Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.
JA N UAR Y 2 0 1 5
S T R I C T L Y C O N F I D E N T I A L
N O T F O R D I S T R I B U T I O N
CONTACT
Kevin Dougherty
+1 ...
PAGE 2
Slide 3: China: Capital Outflows the Critical Fragility
Slide 4: Closed Capital Account + Current Account Surplus d...
PAGE 3
Source: St Louis Federal Reserve, China State Administration of Foreign Exchange
PAGE 4
Devaluation in 71% of cases….China 4yr debt/GDP +49% 2009-’12; +75% 2009-’14…
PAGE 5
 USD has been in a major bull
market and appreciated strongly
against every non-pegged global
currency.
 CNY has ...
PAGE 6
CNY is still up about 27% since
September 2011 on NEER basis,
but the Reversal is clear, and in its
very early days…
PAGE 7
Source: Morgan Stanley, Asia ex Japan Economics: A Comparison of the Current Cycle with 1997-98; August 24, 2015
PAGE 8
 Prior to 2014, the RMB had
extremely attractive Carry Trade
dynamics, resulting in the largest
Carry Trade in his...
PAGE 9
Over $1Tr in ‘hot money’ inflows from 2009-2014 hidden in FDI and
overinflated exports to Hong Kong…These are just ...
PAGE10
 Under IMF FX reserves adequacy
definition, China’s minimum
prudential level of FX reserves is
$2.6Tr. China is le...
PAGE11
 Capital Outflows destroy Base Money in China, which removes liquidity and increases market
interest rates, increa...
PAGE12
1. Capital Outflow Pressures (est. $930B - $1.3Tr+ from 2Q14-end-2015)
• Carry Trade Reversal is structural
• IF TH...
PAGE13
1. China needs Gross inflows to resume. Reversing course on Capital Account
openness will send the wrong signal to ...
PAGE14
All of China’s potential policy responses come with costs. There
are no ‘painless’ solutions
 Strong Currency defe...
PAGE15
Globally coordinated action by Central Banks, Governments and
Supranational Organizations:
• Politically impossible...
PAGE16
 Expect RMB to fall 20%+ vs USD (to 8.0+) This would be a ‘Reset Event’
Globally: All forecasts for Inflation/defl...
PAGE17
Tail Risk trades
• Correlation & Volatility trades
• ‘Best-of’ put options
• Low delta, deep ‘out-of-the-money’ put...
The information in this document does not constitute or form any part of, and should not be construed as investment advice...
Upcoming SlideShare
Loading in …5
×

