In this issue we ask whether investors are running unacceptable EM risks.    In Jan’17 mutiny broke out in the Ivory Coast with troops taking control of the keycities. While resolution was found within 72 hours, a follow on mutiny occurred inMay. Since independence in 1960, Ivory Coast regressed from one of France’smost prosperous former colonies into a state wrecked by coups and civil wars. Ithas also been a serial defaulter. In ‘11 it suspended payments on ‘10 bonds,which in turn were issued as part of re-structuring of securities issued in ‘98,which were part of re-structuring of loans made in ‘70s-80s. Despite thischequered history and less than a month after the latest mutiny, the country inJun’17 attracted almost US$10bn in bids for US$1.9bn issuance at 6.25% for 16years and 5.125% for eight years. In the same month investors placed US$9bnfor 16-year Senegal bonds at 6.25% and Argentina (another serial defaulter)issued 100-year bonds at 7.92%. In Jul-Aug’17 Greece issued 5-year (?) bondsat 4.63% while Iraq sold 5-year bonds at 6.75%. Ukraine’s 10Y bonds (US$) arenow trading at only 7.3%. It seems that the time might be right for even NK orSyria to issue bonds. Considering that the US 10Y are ~2.2% and 30Y at ~2.8%,spreads are now not much more than 300bps, against what is arguably thesafest sovereign.    How can one rationalize such investor behaviour? We do not believe that oldcliché of investors reaching for yield any longer does justice to what is occurring.    It is either a massive bubble or alternatively, investors perceive that the Fedwould be unable to raise the cost of capital and that secular stagnationdominates. The latter is in accord with our view (here) that the cost of capital cannever go up and indeed might need to continue falling, ultimately perhaps turningnegative. Unless private sector productivity recovers or there is a dramatic shiftin public policies, supply of capital must expand at a pace faster than demand forcapital, and hence cost of capital should continue to drop. There is simply noalternative to financialization as neither economies can sustain higher rates norsupply of financial instruments can be curtailed. While there are policies to breakthis ‘doomsday machine’, we do not yet see appetite for extreme measures thatwould be required. No one could possibly expect Ivory Coast to repay bonds, butthen the same applies to the rest of the world, as ‘financial cloud’ (US$400trillion+) continues to grow. Hence, it becomes ‘the greater fool’ game withinvestors counting on the US yields falling and thus search for yield becomingever more frantic. While not ruling-out volatilities, investors could be right.    What could go wrong? The idea behind buying EM bonds at such slim spreadsis that the world is stuck in a secular stagnation, with permanent disinflationarypressures. This has been our view since at least ‘10, but policy makers (here)still strongly wish to normalize. Thus, the key risk facing investors in Ivory Coastbonds is one of policy errors. Persistent attempts to raise rates or withdrawliquidity by Central Banks and/or China policy miscalculations could causesignificant volatility and policy divergence (impacting US$ and liquidity).    However, we maintain that ultimately neither volatilities nor price discovery canbe ever truly re- introduced as these are deadly to an ongoing financialization.    The only viable policies are management of chronic ‘bubbles’ rather thannormalization. For investors who are concerned that volatilities might spike, EM(particularly Asia ex) equities, while sharing similar risks and rewards,provide an alternative to bonds with greater direct exposure to secularlyrobust sectors (such as tech), fair (though no longer cheap) valuation and lowerfunds flow frenzy. We continue to prefer NE Asia and India to ASEAN.

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