows 100% foreign ownership for single brand retail and multiple brand companies like Wal-Mart (NYSE: WMT) can now own 51%.
• Vietnam is considering changes to property ownership rules for farmers, a seismic shift in a communist country.

A Yen for Travel

The persistent strength of the Japanese Yen,, coupled with the after-effects of last year’s tsunami has vastly accelerated the movement of funds out of Japan and around the Pacific Rim.  In Vietnam, Japanese direct investment has accounted for nearly 70% of the total foreign investment through late May.  At $3.68 billion, that represents more than double what Japanese companies invested in Vietnam in 2011.  Japanese investment in China rose 16% in the first quarter as well.

Japan’s current plight of high debt, aging population and high-priced labor make it a difficult case for outside investment even though, since Fukishima, they have encouraged this inflow of capital.  For them to prosper they will have to invest heavily in their poorer neighbors.  The strong Yen has granted them that opportunity to get maximal return on investment.

Regional Investments

This will become a dominant theme of the next 20 years, the regional investment of Southeast Asia into Southeast Asia.  A recently released report by the OECD in conjunction with the National Science Foundation revealed that for the first time the 10 major Asian countries (China, India, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, Thailand) matched U.S. investment into science and technology in 2010.  China’s investment is growing at a CAGR of 25% since 2009.  While the U.S. and Japan grew the slowest at 6%.

Once the current round of issues in Europe are brought to a conclusion, most likely with a stronger political union which will stabilize the financial system, capital will then flow out of U.S. treasuries in a torrent.  The Euro will benefit as will the BRICS nations and Southeast Asia.  At which point the focus will have to shift to the U.S.’s budget and monetary problems. 

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