Many of my recent posts on the emerging markets (EM) have focused on the opportunities.
Stocks in countries like China, Korea and Brazil are all trading at price/earnings ratios below 10x, despite earnings expectations that are much higher than U.S. companies. In addition, dividend yields on EM stocks are surprisingly robust; Chinese stocks offer a 3.3% yield, for example.
Yet in recent days I am getting the gnawing feeling that perhaps the current situation has the potential to become more serious.
The Financial Times this morning has several articles on the turmoil in the EM.
On the front page, for example, in a article titled "Developing world central banks lose $81 bn in reserves since May", they note that the reserves of some of the EM countries have taken a noticeable hit:
Some countries have suffered more precipitous drops. Indonesia has lost 13.6 per cent of its central bank reserves from the end of April until the end of July. Turkey has spent 12.7 per cent and Ukraine has burnt through almost 10 per cent. India, another country that has seen its currency pummeled in recent month, has shed almost 5.5 per cent of its reserves.
The FT goes on to note, however, that other EM countries like China and Russia have seen almost no impact from currency withdrawals.
One of Random Glenings favorite columnists Ambrose Evans-Pritchard was sounding the alarm yesterday in the London Telegraph. He makes some comparisons to the EM meltdown in the late 1990's that ring true:
It was Fed tightening and a rising dollar that set off Latin America’s crisis in
the early 1980s and East Asia’s crisis in the mid-1990s. Both episodes
were contained, though not easily.
Emerging markets have stronger shock absorbers today and largely borrow in
their own currencies, making them less vulnerable to a dollar squeeze.
However, they now make up half the world economy and are big enough to set
off a crisis in the West...
Hans Redeker from Morgan Stanley said a “negative feedback loop” is taking
hold as emerging markets are forced to impose austerity and sell reserves to
shore up their currencies, the exact opposite of what happened over the past decade
as they built up a vast war chest of US and European bonds.
The effect of the reserve build-up by China and others was to compress global
bond yields, leading to property bubbles and equity booms in the West. The
reversal of this process could be painful.
However, Paul Krugman in this morning's New York Times remains cautiously optimistic that we are not about to see a repeat of earlier crisises:
Does this reversal of fortune pose a major threat to the world economy? I don’t think so (he said with his fingers crossed behind his back).
It’s true that investor loss of confidence and the resulting currency
plunges caused severe economic crises in much of Asia back in 1997-98.
But the crucial point back then was that, in the crisis countries, many
businesses had large debts in dollars, so that falling currencies
effectively caused their debts to soar, creating widespread financial
distress. That problem isn’t completely absent this time around, but it
looks much less serious.
Still, Krugman does not dismiss the worry that all of this could turn into something more serious:
In fact, count me among those who believe that the biggest threat right now
is that policy in emerging markets will overreact — that their central
banks will raise interest rates sharply in an attempt to prop up their
currencies, which isn’t what they or the rest of the world need right
Historically September is the weakest month for U.S. stocks, according to the Stock Traders Almanac. Negative news flow combined with an historically difficult month for stocks could add fuel to a bearish fire:
Since 1950, September is the worst performing month of the year for
DJIA, S&P 500, NASDAQ (since 1971) and Russell 1000. A 3.1% advance
last September lifted Russell 2000 to second worst (since 1979).
September was creamed four years straight from 1999-2002 after four
solid years from 1995-1998 during the dot.com bubble madness. Although
September’s overall rank improves modestly in post-election years going
back to 1953 (third or fourth worst month depending on index), average
losses widen to 0.9% for DJIA, SP 500 and NASDAQ and to 1.6% for Russell
2000. Although September 2001 does influence the average declines, the
fact remains DJIA and S&P 500 have declined in 9 of the last 15
post-election year Septembers.