Finding Opportunity Far and Near

By Frank Holmes

CEO and Chief Investment Officer

U.S. Global Investors

Frank Holmes Traveling in Latin America

Samuel Johnson once said, “The use of traveling is to regulate imagination by reality, and instead of thinking how things may be, to see them as they are.” Although penned by an 18th century English writer, the idea holds true in today’s highly connected world of search bars, tweets and breaking news. Our portfolio managers’ research trips to foreign countries authenticates the data from a Bloomberg terminal or an earnings report. Treks add tacit knowledge to our wealth of explicit facts.

This week, I’ve been traveling in Peru and Colombia with former president Bill Clinton and Frank Giustra in conjunction with the Clinton Giustra Enterprise Partnership. I’ve been involved with this impressive organization since its inception. I love how it brings together private companies, government and communities in developing regions of the world to eradicate poverty by growing jobs and training local workers.

As part of the trip, Clinton signed an agreement between the foundation and Peru’s Ministry of Foreign Trade and Tourism to promote and reward hotels and restaurants that buy from local producers.

Each group will give $450,000 over the next three years to train local producers to become suppliers for Cusco’s hospitality and restaurant sector. All told, suppliers should bring in more than $5 million in income over the next five years and benefit more than 1,800 people, according to the Clinton Foundation.

In Cartagena, Colombia, Clinton and Giustra celebrated the opening of a warehouse that will provide a local supply chain for the area’s hospitality, restaurant, catering, and supermarket sectors, as well as the Acceso Training Center, which will train about 20,000 local residents over the next 10 years to work in the hospitality sector.

Bill Clinton and Frank Giustra with Peruvian President Ollanta Humala and his wife, Nadine Heredia in Lima (left) and at a ribbon-cutting ceremony in Carhagena, Colombia (right).

Moving beyond Latin America, other U.S. Global portfolio managers are finding exciting opportunities on their travels. When Michael Ding recently traveled to Thailand, he immediately identified a potential investment as soon as the plane touched down in Bangkok. See the video here.

And with emerging Europe growing faster than its western counterparts, Director of Research John Derrick, and Portfolio Manager Tim Steinle are headed to Warsaw and Prague to visit with local companies and management. We are optimistic about many expanding opportunities in this area and are excited to consider them for a holding in our recently renamed Emerging Europe Fund (EUROX).

Back in the U.S., no one needs to travel far to see the tremendous growth in domestic stock prices. Over the last four years, the S&P 500 climbed 21 percent annually.

But how much further should you expect them to go? The Federal Reserve Bank of New York had the same thought and delved deep into data to find out.

Would it surprise you to learn that a vast majority of equity valuation models state that stocks should head much higher over the next five years?

This is research based on 29 different equity valuation models and surveys that use varying economic and market-related data such as dividends or inflation to calculate potential future returns. Using a weighted average, the New York Fed estimated the equity risk premium over the following month.

Simply stated, the equity risk premium is the expected future return of stocks minus the risk-free rate, such as a Treasury bill. For example, if the estimated future return of stocks is 5 percent and a Treasury bond yields 4 percent, the premium is the difference between the two figures, or 1 percent.

Looking back over five decades of annualized results, there’s always some premium for stocks. This intuitively makes sense, because in exchange for taking higher risk, investors expect to receive higher returns.

Equity Risk Premium Suggests Stocks Could Head Higher Over Next Five Years

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During these 50 years, the premium nearly fell to zero two times. One time was in 1987, when investors’ exuberance toward the equity market caused stocks to rise quite sharply.

The most recent dip in the equity risk premium was at the height of the great tech boom in 2000. Many investors remember triple-digit price-to-earnings multiples. And some companies saw terrific price appreciation even though there were no reported earnings to be had at all. You’ll remember Fed Chairman Alan Greenspan coining the phrase, “Irrational Exuberance.”

Looking at the chart above, today we see an opposite picture. In fact, today’s equity premium is at 5.4 percent, as high as it was in November 1974 and January 2009.

And what happened in these two time frames? Well, we saw the dramatic increase in equity prices from 2009 to today.

Back in the 1970s, investors experienced the collapse of the Bretton Woods system and “a terrible case of stagflation,” says the Fed of New York. However, that didn’t stop the stock market, as gains were incredible, increasing nearly 15 percent on an annualized basis from 1974 to 1979.

