The Edmond Sun


February 7, 2014

THE ASTUTE INVESTOR: Emerging market turmoil and taper tantrums

EDMOND — I hate to say “I told you so,” but I told you so. Actually I don’t hate it because I was right. The title of my Sept. 21, 2013, Edmond Sun column was “Beware of Emerging Market Currencies.” And here we are in 2014 with emerging market currencies and stocks going in the tank.

In that column I wrote, “As we move into the fall of 2013 and turn the calendar to 2014, I expect this trend to continue. Economic activity in the U.S. is steady, although at a very low level. There are no signs of a robust explosion to the upside. Likewise, Europe is not spiraling down, but it’s not on a soaring trajectory either. This leaves the BRIC (Brazil, Russia, India and China) economies and their compatriots to deal with growth internally, and now to deal with their own mini-credit bubbles and locally inflated asset prices.”

There is some consensus opinion lately that the cause of the U.S. stock market decline so far this year has been the problem the Fed’s tapering is creating in emerging markets. But emerging markets have been struggling for three years and they certainly had no effect on the bull market in the U.S.

As the Fed lowered interest rates to basically zero during the past several years, the hot money went looking around the world for better returns. Money poured into emerging market countries looking for higher rates. This also drove their currencies higher and created challenges as to what to do with all the money. As is often the case, not all of it was deployed wisely.

We are now seeing what happens when it goes the other way. In the past few months, with the decision that the Fed would begin tapering the amount of QE (bond buying), the hot money has been leaving emerging countries like rats leaving a sinking ship. Currencies and stocks in India, Brazil, Indonesia and many others fell like a rock. Of course, the Fed says that is not their problem, but if it spirals out of control it will become our problem.

The U.S. Federal Reserve’s decision to taper monetary expansion by another $10 billion recently has major ramifications for world markets. In comparison to the total amount being spent on a monthly basis, the taper may seem gradual, but it has created an enormous hole in market demand.  To put it in context, $10 billion of debt purchases is more than the average monthly portfolio investments into Turkey, India, Brazil, Indonesia, Thailand, Chile and Ukraine combined. The $20 billion that already has been removed from the market is roughly equivalent to the monthly flows of all those countries plus Mexico and Canada.

The same buyers who poured into these emerging market currencies are now quickly rushing out.  This leaves developing countries with few options and all of them are bad. They could raise interest rates (attracting more carry trade buyers), but that would slow or choke their economic growth.  They could buy their own currencies in bulk to prop up prices, but they’d deplete their currency reserves. Or they could do nothing (allowing the free market to figure it out), which likely would put emerging market currencies into a free fall and create high inflation. This is truly one of those “between-a-rock-and-a-hard-place” scenarios.

On Jan. 28, Turkey raised its overnight lending rate from 7.75 to 12.5 percent. Yes, that is in just one day! Will it work? We’ll see. While the hike is a bolder-than-expected move designed to jolt investor interest, they are basically using a sword to fight off a barrage of artillery as a wrenching political crisis continues to erode investor confidence.

Many emerging country economies are very export dependent, particularly commodities. With commodities in the early stages of a multi-year decline, and capital searching for more attractive or safer opportunities in the U.S. and other developed countries, emerging markets face a daunting challenge. Yes, they certainly will be the places where long-term growth opportunities abound, but in the near to intermediate term, they’re in a bind.

After the sharp decline, especially in the first month of 2014, emerging market stocks may well be due for a short-term bounce. In my opinion, that could be short lived and there is still plenty of downside left. Some analysts are talking about what a bargain they are now. I think it’s best to stand aside for now.

You could call this being hit by a BRIC. Beware. The one positive consequence for us, as I’ve been saying for a while now, is a very bullish outlook for the dollar. Thanks for reading.

NICK MASSEY is a financial adviser and president of Householder Group Financial Advisors in Edmond. Massey can be reached at Securities offered through LPL Financial, member FINRA/SIPC.


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