Fitch cut its outlook for Iceland's debt. The stock market dropped 3.3% and the krona dropped 2.4% in reaction. Further, the Stockholm listed shares of Kaupthing Bank (personal holding), the largest company by market cap in Iceland, fell almost 6%.
Long-term foreign debt and local currency debt are still rated AA- and AAA respectively. The downgrade appears to be primarily driven by the current account deficit and Fitch expresses concerns about economic overheating leading to a hard landing.
I am very fond of Iceland as an investment destination and have written about it several times. My exposure to Iceland is quite minimal as I outlined previously. Of the money I have sent directly to Iceland, half is in cash. The other half is in the ICEX-15 ETF. After the fall today it is at ISK 1999, I bought in at ISK1912.
I bought the Stockholm listed Kaupthing shares (KAUP.ST) at SEK 88. I had a lucky sale of 1/3 of the position at around SEK 122. With the move in the Swedish krona factored in I was up close to 40% in two months so selling a little made sense.
Nothing has changed with regard to my long-term faith in Iceland. That I started being right and perhaps now I am wrong is not so important. What is important is how risk was managed. I think the most I had in Iceland was 4% of my investible assets. If you can buy into the idea that Iceland, the country, will never go to zero, how much was I risking? Maybe 2% (that seems like too much but maybe?) of my investible assets. At this point I may not even be down on my original investment, I haven't counted nor am I likely to.
The decline today in my Icelandic holdings are mostly (if not completely) offset by the lift in energy and Australia. There is nothing all that clever here just basic textbook diversification.
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Cracks in Emerging Markets
Our Comment is by Eric Roseman, Investment Director of the Sovereign Society and editor of Global Mutual Fund Investor.
Dear A-Letter Reader:
"This time it's different." Those are the most dangerous four words in the investment business and always manage to surface towards the end of a secular bull market. Most recently, it was "supposed to be different" for technology stocks in the late 1990s, circumventing reality as prices soared to record levels each year from 1995 to 2000. And now, we have those wonderful emerging markets - only ten years ago coined "submerging markets."
From its low in October 2002, the MSCI Emerging Markets Index has skyrocketed 205% as every bourse from Brazil to Korea heads to the moon. Driven mostly by low interest rates, a boom in commodities and a series of credit upgrades for several high profile countries, the emerging markets are back. The bad news, however, is that we're probably closer to the cliff at this point as record mutual fund inflows suggest the end is near. Coupled with manic speculation in many markets, namely Moscow and Mumbai, everyone is jumping aboard the money train.
Cracks in the bull market have started to appear. On Feb. 22, Iceland's currency and debt markets suffered a first-class pounding following a credit downgrade by Fitch Ratings. The rating agency downgraded Iceland's local AAA-rated bonds to "negative" from "stable." Iceland's stock market managed to escape the sell off, but should investors continue to dump her currency, stocks in Reykjavik will most surely follow the currency to the basement.
Iceland, a classic example of a high-yield emerging market, has drawn much global fanfare over the last four years as investors chase higher income rates. Iceland's benchmark bonds pay a fat 10.75% or a hefty 6.2% premium compared to ten-year US Treasury debt. But in Iceland, a small economy highly dependent on fishing, the nature of the beast is now volatility.
A rising current account deficit triggered this week's sell-off of the Icelandic krona. Though many nations can run a negative trade balance for years - the United States is a prime example; some smaller countries have paid a dear price for not correcting their trade imbalances. This was the case in Asia in 1997 and 1998, Latin America in the 1970s and early 1980s, and Russia in 1994 and 1998.
This time, it's different. When everyone is buying the same market, speculating in the same trend and throwing record amounts of capital into an asset class, watch-out. Iceland is just the beginning as other weaker credits eventually come to surface.
ERIC N. ROSEMAN, Montreal, Quebec
Investment Director, The Sovereign Society Ltd.
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