The chart illustrates a tremendous case for U.S. stocks over the next five years. We’re not the only bulls in this field: Business Insider lists economist Jim O’Neill from Goldman Sachs, hedge fund manager David Tepper and Barry Ritholtz as experts who “all love this bullish stock market metric.”

Index Summary

  • The major market indices moved higher this week. The Dow Jones Industrial Average rose 1.56 percent. The S&P 500 Stock Index moved higher by 2.07 percent, while the Nasdaq Composite gained 1.82 percent. The Russell 2000 small capitalization index rose 2.17 percent this week.
  • The Hang Seng Composite fell 1.13 percent; Taiwan gained 1.06 percent while the KOSPI rose 2.16 percent
  • The 10-year Treasury bond yield rose 5 basis points this week, to 1.95 percent.

Domestic Equity Market

The S&P 500 finished the week roughly 2 percent higher as market sentiment continues to improve. The S&P 500 ended the week at 1,666, which is exactly 1,000 points higher than the lows we hit in March 2009. The market continues to look across the valley and focuses on the growth potential in the second half of the year and into 2014.

Domestic Equity Market - U.S. Global Investors

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  • The financials sector was the leader this week with broad based strength. The sector was led by the trust banks such as State Street Corp, Bank of New York Mellon and Northern Trust. Bellwether names in the sector also had a strong showing such as JP Morgan Chase, Goldman Sachs and Citigroup.
  • The industrial sector was runner up and also a strong performer this week with the defense and aircraft related names rallying such as Boeing, Northrop Grumman and Lockheed Martin.
  • Cisco Systems was the best performer this week rising by nearly 15 percent. The company reported better than expected earnings as margins improved and the company gave encouraging comments regarding the near-term outlook.


  • The telecommunication services sector was the worst performer this week as the market is in “risk-on” mode and lower beta areas of the market have lagged.
  • The utilities sector also under performed but still rose by more than one percent.
  • Cliffs Natural Resources was the worst performer in the S&P 500 this week declining 12.07 percent on weak iron ore prices and giving back much of last week’s 18 percent gain.


  • The market continues to climb that proverbial wall of worry and just shakes off any bad news and rallies smartly on good news.
  • Global central banks are literally pulling out all the stops in an attempt to ignite economic growth. The European Central Bank (ECB) cut interest rates last week, which is a move in the right direction as far as the market is concerned.


  • A market consolidation wouldn’t be a surprise after a strong start to the year.
  • Expectations for cyclical areas of the market are low and allowing stocks to rally when companies just meet expectations. If the global economy were to deteriorate the market wouldn’t have much to fall back on.

The Economy and Bond Market

In a replay from last week, Treasury yields headed higher this week even as economic data was mixed. It likely reflects a continuation of a sentiment shift that can also be seen in the equity markets as investors shift from relatively safer assets to more riskier areas of the market.

Domestic Equity Market - U.S. Global Investors

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  • Inflation data for April was benign with both PPI and CPI falling for the month. On a year-over-year basis CPI has risen a modest 1.1 percent and gives comfort to the Federal Reserve that inflation is not currently an issue.
  • Retail sales data for April were better than expected even though some high profile retailers reported disappointing results for the month. Housing data was mixed overall but building permits in April rose sharply, which is a good indicator for future activity. Homebuilder confidence also increased in April.
  • Japan GDP rose 3.5 percent in the first quarter as fiscal stimulus and aggressive central bank policies combined with a weaker yen drove positive results.


  • Industrial production fell 0.5 percent and was worse than expected in April.
  • The eurozone has yet to recover as first quarter GDP fell 0.2 percent. This marks the sixth consecutive quarter of contraction.
  • Wal-Mart earnings report was a disappointment and the company’s second quarter guidance was downbeat. This is a bellwether reading of the average American and doesn’t bode well for a near-term pick up in activity.


  • The Fed continues to remain committed to an extremely accommodative policy.
  • Key global central bankers are still in easing mode such as the ECB, Bank of England and the Bank of Japan. The Bank of Japan in particular is aggressively easing currently and the ECB recently cut interest rates.


