Thoughts about moving averages

There's a certain sort of trader or market commentator who gets excited when they see the current market price or index level rising above or below a particular moving average, be it the 30-day, 60-day or 180-day moving average. And it's easy to see why, because when you look back at the historical graph, then looking back on when those crossing points happened was normally a good time to buy or sell. In general, if the spot price crosses a longer moving average from above, that's a signal to sell, and when it crosses from below, it's a good time to sell.

And actually, it turns out that if you did this, you would outperform a buy and hold strategy for all three moving averages. The best one is the 30 day moving average. I've built a little spreadsheet that models this trading strategy with the Russian RTS index, and you can download it from here. You can cut and paste your own time series, and try your own pairs.

Actually, as it turns out, the best trading strategy of all would have been to use the 26 day moving average and the spot price. This holds if you look at the RTS since inception. I got all excited about this, until I looked at the last twelve months, which shows me that I should have been using the 1 day moving average instead of the spot price, and the 84 day moving average. The 1 and 26 pair would have made me money, but much less. The 1 and 30, and the 1 and 60, and the 1 and 180 would not have done so well.

(You can investigate this using the data tables function of Excel. I haven't included it in the spreadsheet linked above, because it's very processor intensive, and makes the spreadsheet very unwieldy. If you want to play with it, I've included it in the spreadsheet here, but it may crash your computer, as it's a bit buggy, and needs quite a powerful computer. It might make sense for you to build your own data table in Excel, which is quite simple, and is a useful thing to learn.)

So what works for one period doesn't necessarily work for all periods. Also, when I applied this to the S&P, it turned out that almost none of the strategies outperformed a buy and hold strategy, and those that were, were fairly randomly distributed. (By the way, I haven't found any investigations of this in the literature or online, and would love to see references if anyone knows of anyone who has investigated this topic. I can't believe I'm the only person who has thought of it. And also I know that there are easier ways to do this than Excel, but my programming isn't up to it yet.)

What does this have to do with emerging markets? Well, it's more about investing in general. Beware of any rules of thumb, because they don't necessarily hold up when you test them against the data. It may be that these trading rules are only stable over a short period of time, and need to be continually updated. I suspect that a lot of high frequency trading programs use variants on these strategies, calculating optimal patterns, and then trading with them. The bottom line is that technical analysis is complex stuff, and should only be used if you have a lot of computational firepower to deploy - using crude tools will almost certainly lead to disappointing results.

Demographics

"Demographics is Destiny" when it comes to forecasting long term capital flows.

This is the World Bank's data on current population growth - by and large, the countries with the fastest growing populations are also emerging markets - the more advanced countries aren't growing at all. There are a couple of wrinkles in the data - rich Islamic countries also have fast growing populations, and many of the former Soviet countries have falling populations.

Population growth is a good thing - people are after all a factor of production, just like materials and technology, so the more of them you have, the greater your potential GDP. And even better, once you have paid this factor of production, they go out and buy your output! So the greater the population, the greater the addressable market size, and so the greater potential for corporate growth. This why no one who is interested in economic growth should oppose immigration.

Here's a link to a full database of age dependency ratios. Again, the emerging markets do better here, so resources are not being siphoned off to pay for the upkeep of a large nonworking population, and this means that they can be addressed to more productive purposes. I'm not sure if the countries which report a zero dependency ratio really have no pensioners at all, or if the numbers are negligible relative to the working age population, or if they just didn't report data. They are all quite small countries, and not really investible, so I've left them off the graph below.

As with population growth, it's the older more mature countries that have a high pensions burden, and African and Islamic countries that don't. Now, for some of the African countries, this reflects low life expectancy, so not many people survive to pensions age, implying that the economy has different problems to deal with. And one shouldn't be too static about the analysis - it seems inevitable that the pensions age will rise in the mature economies, which will simultaneously boost the working age population and reduce the retired population, so that fraction will come down.

Having a high dependency ratio is not necessarily a bad thing - it's a mark of success in that you have created the conditions to have lots of people survive beyond working age. But it creates imbalances - either you're funding those pensions via taxes, which is a drag on the economy, or you're funding it with savings, which can distort your allocation of investment - capital is too cheap when the pensioners are accumulating retirement funds, and it gets too expensive when they start spending their savings.

Also, there's another aspect of pensioners and economics. Larry Summers co-wrote a seminal and prophetic paper back in 1990, which used a generational model to show that trade imbalances could develop when you had an ageing population, which was spending its savings to fund retirement. This would mean that unless the younger generation was saving to match them, then it must lead to a persistent current account deficit. So funds get transferred from the old country to the younger, exporting one, as has happened between the US and China.

