From the CEO
One of the major political risks coming out of the new Trump administration is the apparent conflict in early-term policy objectives. Last week the president spoke openly about the relative strength of US dollar against other currencies, noting that it was ‘too strong,’ and thus creating a headwind to American firms that had to compete with foreign firms for export dollars.
To be sure, the dollar’s strength is tied to a number of items, including a relatively robust US economy and weak commodity prices, and further expected Fed tightening (most are expecting three quarter point increases in interest rates by the end of this year). However, a number of the administration’s policy goals – indeed the ones that seemed most popular during the election campaign – seem to stand out as major ‘push’ factors sending the greenback higher. They include cuts to income and corporate taxes (the latter includes a plan to induce firms to repatriate profits), a tax on imports, and infrastructure spending, to name the most obvious.
Trump’s options for bringing down the buck are pretty limited: Some have suggested he could urge the Treasury to intervene in the currency markets, or push the Fed to target the exchange rate. But such moves could harm the market for treasuries and run into opposition from the G20.
Interestingly – and this appears to be playing out at present – some of the president’s recent announcements seem to be doing some of the lifting in pushing the dollar into weaker territory, including concerns over the future of American trade policy after Trump pulled the US out of the Trans-Pacific Partnership, as the dollar eased once the president nixed the deal days after assuming the top job.
This leads us to Mexico. The country’s political risk score moved into the “High Risk” category (again) in August of last year. Some of the reasons for the move include falling consumer confidence levels, a weaker peso and rising inflation, several high profile resignations, persistent corruption, and an unpopular leader.
Our clients in the institutional investor world are well aware of the maxim that higher risk can hold out higher returns. Indeed, one of our long-time clients, a hedge fund manager from Europe, calls every so often, looking to discuss the most-risky countries, according to ICRG’s political risk tables and our composite risk scores. We can imagine he seriously considers long position in various asset classes of these risky places.
In any case, for those with significant appetite, the case for some asset classes in Mexico looks compelling.
On the equity side, most of the drawdowns over the past year are the result of the President Trump’s comments or campaign promises and the uncertainty and momentum that they have created. However, given the nature of the US economy and the kinds of checks and balances that are in place, we suspect much the campaign rhetoric that does result in policy will be diluted. President Trump is a pragmatic individual; and given the well-entrenched supply chain that exists between the two countries (and others) the potential harm to the US (consumers and industries) should outweigh any perceived benefits.
On the sector side, assuming NAFTA or related trade arrangements with Mexico are revised contrary to Mexico’s interests, clearly Mexican manufactures and exporters will face some easing in their stock prices. However, if the president’s promise of ‘revamping’ America’s infrastructure is realized (and it was noted clearly in the inauguration address) then some firms, such as Cemex, should do well.
Additionally, depending on how the early stage meetings go with President Trump and the Mexican and Canadian leaders, we suspect (assuming the meetings are constructive and contain benefits for all parties) it will be a good time to begin building a long position in the peso. The currency has sold off far too much on rumor. However, should the meetings with Mexico not go well, there will be further downside to the currency against the USD, resulting in higher domestic inflation, slower growth, higher financing costs, and a higher debt servicing burden – all of these things are occurring at present.
One aspect of our risk models that should be borne in mind is that they provide our clients with insights into undervalued currencies, using a combination of several risk metrics and relative purchasing power. Among the most undervalued in our universe is the Mexican peso, followed by the rand (South Africa), and the Norwegian krone. Note that, in addition to Mexico, South Africa’s political risk profile is a low-ranking “Moderate Risk” – just a few points from the “High Risk” threshold. The krone has been beaten down by tanking oil prices over the past two years but has performed well against the greenback since the end of this year.
Turning to the risk ratings of the ICRG this month, Burkina Faso’s risk profile rose (suggesting higher risk), as firms owned by the mining tycoon Frank Timis requested a hearing before the International Court of Arbitration in Paris. Timis wants $385 million in damages given the government’s efforts to block the Tambao project, whose manganese deposit is valued at $1 billion. Pan African Minerals – one of Timis’ firms, and the one developing the mine – was told last year to suspend operations as the interim regime was undergoing a review of all mining contracts awarded under the regime of former president Blaise Compaore.
PRS thinks the dispute will not end anytime soon given the uptick in commodity prices (and the lure this presents to the government and its less-than stellar books). The regime also plans to raise electricity prices, which will very little to help ease social tensions.
Brazil’s risk profile also deteriorated this month as the economy fell deeper into recession, and some recent testimonies in the Petrobras graft investigation look like they will up the odds that President Temer might not serve out his full term in office, which ends in December, 2018. It would be the job of Congress to appoint a successor, which should help in terms of providing some policy continuity, however.
Clients should know that PRS has been featured in the press often over the past month, notably for its outlook on select countries. Private Equity International asked us for our assessment of the risks facing private funds and their ability to deploy capital abroad in the face of rising as the rise of populist movements. Readers can find the article in the February issue of Private Funds Management (www.privatefundsmanagement.net).
Similarly, Modern Trader magazine (www.moderntrader.com) asked us to provide a set of assessments and forecasts for select geopolitical events and their impact on various asset classes in their special February issue on forecasting. We talk about the trajectory of US equities, the trading strength of the yuan, the outcome of France’s elections on the 10 year note, and much more. (https://lnkd.in/eCh4ABv).
And, as is the case monthly, the IMF used a number of our risk metrics and data series to further their very interesting research agenda. Significantly, the Fund queried how political and country risk affects growth and, in so doing, examined the scope for further global and regional financial integration in Latin America, quantifying the potential macroeconomic gains that such integration could bring (https://lnkd.in/edubCt5).
The Fund also considered US monetary conditions and emerging market corporate debt, and used our financial and economic risk data to analyze this relationship. The study made clear the inverse relationship, which is especially pronounced among SMEs, and those in open economies with flexible FX rates. (https://lnkd.in/eieWF78).
Clients should note that over 50 countries (of the 140 covered) had their political risk profiles adjusted in January, affecting some 70 individual risk metrics.
Thanks for your continued support, and please contact us if we can be of any assistance.