If terrorism is set to go cyber, how will that affect your portfolio and how should you hedge against it? And what’s more scary, a eurozone implosion or an Israeli strike on Iran?
These are some of the questions not in the headlines that a global macro specialist such as Matthew Murphy of Eaton Vance (International) considers over his cornflakes.
Murphy offered some insights on these and other issues during a Q&A session at AsianInvestor’s seventh annual Asian Investment Summit, held at the Conrad Hotel last week.
He is in a team of 32, including 11 investment professionals, running a bottom-up macro absolute return strategy with over 100 positions in 57 countries. Its exposures are largely in sovereign and quasi-sovereign credit, currencies and interest rates, and it tends to focus on lesser-known countries while hedging downside risk.
Asked what investors should be more scared about – paralysis surrounding a US recovery, eurozone contagion, a China slowdown and an Israeli strike on Iran – Murphy identified the eurozone as the most acute issue.
He pointed to two fundamental problems: outstanding debt, which he suggested will probably not get paid back, and the inherent structure of the currency union.
“You have a significant disparity in competitiveness among the countries within the eurozone, leading to large balance of payments imbalances,” he noted. “The issue is the euro is undervalued for Germany and overvalued for everyone else. But no country can create the euro, that is why Spain cannot inflate its way out of its debt problem.”
He stressed that what happens in Europe is a problem for all investors as it bleeds into the financial economy, the banking system and the real economy. He argued the only fix would be a united state of Europe – highly unlikely given decades of war, cultural and language differences and the thorny prospect of giving up sovereignty.
He described the eurozone as structurally floored but “a slow melt”, with Greece and the rest of the zone playing a game of political chicken.
“Greece never belonged in the eurozone because it doesn’t have the necessary systems to understand what it owes people and how much it owes.” he added. “This is not a country that can pay back its debt, nor is it capable of implementing the necessary reforms in order for it to get the [bailout] money.”
Nevertheless, he suggested the eurozone was not ready to say goodbye to Greece just yet, with an exit sure to be extremely damaging to the financial system.
If an exit happens, he said investors need to be braced for a huge injection of liquidity into the banking system by the European Central Bank. His biggest concern would be if the eurozone implemented a bank holiday, therein triggering a potential panic.
In fact he suggested a Greek exit would provide the political cover necessary for the ECB to create huge amounts of euros and stem big bank failures.
On the question of where he sees underpriced assets, he highlighted Uruguay, with its rule of law, independent central bank and fiscal policy without special interests. He described the administration of former guerrilla leader Jose Mujica as “fantastic”.
“He drives a VW and lives in a modest flat,” Murphy said. “When he was younger he was a Marxist guerrilla and tried to incite a coup to bring the government down. He went to prison for 15 years and spent two years at the bottom of a well. When he emerged he was a free market capitalist in the purest sense of the word.”
He noted that bills in Uruguayan pesos pay 8.5%, against inflation of 7% and therefore a real return of 1.5% – in contrast to the US, where treasury bills lose 3% a year in real terms.
Another country the team is looking at with interest is Rwanda, which Murphy described as on an interesting path to building robust capital markets.
Its highest conviction in Asia is the Malaysian ringgit, which he said is fundamentally undervalued. He pointed to the prospect of improved productivity dynamics should prime minister Najib Razak be re-elected and allowed to implement planned reforms.
The firm’s second favourite Asian pick is India on long-term fundamental grounds. However, it has been reducing its long-term rupee positions because of intermediate fundamentals: declining growth, rampant inflation and political paralysis.
Near the end of the session, when asked to identify scenarios he and his colleagues come up with that are not in the headlines, he pointed to cyber terrorism and a potential Israeli strike on Iran.
“What if terrorism is no longer suicide bombs and drone attacks, what if traffic lights in New York City are shut down?” he said. “I do not know how you hedge against an attack on water filtration systems. It is going to slow economic growth. To a degree we want to be positioned in countries that are somewhat isolated from the global winds of risk-on and risk-off.”
But he does not believe there will be a unilateral Israeli strike on Iran. “That one is easier to hedge, you go long on oil producers such as Malaysia, Nigeria, Norway and Venezuela.”