  • Inflation in some corners of the globe is getting the attention of policy makers and may be an early indicator for the rest of the world.
  • Trade and/or currency “wars” cannot be ruled out which may cause unintended consequences and volatility in the financial markets.

Gold Market

For the week, spot gold closed at $1,359.55, down $88.65 per ounce, or 6.12 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, fell 11.4 percent. The U.S. Trade-Weighted Dollar Index gained 1.27 percent for the week.


Gold's Movement Relative to the 2011 Commodities Peak

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  • The chart above shows the price action of key commodities since 2007 plotted on the back of the Reuters’ Continuous Commodity Index (CCI). In the chart, the four commodities and the commodity index are equalized to 100 on April 2011, the time when the commodity index peaked. In comparison, gold’s performance is remarkable in relation to the other commodities following the April 2011 peak. Not only has gold outperformed, it is the only commodity that is close to its April 2011 value. Comparatively, the commodity index has lost roughly 23 percent, while copper declined by 30 percent. As such, despite the negative publicity gold has drawn in 2013, it appears it continues to be king among commodities when it comes to storing value.
  • The World Gold Council issued its first quarter 2013 Gold Demand Trends report. The council reports demand for gold bars and coins was 10 percent higher in the first quarter compared to a year earlier, while demand for jewellery increased 12 percent. Similarly, central banks’ net purchases exceeded 100 tonnes for the seventh consecutive quarter. It is worth mentioning that these numbers provide evidence of strong physical demand from all sectors, even prior to the widely disseminated news of the skyrocketing demand for physical gold that followed the April 15 price drop.
  • New Gold announced that it unwound a legacy gold hedge book at its Mesquite mine in California. The company paid $67.5 million to retire the hedge which called for delivery of 5,500 ounces of gold per month at a fixed price of $801 per ounce until the end of 2014. The remaining delivery totaled 110,000 ounces gold. The transaction was completed at an average gold price of $1,396 per ounce. By eliminating the hedged position, the company is now completely unhedged and fully levered to benefit from future upside in the gold price.


  • The U.S. dollar continues to gain against most other currencies, which traditionally translates into lower commodity prices. The dollar index, which measures the value of the greenback against a basket of six major currencies, surged to the highest levels since 2010. The strength was revived by a news article last Friday which speculated that the Fed may have already devised an exit from its $85 billion monetary easing program. This week, the dollar also received support from data showing that consumer sentiment rose to its highest level after the fall of 2008. The dollar has risen at an annualized rate of 25 percent so far this year.
  • Money managers withdrew $1.27 billion from gold and precious-metals funds in the week ended May 8, according to analysts tracking money flows. This year’s outflows have reached $20.8 billion, the largest redemptions since the data began to be collected.
  • Barrick Gold Corp reached a preliminary agreement with the Dominican Republic government to increase the share of profits from its Pueblo Viejo gold mine going to the Caribbean nation. President Medina of the Dominican Republic had demanded in February that the company renegotiate the contract signed with a previous government for the Pueblo Viejo mine, as he threatened to impose a windfall tax on profits. The tentative agreement would add to roughly $1.5 billion being directed to the nation over the project’s 30 year life. The company will be handing around half the cash flow obtained from the project to the government for the next three years, further straining the firm’s working capital. Although we welcome the resolution of the dispute, we believe the terms upon which the deal was reached are only to the benefit of the nation and do not present a symmetric share of the downside risk.


  • In a Form 13F release of May 16, it was reported that Soros Fund Management LLC, the hedge fund founded by George Soros, significantly increased its gold related holdings. The most notable addition was the purchase of over $25 million worth of call options on the GDXJ Junior Gold Miners Index. In addition, the fund reportedly owns more than $239.2 million in gold related financial assets. The release contrasts the fund’s February release in which gold related exposure had declined significantly. Back then we reported that Soros being a savvy investor would have likely swapped his gold exposure to yen denominated positions, rather than outright selling. Regardless, this recent move by one of the world’s most closely followed hedge funds should help draw appetite for gold stocks and bode well for a surge in gold equities.
  • The sell-off of Dundee Precious Metals subsequent to the Bulgarian elections is overdone according to Leon Esterhuizen of CIBC World Markets. The company issued a statement noting that it's "business as usual" at all of its operations, after the company's share price fell 15 percent following the elections on Sunday. The already contentious elections have become more controversial after Bulgaria's biggest political party said it will seek to have the result of Sunday's deadlocked election cancelled on grounds of a violation. As per the company, neither the Chelopech operation or Krumovgrad project are likely to be materially impacted by this political turmoil. We agree with Leon in that Dundee Precious is very attractive at current valuations as it remains an acquisition target for anyone needing access to its unique smelter in Namibia, one of a handful in the world that can treat high-arsenic-content concentrates.
  • Additional exploration and metallurgical sampling performed by Klondex Mines on its Fire Creek project has revealed significant visible mineralization with grades as high as 496.6 grams per ton. Similarly, Gran Colombia Gold shared some of its recent exploration success during its first quarter earnings’ conference call. The company reported multiple intercepts of visible gold, as high as 663.32 grams per ton at its Segovia project. Encountering such high gold mineralization allows greater operational/development flexibility for miners, increases the likelihood of the project becoming a successful and profitable venture, and adds to the overall excitement around the project.


