There is nothing like a move in the bond market to make a point. When bonds of developing nations are rallying — that is a sign of strength and the right fiscal and monetary management.
And when bonds of a developing nation surpass those of a developed nation — giving it lower financing cost — this is an exceptional cause for celebration for investors in emerging market equities as it shows that the game has now truly changed.
Last week, the Czech Republic sold its first euro-denominated bonds at better rates than those of higher-rated Italy. The credit rating means little in this case as it is well known that credit ratings agencies always lag the market. The Czech Republic sold 2 billion in new debt due in April 2021 — priced to yield 105 basis points more than the benchmark rate, while similar debt issued by Italy yields 116 basis points more than the benchmark rate. Now, 11 basis points (0.11%) may not sound like a big deal to you and I — but on 2 billion EUR worth of bonds that is 2.22 million a year.
Furthermore, while some PIIGS countries and their banks cannot manage to issue new debt, resulting in large dislocations in the currency markets, the Czechs received orders in excess of 5 billion euros — this shows keen investor interest. In addition, Czech bond yields are at record lows as the government has promised to halve its fiscal deficit in three years; that shows confidence that the market believes what the government says (not always the case on the global bond scene).
This bullish action in the bond markets is due to the fact that the Czech Republic (the most advanced Eastern European E.U. member) and its neighbor Poland (the most populous) have much lower indebtedness than the rest of the E.U. — public debt-to-GDP is 40% and 54% respectively for the two. Public debt-to-GDP will reach 85% in euro-area countries and could be as high as 118% in Italy this year.
Czech Investment Opportunities
A friend always said about the investment business: “No matter how bullish or bearish you are, you always have to give the people something to buy; there is always something to buy.” This is absolutely true, but, in the case of many emerging markets we are constrained by the ADR or ETF universe.
What good is it to you if I told you that I thought Czech euro-denominated bonds were a good buy on any weakness likely to result from PIIGS issues this fall? Not much, considering the lack of easy accessibility for U.S. investors.
So, I did some searching on ways to play the Czech boom and here is what I found.
- · S&P Emerging Markets Infrastructure Index Fund (NYSE: EMIF), expense ratio of 0.75% and Czech weighting of 6.28%.
- · MSCI Emerging Markets Eastern Europe Index Fund (NYSE: ESR), expense ratio of 0.72% and Czech weighting of 5.77%.
- · WisdomTree Emerging Markets High-Yielding Fund (NYSE: DEM), expense ratio of 0.63% and Czech weighting of 4.91%
- · SPDR S&P Emerging Europe ETF (NYSE: GUR), expense ratio of 0.59% and Czech weighting of 4.37%
However, we don’t have a dedicated Czech Republic ETF like we have with Poland. The ETFs in the table above have their largest weighing in Russia as it is by far the largest Eastern European market by market capitalization.
So, buying any of the ETFs above means you are buying more Russia than you are buying the Czech Republic, but it is the only way to gain exposure. Most ETFs have a higher weighting in Gazprom (OTC: OGZPY) and Lukoil (OTC: LUKOY) than they do in whole Eastern European countries, which is not a bad thing, as those two energy firms hold the number-one and number-two positions in hydrocarbon reserves of any publicly-traded energy companies in the world.
Now, with that said, the largest bank in the Czech Republic, Komercni Banka, does have an ADR that trades OTC, but I will do you a favor and not include the ticker symbol. This is because the last trade that I saw was up $29.31 on 179 shares of volume — this is a ridiculous move clearly driven by the ineptitude of the person handling the trade.
I am mentioning this as a reminder that most, if not all, OTC trades have to be done with limit orders as the friendly market makers somehow never miss an opportunity to legally rob you, as evidenced above. Other than the lack of good liquidity and the last trade, the shares have a great fundamental picture — trading at around 13 times earnings, yielding 4.1% with a return on equity of 17%.
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