0

Share

Download to read offline

China & EM fallout

Download to read offline

  • Be the first to like this

China & EM fallout

  1. 1. JA N UAR Y 2 0 1 5 S T R I C T L Y C O N F I D E N T I A L N O T F O R D I S T R I B U T I O N CONTACT Kevin Dougherty +1 203 569-7743 kevin@kdgfam.com China & EM, here we go again...
  2. 2. PAGE 2 Slide 3: China: Capital Outflows the Critical Fragility Slide 4: Closed Capital Account + Current Account Surplus does NOT Protect Against Crisis Slide 5: Global Currencies vs USD Slide 6: What RMB Devaluation? Slide 7: Asian Devaluations in 1997/98 Slide 8: China Carry Trade Dynamics Slide 9: Hidden ‘hot money’ inflows Slide 10: China FX Reserves & Sufficiency Slide 11: China Base Money Dynamics Slide 12: Why China Will Give up its RMB Defense Slide 13: Why Not Just Enforce/Tighten Capital Controls? Slide 14: Can China halt Disorderly Disruption? Slide 15: What Can/Will Global Institutions Do? Slide 16: How to Position for China Disorderly Disruption Slide 17: How to Position (continued)
  3. 3. PAGE 3 Source: St Louis Federal Reserve, China State Administration of Foreign Exchange
  4. 4. PAGE 4 Devaluation in 71% of cases….China 4yr debt/GDP +49% 2009-’12; +75% 2009-’14…
  5. 5. PAGE 5  USD has been in a major bull market and appreciated strongly against every non-pegged global currency.  CNY has only devalued 8% from its peak ( 6.05 RMB/USD in Jan 2014).  RMB devaluation allows China to take back control of its Monetary Policy and implement needed easing, in addition to restoring competitiveness lost over the last years due to its USD quasi-peg.
  6. 6. PAGE 6 CNY is still up about 27% since September 2011 on NEER basis, but the Reversal is clear, and in its very early days…
  7. 7. PAGE 7 Source: Morgan Stanley, Asia ex Japan Economics: A Comparison of the Current Cycle with 1997-98; August 24, 2015
  8. 8. PAGE 8  Prior to 2014, the RMB had extremely attractive Carry Trade dynamics, resulting in the largest Carry Trade in history (est. $2-3Tr)  ‘Hot money’ inflows were hidden in the Current Account (fake exports) and Capital Account (fake FDI), making exact calculation of the size of the Carry Trade impossible.  The RMB Carry Trade is now reversing, adding to Capital Outflow pressures. An estimated $1-2Tr of the Carry Trade has not been unwound yet.
  9. 9. PAGE 9 Over $1Tr in ‘hot money’ inflows from 2009-2014 hidden in FDI and overinflated exports to Hong Kong…These are just 2 of many channels
  10. 10. PAGE10  Under IMF FX reserves adequacy definition, China’s minimum prudential level of FX reserves is $2.6Tr. China is less than $700B away from that level.  Estimated $500B-1Tr of China’s FX reserves are in illiquid assets (FX loans to SOE’s; Capital injections in policy banks; investments in external entities, etc.)  China Household Bank Deposits are 55 Trillion CNY ($8.4Tr); ‘Quasi-liquid’ WMP & Equity holdings are around 30Tr CNY ($4.6Tr) Source: Citibank: EM Macro & Strategy Outlook; Aug 21, 2015
  11. 11. PAGE11  Capital Outflows destroy Base Money in China, which removes liquidity and increases market interest rates, increasing pressures on the financial system and raising the risk of a full blown financial crisis  Interest rate and RRR cuts by the PBoC have been fully neutralized by Capital Outflows (which have taken Monetary Policy control away from China), and will continue to be ineffective until net Capital flows balance again. Inflating monetary policy requires a much bigger exchange rate adjustment  Capital flows will only balance once the market believes no further sharp devaluation lies ahead and that the RMB is trading at or near a ‘market equilibrium’ level
  12. 12. PAGE12 1. Capital Outflow Pressures (est. $930B - $1.3Tr+ from 2Q14-end-2015) • Carry Trade Reversal is structural • IF THESE CONTINUE, NOTHING ELSE MATTERS. It will not be about what China’s leadership ‘wants’ to do, it will be about what they are ‘FORCED’ to do. 2. Domestic Liquidity Considerations & Monetary Policy • RMB defense is destroying Base Money & tightening liquidity, increasing domestic pain • China needs Monetary Policy flexibility, & lower Real Interest Rates • Devaluation and letting RMB find ‘market equilibrium’ will make Monetary Policy effective again as easing steps will no longer result in new liquidity immediately turning into more capital outflows 3. Deflationary Pressures: PPI in deflation for 46 straight months 4. Prevent Debt-Deflationary spiral 5. Relatively low FX debt – around $1Tr – means limited pain 6. Lower RMB will support (CNY denominated) Domestic Equity market 7. Restore Lost Competitiveness 8. Encourage resumed gross Capital inflows & balanced net flows