This has created an imbalance, because China has chosen not to let its currency float accordingly, and the same sort of thing is happening in the Eurozone, because exchange rates are fixed between countries. But that means that if one country is a net dis-saver, because its older population is spending its retirement savings, then it must run a current account deficit with younger countries, whose workforce is accumulating savings for retirement. With fixed exchange rates, this takes a generation to reverse, which is generally longer than capital markets are willing to wait.

The key thing to bear in mind, though, from the point of view of a macro EM investor, is that you want to be on the side of the country that is supplying the goods to the retired population. You get demand growth for the country's output (especially in the consumer goods sector), and there's an upward bias in the currency. These types of long term trends are what enable you to sleep soundly with long positions through turbulence. So seek out countries with population growth and low dependency ratios.

Thinking about India

The Economist had a big splash about India a couple of weeks back - as usual with the Economist, it's pleasant to read, but you don't end up much wiser about anything other than that magazine's predictable prejudices. As always with the Economist, it was a useful starting point for thinking about India, and for reading further on the subject. My problem with the article was that it's a bit "on the one hand, on the other hand" - yes, there are some dynamic companies in India, but there are some state-controlled dinosaurs too. You could say the same about Russia (although the Economist would leave out the bit about Russia's dynamic companies). You could probably say the same about America or Japan.

The IMF blog also had a nice piece about India with a bit more meat in it. What this brought home to me is that India is much more like a "normal" developing economy - running a current account deficit, importing capital, diversifying its economy, that sort of thing. There's no sense that the government is trying to implement a transformative policy like that in China, and there are no commodity flows or stocks to deal with.

You could argue that India's "raw material endowment", like China's, is its huge population. But then, India hasn't implemented a policy of consciously making its workforce cheap, via the exchange rate. Why would they? No government seeking re-election would consciously hold back the standard of living of its population, as the Chinese government did in the 90s and early 00s. This means that India has modernised more slowly, but doesn't have to deal with the surpluses that the Chinese government has to recycle (current account surplus becomes capital inflows, which are either sterilized by buying Treasuries, or allocated top down into government approved investment). Of course, you get much faster economic development if you have the capital sitting there ready to be used, but one of the uses of adversity is that if capital is scarce, it gets allocated more efficiently.

This means that India might well be a happy hunting ground for stock pickers, because you don't have to continually keep an eye on the government or the global macro in the same way. Yes, there's an issue about the availability of capital to fund the current account deficit, but in a world of global imbalances, there is a large pool of capital looking for a good return. India has a reasonably flexible exchange rate which means that what you lose in the short term if the exchange rate falls can be made back in the long term because the terms of trade benefit. There's no second guessing what the government, US Congress, the oil price, or the commodities markets are going to do, unlike with China or Latin America or Russia.

One of the themes of this blog is going to be that individual stock picking in isolation is perilous, especially in emerging markets. You might find a good little company, that seems well managed and with a clean balance sheet and growing income statement. Something like a consumer play in China or Russia or Indonesia or Mexico, which offers the hope of being the local equivalent of Coca-Cola or MacDonald's. And maybe it will. But you will have to endure a great deal of pain in the short term if that stock price is driven down by perceptions that China is going to raise rates in order to stop baby food companies speculating in copper, or that the oil price is under attack from Libyan or Iraqi or even Brazilian supply. Even without that, you could own, say a nice little bank in a stable market, and see it decimated just because banking stocks are getting hit globally because of a rogue trader in France. No company is an island.

The other theme is that there are all kinds of missing markets and regulations that means that developing markets will not react in the same way to policy stimuli as their more developed counterparts. And you have to be aware of this. For instance, the proposition by Michael Pettis that higher interest rates might be expansionary in China, because people will earn more on their savings. Or that higher interest rates would automatically strengthen the currency - they do in most cases, but in Russia they might not, if the oil price happened to be going up at the same time. Before you apply the lessons you learned from Samuelson or Lipsey, think about what assumptions they were making, and whether they apply in this case.

But India is one country that perhaps goes against these themes. It has a more diversified economy, so there is less need to focus on one particular industry or commodity, and it has a flexible exchange rate and a current account deficit, so it's much more like a "normal" economy. Which is a good thing, as it means that although India's growth may be less rapid than other markets, it will be more steady and less volatile.