  • Japan is helping create disinflationary growth around the world, according to the analysts at Cornerstone Macro. In their Portfolio Strategy report for this week, they argue that the fresh rounds of monetary easing, and in particular the actions by the Bank of Japan are a huge surplus for U.S. consumers, at least in the short run. One of their main arguments is that weak yen policies have provided support for the dollar, which has allowed equities to rise without a comparable rise in commodity prices. They argue that the outperformance of the S&P 500 relative to a commodity index is strongly, negatively correlated to the value of the Japanese yen. This correlation has been particularly strong since November when the Bank of Japan monetary easing program was announced.
  • Nomura currency guru Jens Nordvig has turned very bullish on the U.S. dollar. He argues the U.S. dollar real effective interest rates are trading close to multi-decade lows, making them very likely to increase sharply. In addition, the rising likelihood of domestic energy independence, the overall decline of commodities, and the shrinking trade deficit should all bode well for the greenback. Nordvig is calling for meaningful gains by year end, which is consistent with many bulls’ call for the return of king dollar.
  • Gold premiums in India, the world’s biggest buyer, more than doubled as the Reserve Bank of India limited imports by banks, on a consignment basis, to only those required to meet the genuine needs of exporters. The restrictions on bullion imports by banks are aimed at restraining a record current-account deficit. As a result, bullion dealers are not accepting fresh orders, and it remains to be seen if there will be another route to import the precious metal. Bloomberg reports the trade deficit widened in April to $17.8 billion from $10.31 billion in March as gold and silver imports more than doubled to $7.5 billion from a year ago.

Energy and Natural Resources Market

Peruvian Stocks vs. Emerging Markets

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  • South Korea’s liquid natural gas (LNG) imports grew 29 percent year-over-year to 3.51 million metric tons in April as domestic demand increased according to the Korea Customs Service.
  • China’s refined copper output rose 14 percent from the prior year in April to 558,000 metric tons, according to NBS. As a result, output of refined copper for the first 4 months totaled 2.1 million metric tons, up 11 percent year-over-year.
  • U.S. steel output remains at a 9-month high of 1.9 million tons for the week ending May 11, with higher output in Great Lakes offset by lower Southern region volume. As a result, quarter-to-date output is 11.2 million short tons, plus 4 percent from the prior period.


  • China’s crude processing decreased to 9.36 million barrels a day in April, the lowest level in eight months. That is the lowest since August and 8 percent below December’s record, according to data published today on the website of the Beijing-based National Bureau of Statistics.
  • Industrial metals were under renewed pressure yesterday amid fears that Beijing may introduce more stringent policy on the property market. According to local media, real estate developers will need to obtain government approval for pre-sale of homes. This could limit new project growth and associated metals demand as pre-sale has been a key source of funding for properly developers.
  • Further data points to a slowdown in China’s economy as year-to-date electricity growth remained low at 3.8 percent from the prior year and urban income growth slowed to 6.7 percent year-over-year, indicating a lack of momentum for industrial activity and consumption despite a further acceleration of credit growth and money supply.


