The Brewing Turmoil in Emerging Markets

Oh the irony! In Bernanke’s last meeting as Chairman of the US Federal Reserve, he fails to give markets what they want. Stocks spit the dummy and fall more than 1%. What happened to the Bernanke put?

That’s right. After a two day meeting, the Fed’s press release made no mention of the growing turmoil in emerging markets. It announced that it would continue with its gradual ‘taper’ program, reducing assets purchases by another US$10 billion per month starting in February. Now, the Fed will ‘only’ buy US$65 billion in assets per month.

Usually, whenever stock markets get the wobbles the Fed is there with reassuring words, letting the punters know that they can go on punting without fear. Back in June last year, when markets first writhed in pain and anger about the prospect of a taper, Bernanke responded by saying the Fed was willing to ‘push back’ on its tightening pace.

With that Bernanke ‘put’ in place, markets went spec crazy again.

But not this time. The Fed’s statement focused completely on the US domestic economy. The Fed thinks that growth will pick up this year as fiscal policy becomes more neutral, and not acting as a drag on growth as it did throughout 2013. Here’s what the Fed said about it:

‘Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy.’

The ‘current asset purchase program’ came into force in September 2012. That’s when Bernanke jacked up the pace of debt monetisation to US$85 billion per month. He did it to offset tighter US fiscal policy, but it helped to unleash a surge of speculative activity in asset markets.

Of course the Fed doesn’t acknowledge that its policies foster destabilising speculation, so it’s no wonder today’s statement makes no mention of the fragility of the emerging markets. That’s someone else’s problem.

As we said yesterday, the Fed sets monetary policy for the domestic economy, and damn the consequences elsewhere. But when you’re dealing with the world’s reserve currency there will be consequences. So when you’re monetising around US$1 trillion per year of debt based assets, you’re going to create a tide of liquidity that goes searching for short term returns.

And then when you start to change policy, that tide is going to come back the other way, with major implications. It will be funny to see what the Fed says in three to six months’ time when slowing growth in the emerging markets begins to feed back into the US economy. Again, there will be no mention of the role the Fed played in causing it all.

Don’t think that we’re talking about a few minor, peripheral economies here like Argentina or Turkey. This trend will impact all emerging markets to varying degrees. Taken together, they make up around half the global economy. Companies in the S&P500, who derive a decent chunk of their earnings from these markets, will feel the effects first.

That’s probably why US markets are selling off now. Less play money from the Fed and the prospect of slower global growth don’t make for a ‘risk-on’ environment.

But you’re probably wondering what the big deal is. After all, the Fed will still create additional liquidity each month to the tune of US$65 billion.

The nature of inflation always requires more…a faster growth rate, not a slower one. So the fact that the Fed’s asset purchases are slowing and will continue to slow this year is weighing on the ability of speculators to take risk and create even more liquidity. Liquidity begets liquidity…and the opposite also holds true.

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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