China - Happy Landings?

China - The Big Questions
China's "hard or soft" landing seems to be one of the three items that are worrying macro strategists (the others are the Eurozone crisis and the US economy). This is an old story - since 2000 there has been a narrative whereby China starts trying to boost its economy, runs into inflation, slams on the brakes, and the resultant fall in commodity demand has negative knock-on effects for commodity prices and exporters.

I'm not a China expert, although my father was. Sadly, I was not smart enough to tap my father's massive knowledge of Chinese history when I had the chance, so I've had to make up the deficit on my own time, while focussing on other markets. Fortunately China has been very important for my core field, and also there are plenty of excellent commentators like Jonathon Anderson, Michael Pettis, or Patrick Chovanec. (For the last two, see the side links). I think I have a fairly good handle on how China policy (or more importantly, perceptions of China policy) affect GEM sentiment.

And the fact is that there's a perception that if China does hit the brakes, then other markets will slam into a wall. China is seen as the engine of growth and demand for South East Asia, and as a core market for the commodities of Latin America and Russia. Because the rest of the world is not looking too hopeful right now. The US is coming out of a recession - just - with GDP growth at just 2.5% (less than 2% is a recession), and with some signs of consumer confidence returning. However, Congress is going to spend the rest of the year making cuts in spending, and this austerity may be too much for the fragile recovery. The next President will have to either raise taxes or cut spending. Europe is also heading into austerity, as the aftermath of the Euro crisis means that governments cut spending, and banks cut lending.

So China is important. I want to argue though, that even if they do tighten, this is not going to be a disaster for the rest of the EM world, and certainly not for China. First, do yourself a favour and read this excellent article by Michael Pettis. For me, the most interesting idea of the article is that higher interest rates could actually be expansionary, as it will increase the income on savings, leading consumers to spend more (but there's a lot more than just that).And it need not reduce the spending on infrastructure, as much of this is government-mandated (and therefore not interest sensitive) and in any case interest rates are low, and companies have cash.

So don't assume that if the Chinese raise rates, this will necessarily lead to a crash in steel prices, or copper prices, or Chinese growth in general. The bottom line is that China will urbanise, one way or another. It has a crazily ambitious five-year plan, which can probably be taken with a pinch of salt, like most government promises but the secular growth direction is still there.

10 million Chinese and 5 million Indians will be moving from the countryside to the town every year for the foreseeable future. This is the difference between Brazil and Russia on the one hand, and India and China on the other. Russia did its urbanization in the postwar period, as did Brazil.

Country	2010 Urbanization
Brazil	86.5%
Russia	73.2%
India	30.0%
China	47.0%

In the next 5 years, according to the UN population survey, China will add another 78 million urban population and India will add another 56 million, just under 27 million per year, a Tokyo, two New Yorks, or four Londons. 


The bottom line is that markets are going to be choppy given that perceptions of China fiscal and monetary policy will change. Your job as an emerging markets investor is to see through that and keep your eyes fixed on the longer term horizon, and the fact that China offers real growth because of the massive urbanisation that will definitely happen, at a time when the major economies of the world are looking lacklustre because much of their best growth is behind them.

Blog manifesto

The other day, there was a request on one of my LinkedIn groups for good emerging markets investment blogs. There was a lack of replies, which suggested a gap in the market. So I thought about what would make a good emerging market investment blog, and this is what I'm going to try to create here. There are some blogs that cover this space, and I've linked to them on the side, and in another article I list them with my own comments. Naturally, I'll be delighted to read and link to other blogs that you may suggest.

Now, what's this blog all about? "Emerging markets" as a term really evolved when the World Bank decided (rightly) that "poor, badly governed, possibly post-Imperialist, underdeveloped countries" was neither catchy or politically correct enough. The term perfectly captures the amount of work that the intrepid development bankers at the World Bank needed to do, coupled with a note of hope about what the countries would become. There's even a metaphysical aspect - "developing" carries with it an undercurrent that these countries must necessarily become like the West, whereas "emerging" implies that they have some choice about the path they will take.

But enough psycho-linguistics. An investment blog has to talk about making money. And the reason why investors are attracted to emerging markets is that they offer the possibility of growth, similar to that undergone by the greatest emerging market of them all, the USA. If only we had invested in Manhattan farmland, or Woolworth's, or Coca-cola, or Wal-Mart, any of the other great companies that have made money by catering to the needs of the nation as it grew from frontier land to Great Industrial Nation. As we look at the countries that have made these great leaps forward, it's a natural inclination to look for those who haven't done it yet, and assume that they will follow as well.