  13. 13. PAGE13 1. China needs Gross inflows to resume. Reversing course on Capital Account openness will send the wrong signal to the market and discourage inflows 2. Investor confidence will likely be severely damaged if China backtracks on Capital Account openness and renews Capital controls, as this will be a clear signal of loss of control 3. Capital Controls unlikely to work anyway. Successful uses of Capital Controls (Malaysia 1998, Iceland 2009) – Capital Controls were imposed AFTER large devaluations (48% at the trough in Malaysia, eventually stabilizing at 35%; over 50% in Iceland). • Similar to different effectiveness of Hong Kong Gov’t stock rescue in 1998 (successful – HK Gov’t bought after collapse), and China Gov’t stock rescue in 2015 (unsuccessful – China Gov’t bought too early trying to prevent a collapse) 4. Capital Control attempts fail, and result in increasing Capital outflows and ultimately devaluation, after burning through capital that would have been better used to support economic recovery.
  14. 14. PAGE14 All of China’s potential policy responses come with costs. There are no ‘painless’ solutions  Strong Currency defense, maintain gradual depreciation 1. Capital outflows will continue and likely accelerate 2. Domestic Liquidity will continue to tighten 3. Monetary Policy easing will continue to be ineffective 4. No help for heavily indebted, heavily overcapacity Corporate sector  Allow RMB to “float” 1. “Front running Capital outflows” stop 2. China regains control of Monetary Policy 3. Corporate sector restores some competitiveness 4. Deflation likely turns to inflation, helping with crippling Corporate debts Lessons from Previous crises – 1997 Asian Financial Crisis, early 1990’s Nordic crisis, 1992 UK deval, 1990’s (and ongoing…) Japan - are clear: • Devaluation can be a critical and necessary component of recovery • Devaluation is not a “cure all”, but it is part of the adjustment process
  15. 15. PAGE15 Globally coordinated action by Central Banks, Governments and Supranational Organizations: • Politically impossible BEFORE crisis. Even if there is a “bailout package”, or new global Currency regime, it will not happen before there are sizeable losses across assets • Same with US Fed reversing course • China too important to allow to fail? So was Russia in 1998…. • Impact on Confidence: Will investors embrace QE4 as they did the previous versions, or will this be the “Emperor’s Clothes” moment? Geopolitics are much more poisonous now than they were in 2008, 1997, 1994, 1991…… • US Presidential election, UK EU Referendum, Taiwan election • During previous crises, there was significantly greater political stability, US Economic power and policies were unquestioned and all of the recipient states had friendly relations with the US
  16. 16. PAGE16  Expect RMB to fall 20%+ vs USD (to 8.0+) This would be a ‘Reset Event’ Globally: All forecasts for Inflation/deflation, Interest Rates, Currency crosses, Growth, Commodity prices would have to be ripped up.  There is no place to hide in EM…1997-98 type crash probable…China today is 1.6-2x the size Asia ex-Japan was in 1997 as % of global GDP  1st derivatives of China (commodities & commodity exporters) have already had substantial losses, as have 2nd derivatives (currencies of commodity exporters, EM Equities, EM focused Asset Management, MNC’s with heavy China exposure), but 3rd and 4th derivative trades are early in their corrections. High beta assets at historically high valuations (Hong Kong property….) face major corrections  Investor liquidation from EM will indiscriminately hit all EM risk assets, even those that do not sell to, or compete with China (i.e. India)  DM Risk assets all vulnerable too. US$ and US Gov’t Bonds may be the only ‘safe havens’.
  17. 17. PAGE17 Tail Risk trades • Correlation & Volatility trades • ‘Best-of’ put options • Low delta, deep ‘out-of-the-money’ puts. Avoid spread trades What are the Peregrine’s and Lehman’s today? • Dependent on Wholesale market liquidity • Long the Wrong Assets: Carry Trade, Commodities, China, EM • Beware Counterparty Risk!! Avoid Asia & EM focused counterparties When will it be time to get Long Again? China is the Epicenter of stress in EM and Commodity markets, and a prime contributor to DM uncertainty. EM & Commodities will not hit bottom until China’s disorderly disruption is resolved, which requires some combination of: Devaluation (extremely likely), systematic Debt restructuring (already started, but very early in the process), ‘sane’ Equity valuations (ongoing). Only AFTER this, and the associated capitulation out of EM, should EM present another “once-in-a-generation” investment opportunity….