  • Africa’s oil demand will climb at a faster pace than most of the world in the next five years because of rising transport and power-generation needs, the International Energy Agency said. Gasoline and gasoil consumption are each forecast to rise 4.5 percent a year, while the use of jet fuel or kerosene will advance 3.9 percent. The gains will boost Africa’s oil use by 4 percent a year from 2012 to 2018 compared with an average of 1.2 percent growth globally.
  • The Times of India reports that “China, the world's largest rice consumer, is expected to become the largest rice importer this year, according to a new report. China's rice imports this year will surge to three million metric tonnes from 2.34 million tonnes a year ago, according to a U.S. Department of Agriculture report. If the forecast holds true, it would represent a sharp increase as the country's rice imports hovered around 450,000 tonnes per year over the five-year period that ended in 2011, official data showed. It would also make China outstrip Nigeria to become the world's largest rice importer.
  • China will probably commission additional storage sites for its strategic petroleum reserve this year, boosting crude demand even as construction work on the program takes longer than expected, according to the International Energy Agency (IEA). The nation, the world's second-biggest crude consumer, will add 245 million barrels of capacity in the second phase of its emergency stockpile plan, the Paris-based IEA said in its Medium-Term Oil Market Report released this week. This is up 45 percent from the IEA's original estimate of 169 million barrels.


  • Credit Suisse issued a report that said gold will trade at $1,100 an ounce in a year and below $1,000 in five years, implying lower than expected inflation expectations and further weak sentiment for the commodity sector overall.

Emerging Markets


  • Dividends paid by Latin American equities have been crucial in cushioning the 14.9 percent fall in the MSCI Latin America index over the past five years. Earnings weakness, multiple contraction, and foreign exchange losses have weighed heavily on the region’s equities. However, the reliability of dividend payments by local companies has returned a cumulative 18.3 percent since 2007, effectively easing the region’s recent weakness.

Dividends Key Factor in Easing the Decline of Latin American Stocks

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  • Moody’s upgraded Turkey’s credit rating from Baa3 to Ba1 with a stable outlook. The move brings about the long awaited second investment grade rating, following Fitch’s upgrade in November 2012. The agency highlighted the recent and expected improvements in finance metrics, as well as noticeable progress on structural and institutional reforms. In addition, Turkey’s central bank cut rates by 50 basis points, exceeding analyst expectations as it seeks to contain currency appreciation. The lira has been strengthening as capital inflows seeking to benefit from the country’s promising economic growth remain strong.
  • Indian inflation declined to a 41-month low in April. The wholesale-price index rose by 4.98 percent year-over-year, compared to initial analyst estimates for a 5.45 percent increase. The measure gives the central bank room to extend its monetary easing program and support growth in Asia’s third largest economy. The news was welcome by foreign investors who were net buyers of Indian equities.
  • China April power consumption was up 6.8 percent versus 1.9 percent in March, indicating better economic activities and contributing to a stable Li Keqiang Index. April power generation was up 6.2 percent versus 2.1 percent in March.
  • April data were roughly in line with market expectations, and showed only modest improvement from March. Industrial production improved rising 9.3 percent from 8.9 percent in March. April retail sales growth recovered modestly to 12.8 percent from 12.6 percent in March.
  • April property investment in China was up 23.1 percent, which helped fixed asset investments increase by 20.6 percent.
  • China smartphone volume grew 39 percent in the first quarter this year, showing strong domestic demand.
  • Korea’s jobless rate declined further to 3.1 percent in April from 3.2 percent in March.
  • Vice Premier Zhang Gaoli says China won’t approve new steel, cement, aluminum smelters, ship-building projects.


  • Not only has the Peruvian stock market been held hostage to falling metals prices, due to its heavy weighting in mining stocks, the country’s economy has also suffered a blow to its exports that resulted in significantly slower than expected economic growth. In March, economic activity grew at a pace of 3 percent, a far cry from the 4.5 percent median forecast. In addition, the country’s stock market has lost nearly a fourth of its value year to date, significantly underperforming its emerging market peers. However, the domestic fundamentals remain strong and the central bank has room to cut rates if the export slowdown becomes broad based.

Peruvian Stocks vs. Emerging Markets

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  • Despite some analyst optimism with respect to the situation in the eurozone, new GDP growth estimates from Brussels continue to paint a gloomy picture for 2014. The chart below shows that, although all shown countries are expected to have positive GDP growth in 2014, the vast majority will grow at rates below 2 percent. Similarly, the eurozone is expected to grow only a meager 1.2 percent. However, it is worth noticing that the countries leading the return to growth and restarting the European Union are located in Eastern Europe.