And by and large, the pattern has played out quite well. Take a country with a reasonable endowment of land, natural resources and population, add some Washington consensus pixie dust, and countries like South Korea, Singapore, Poland and Australia have made their ways from economic backwaters in need of assistance from development banks to being industrial nations in their own right. Take the countries in the graph below - if China with its 1.3 billion population goes from 37 cars per thousand population to 370, that takes you from 50 million cars to 500 million. Total world car production in 2010 was 58 million (OICA)! And we can say the same with housing, roads, or any one of the trappings of civilisation.

Cars per 1000 Population

Source: Wikipedia 

It's the growth, stupid! 

The bottom line is that emerging markets are seen as having room for growth, and the attraction for investors is the possibility of investing in that growth at an early stage. The danger of course is that expectations will not be realised, but then no risk, no return. If it were so easy to generate economic growth, many more countries would have done it a long time ago. Some countries may lack a favourable external environment, which starves them of the resources that they need such as raw materials or capital. One of the themes we will be talking about is whether oil shortages, leading to higher oil prices, could be fatal for the development of countries without their own energy. But in general the miracle of comparative advantage means that countries can get the resources they need via trade. 

Most countries fail to deliver growth because of internal institutional constraints - in general it's because existing bureaucracies won't give up their power, and so won't liberalise enough to allow entrepreneurs to drive the economy forward. There is no question that North Korea has the potential to become just as much of an economic tiger as its Asian neighbours - it shares their advantages of a cheap, educated labour force and proximity to the huge markets of China. However overwhelming state control and the absence of private business means that its potential is unrealised. On the other hand, doom was predicted for the Baltic states when they decided to go it alone - they had no raw materials, industrial sectors that depended on cheap energy from Russia, and a recession in Western Europe - however, they got their policies right, and have acceded to the European Union, even though many economists predicted disaster when they went cold turkey from Russian gas. 

 Between these extreme examples though, lie many stories which are more mixed, and the challenge for the analyst is to identify where the opportunities are in a particular country, given the resource and institutional constraints of a particular country. For instance, some analysts say that you should always buy beer and cement companies in emerging markets. Beer because higher GDP per capita means that people will have more money to treat themselves to a nice cold one at the end of a hard working day, and cement companies because their output will be needed to build all the infrastructure, from roads to office blocks to housing for urban workers. But then, the former might not be such a good idea in an Islamic country, and in many cases the cement industry may be controlled by private or international conglomerates, leaving no opening for the equity investor. But the general idea holds true - things need to be built, and people will consume more, and someone is going to make money in satisfying those wants, and that is the opportunity for the investor. 

 The great thing about emerging markets is that it's win-win. Not so with emerging companies - if someone starts up a new car company in America, for instance, then if it succeeds, it will almost certainly be at the expense of the existing car companies. The producers of Android tablets would love to do well, but this will require them to take customers away from Apple (fat chance, IMHO). Whereas if, say, North Korea were to suddenly see the light and embrace the "right" policies, then net-net, everyone would be better off. Of course, they would produce some things that are produced elsewhere, and there would be competition, but just as many countries would benefit by selling things to the newly-enriched North Koreans. In general growing countries run current account deficits in the early stages of their development, which means that someone is benefitting from extra demand. And even if one country's welfare is reduced by having its exports undercut by a lower cost producer, then other countries are having their welfare increased by having lower cost goods available. Net global economic welfare is increased by a more efficient use of resources. 

 So what's the manifesto for this blog? In some ways, emerging markets are old hat - many markets have already emerged, or even if they are still emerging, there are so many brokerages and commentators talking about them, that there isn't much that is new to say. And if there aren't people talking about it, it may be because there is not much to talk about, which explains the lack of Belarussian or Burmese brokerages. But then you could have said that when the term BRIC was coined, ten years ago in 2001. There was nothing new then, and yet the subsequent decade saw billions of dollars being dedicated to this asset class. And there is still plenty to discuss. There are still many questions about how China will develop, with much of the commentary either slavishly applying basic macroeconomics to an economy whose institutional structure doesn't fulfil the underlying assumptions of classical (or neoclassical) macroeconomics, to issues about how the European periphery will develop given the likely endgame of the Euro crisis, to the eternal questions of whether or not overpopulation and or over-consumption of natural resources will kill growth in the bud. I don't think that the answers to these questions are readily available, so I propose to discuss them in this blog.