Monthly Investment and Research Commentary – August 2015

Country Ranking

  • Magni Research left scores for all countries unchanged last month. Information received in the last month reconfirmed existing scores.
  • The recent trend regarding year-over-year changes continued with the scores of South Korea, Japan, Spain and Philippines rising the most, while the scores of United States, Canada, United Kingdom, Colombia, Hong Kong, India, New Zealand, and Ireland having decreased. Over time Magni Countries Scores generally increase, though countries do experience temporary setbacks.

Continued Chinese Commitment to Reform?

  • Earlier this month, China unexpectedly devalued their currency leading its equity markets to their largest one-day drop in over two decades. This devaluation is one of many recent government interventions intended to counteract a faltering stock market and a slowing economy. The ripple effects from the surprise move are still reverberating across the globe. The devaluation move was presented by the Chinese authorities as allowing market forces a greater role in setting the value for the yuan. However, many outside observers had the opposite interpretation, namely that the devaluation was an attempt to provide a boost to the country’s exporters at the expense of their trading partners. After the Chinese devaluation, the IMF further postponed the yuan’s inclusion in their basket of reserve currencies. The IMF stated that their move was related to the continued inability to easily buy and sell the yuan internationally; as opposed to the devaluation.
  • Recent events increase our concern that China’s various challenges will sap commitment to important reforms. Such reforms, if successfully implemented, could have a material impact in improving China’s score. Until then, China will remain a country with one of the lowest scores.

Unfinished Business in Greece

  • The process of implementing Greece’s latest bailout agreement is moving forward with approvals from the Greek and German parliaments as well as the euro-area finance ministers. The IMF postponed until the end of the year its decision on contributing new money to Greece. The IMF is concerned that more is required to bring Greece’s debt to a sustainable level. The bailout agreement crossed virtually all of Prime Minister Tsipras’ red lines and he was only able to pass the bailout with help from opposition parties. His Syriza party has splintered and a hard left group has broken away to form a new party. Tsipras’ high approval ratings should help his party in the snap elections scheduled for September.
  • For Greece to move up in the Magni rankings, the country will need to undertake reforms beyond what is contained in the bailout agreement. The additional reforms would also better position the Greek economy to grow and the resulting growth would increase Greek debt capacity.

Scandal Hampering Needed Actions in Brazil

  • The probe into bribery and kickbacks at Petrobras has already seen dozens of senior business executives arrested with the focus now shifting to members of the government. Two senior government officials have now been charged with receiving bribes. Political turmoil emanating from this long-running corruption scandal continues to hamper Brazil’s ability to deal with economic problems caused by the slowdown in China, Brazil’s largest trading partner. A collapse in commodity prices has pushed Brazil into a recession which could become its longest since the 1930s. Recent stimulus efforts have led to growing budget deficits and rising debt levels. To protect the country’s investment grade credit rating the government has raised taxes and cut spending, which is further weighing on economic growth. However, with many politicians concerned about protecting their own political futures it has become more difficult to pass unpopular economic stabilization measures.
  • Currently, Brazil ranks in the middle of the countries of the emerging markets. Economic reform could improve Brazil’s ranking, while also creating a corporate governance environment where scandals such as the current one are far less likely to occur.

Little Popular Pressure for Change in Russia

  • Falling oil prices exacerbate Russia’s economic challenges as a lack of economic reform maintains the country’s dependence on oil exports. Beyond its oil dependency, little has been done to raise weak labor productivity, promote better property rights, or enact judicial reforms. Western sanctions over Russia’s involvement in Ukraine place further downward pressure on the economy. Inflation is worsening as Russia, in retaliation to Western sanctions, has banned the importation of selected Western products. The ruble has been the world’s worst-performing currency over the past 12 months. Economists forecast that Russia’s economy will shrink 3.7 percent this year before rebounding slightly in 2016. However, if oil prices remain depressed, a forecasted economic rebound will likely prove too optimistic. Despite the economic problems, government control over the media has helped Putin maintain high approval ratings.
  • The current combination of events make economic reform very difficult. While scoring higher than China, Russia remains one of the lower scoring countries in the emerging markets.

Quality Eventually Shines Through

  • The other international countries continue following their existing trends with most improving the quality of their legal, regulatory, and economic infrastructure systems. That said, the current market volatility has tended to mask underlying country valuations. In the past as volatility subsides, the correlation in performance across countries tends to subside. We believe this pattern will repeat. As the correlation subsides, measures of quality become more important. Magni Country Scores provide exposure to countries based on quality. Specifically, the quality of the legal, regulatory, and economic infrastructure determines the corporate governance environment in each country and has been a good indicator of market opportunity.