How Much Will Europe Grow?

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  • China April fixed asset investment growth was 20.6 percent versus market expectation 20.9 percent, with infrastructure and manufacturing investments slowing to 22.7 and 17.9 percent, respectively.
  • Investment banks are revising down China GDP forecast for 2013 after April economic data release. Bank of America Merrill Lynch downgraded China 2013 GDP to 7.6 percent from 8 percent previously, while JP Morgan cut to 7.6 percent from 7.8 percent.
  • China April FDI was up 0.4 percent for April versus consensus 6.2 percent.
  • Malaysia first quarter GDP slowed to 4.1 percent, below consensus 5.5 percent. Exports were weak declining 0.6 percent, while domestic consumption was strong rising 8.2 percent.
  • China Premier Li Keqiang indicated policy makers are reluctant to stimulate growth.
  • The Beijing Daily reported that only 28.2 percent of the 229,000 college graduates in the Beijing area had secured a job this year. When meeting with college graduates and unemployed people in Tianjin this week, President Xi Jinping stressed the need for growth.
  • Singapore retail sales declined 7.4 percent in April after declining 3 percent in March, worse than market expectation of -2.5 percent.


  • Following this week’s widely publicized $11 billion debt offering by Petrobras, the largest ever for an emerging markets’ issuer, the Brazilian Development Bank, known as BNDES, announced it is ready to seek a bond sale to boost its lending program. For reference, BNDES lent or invested $77 billion last year; that is twice as much as the World Bank. The bank plays a vital role in stimulating economic expansion in the country through investments in companies of all sizes, which are focused on innovation, and sustainable development. The additional funds could be help Brazil break out of the slowing growth cycle of the last few years and keep pace with its Latin American and BRIC peers.
  • The recent credit rating upgrade and central bank rate cuts in Turkey may have some investors thinking the milestones have been reached and it may be a good to time to sell Turkish equities. This is certainly not the case in our opinion. Turkey stands among the strongest countries to benefit from current global easing; internally, inflation is well under control, and domestic consumption is unabated. Furthermore, the country’s stock market continues to trade on a cheaper price to earnings valuation when compared to countries like Mexico, Malaysia, and Thailand. Lastly, HSBC published a Flashnote showing how credit rating upgrades do not limit future performance. To illustrate, the chart shows the performance of the Philippines’ equity market following recent credit upgrades; as is evident, the Philippines equity market returned 10.3 percent on average in the three months after its upgrade. Hence, there is ample reason to believe the Turkish equity mar ket should continue to outperform.

Philippines' Flag Philippines’ Equity Market Continues to Increase After Rating Upgrades


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Source: Bloomberg, MSCI, Thomson Reuters Datastream

  • As shown in the graph below, an increasing number of mobile users also adopt mobile internet. This offers smartphone business opportunities for online shopping, online games, online search, online advertisements, and many other internet applications. The recent merger and acquisition activities and alliance in internet space indicates vast mobile internet opportunities and profits.

Mobile Internet Adoption 4.5x Faster than Regular Internet in China

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  • Some delays and uncertainty are looming in the Mexican construction sector as firms await President Pena Nieto’s announcement of the infrastructure plans contained in the so-called National Development Plan. As with any new president, investors expect multiple ambitious projects to be announced, especially following the numerous campaign promises made by Pena Nieto. However, fear of a break up of the coalition in congress, which pushed back some of the important announcements, in addition to the apparent shift in housing policies to be pursued by the President, are destabilizing the already fragile homebuilders.
  • Russia’s inability to cut benchmark interest rates as it tries to contain inflation led President Putin to announce last month that banks would have to bear the burden of rate cuts. As expected, Sberbank, Russia’s largest bank, announced reductions on the rates it charges on corporate loans by 0.4 to 1.4 percent, effective May 15. Analysts expect the bank to mitigate the squeeze in net interest margins by altering its asset mix.
  • Indonesia current account deficits continued in the first quarter, though improved from prior quarter and better than the market consensus. Stubborn current account deficits may force the central bank to tighten demand to stabilize the currency rupiah. Otherwise, the Bank of Indonesia will continue to deploy foreign currency reserve to buy rupiah.

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