  18. 18. The information in this document does not constitute or form any part of, and should not be construed as investment advice or an offer, invitation, inducement or solicitation to sell, issue, purchase, subscribe for or otherwise acquire shares or other securities, or engage in investment activity of any kind nor shall it or any part of it form the basis of, or be relied on in connection with, any contract therefore. Such offer or solicitation will only be made by a Confidential Private Offering Memorandum for the Fund. No person should rely on any information in this document, but should rely on the Confidential Private Offering Memorandum and other Fund documentation in considering whether to invest in the Fund. The Fund will be available only to qualified investors, as determined by the Fund’s investment manager and its affiliates, in their discretion. Nothing contained herein should be considered investment, legal, tax or other advice, a recommendation to purchase or sell any particular security or entity nor is it to be relied on in making an investment or other decision. Before making an investment decision with respect to the Fund, potential investors are advised to consult with their tax and financial advisors and legal counsel. An investor should carefully consider the Fund’s investment objective, risks, charges and expenses and other important information contained in the Confidential Private Offering Memorandum before investing. No reliance may be placed upon the information or opinions contained in this document. No representation or warranty, express or implied, is given by or on behalf of Kevin Dougherty, KDGF Asset Management LLC, or any of its members as to the accuracy, completeness or fairness of the information or opinions contained herein and, to the fullest extent permitted by law, no responsibility or liability is accepted for any such information or opinions. Investors in the Fund will have a limited right to redeem or transfer Shares of the Fund. In addition, Shares will not be listed and it is not expected that there will be a secondary market for Shares. While the Fund generally is expected to offer to redeem Shares on a monthly basis, there can be no assurance that the Fund will in fact do so at all or to the extent necessary to satisfy Investor demand for repurchases. Shares of the Fund will not be registered under the U.S. Securities Act of 1933, as amended, and may be offered and sold in reliance on exemptions from the registration requirements of said Act and such laws. The Fund will not be registered under the U.S. Investment Company Act of 1940, as amended, and may rely on an exception thereunder. Recipients of this document are reminded that the information in this document and any further information provided by or on behalf of KDGF Asset Management LLC, whilst given in good faith, has not been verified and is liable to change at any time. The information in this document is for information purposes only and is confidential. It is not directed at or intended for distribution to or use by any person or entity in any jurisdiction where (by reason of that jurisdiction’s applicable securities laws, person or entity’s residence or otherwise) such distribution, publication or use would be contrary to applicable law or regulation. It may not be reproduced or further distributed to any other person or entity or published, in whole or in part, for any purpose. Past performance is not indicative of future returns. The information in this presentation is only as current as the date of its publication, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. The information in this presentation may contain projections or other forward looking statements regarding future events, targets or expectations. There is no guarantee that the target allocations or other characteristics of the investment will be realized or achieved, and they may be significantly different than those shown here. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any forward-looking statements are reflected as of the date they are made, and Kevin Dougherty, KDGF Asset Management LLC and its affiliates do not assume any duty to and do not undertake to update forward looking statements. Hedge funds are speculative investments and are not suitable for all investors, nor do they represent a complete investment program. An investment in hedge funds includes the risks inherent in an investment in securities, as well as specific risks associated with the use of leverage, short sales, options, futures derivative instruments, ETFs, investments in non-U.S. securities, bonds and illiquid investments. Investment strategies and allocations are for illustrative purposes only. This presentation describes certain proposed terms of investment associated with a private investment fund that has yet to be formed. There is no guarantee that the Fund will implement these trading strategies and/or allocations at all or do so in the same manner as set forth in this summary. The Fund may change its investment strategies and/or allocations at any time without notification to its investors. There can be no assurance that any investment strategy will be successful or that the Fund will achieve its investment objective after it commences operations. • Kevin Dougherty • +1 (203) 569-7743 • kevin@kdgfam.com PAGE18

Views

Total views

157

On Slideshare

0

From embeds

0

Number of embeds

16

Actions

Downloads

1

Shares

0

Comments

0

Likes

0

×