Tag Archives: EM

Are Emerging Markets Toast?

Domestic stocks outperformed international stocks for a long time. On a year-to-date basis, the S&P 500 Index was up more than 6% through July, while the MSCI EAFE Index was down slightly and the MSCI EM Index was down more than 4%. The international stock returns are after translation to the dollar, so they assume a U.S .investors bought them without using a currency hedge and received the dual return of the stocks in their local markets and the return of the local currency relative to the U.S. dollar.

In every instance (YTD, 3-, 5-, and 10-year periods), the international stocks performed better in their local markets before translation to the dollar. That means the dollar has been appreciating for a while. It has also been appreciating a lot recently.

There have been years over the past decade when international outperformed domestic. Last year was such a year. The S&P 500 produced a 21.83% return, while the MSCI EAFA delivered a 25.03% return and the MSCI EM Index delivered a whopping 37.28% return. But the recent long term has clearly favored U.S. stocks.

In the past emerging markets were said to be “coupled” with the developed world. If the developed world stopped spending, emerging markets suffered greatly. Also, there was coupling in the sense that emerging markets currencies would plunge when the dollar strengthened, and they’d have to spend all their reserves to prop up their currencies. Emerging markets countries borrowed debt in dollars or other developed world currencies, and dollar appreciation put an extra burden on them.

Has decoupling occurred now? Will the dollar’s rise crush emerging markets again, or have things changed? Are emerging markets able to stand alone now? Nobody knows. Clearly Turkey has been on a borrowing binge that it’s paying for now. But it’s not clear that’s the case with other developing countries.

It’s the dollar, stupid

Still, the FT’s John Authers writes of a “fragile five,” referring to five countries whose currencies are succumbing to a strong dollar — Turkey, India, Indonesia, Brazil, and South Africa. The currencies of these five countries also came under pressure during the “Taper Tantrum” of 2013 when Ben Bernanke talked of tapering his QE purchases.

Authers also notes that the price of gold tells us that the U.S. – or the U.S. dollar – is the cause of the current crisis. Gold has been depreciating; it has “behaved exactly like an emerging market currency, and has endured a true correction, dropping more than 10 per cent from the high it set early in the year.” All currencies depreciating relative to the dollar helps keep inflation in check, but it’s bad for the U.S. trade deficit. It doesn’t encourage American exports.

Authers wonders if the Fed will postpone future rate hikes the way it postponed reducing its bond purchases to temper the anticipation regarding the end of QE. This may indicate if emerging markets turbulence becomes calm.

On the other hand, perhaps Authers is putting too much faith in the Fed’s ability to assuage fears about rate hikes and the dollar. A  recent MarketWatch article noted that emerging markets governments drain their dollar reserves in an effort to bolster their currencies. That means there are potentially “fewer dollars available for interest payments, pushing investors to demand richer yields as compensation for holding riskier debt.” The article reported that dollars custodied by the New York Fed for foreign central banks had decreased by $60 billion to $3.04 trillion in May, off from its peak f $3.11 trillion in March. Given that emerging markets countries borrow in dollars (and other developed market currencies), this could spell more trouble. Time will tell.

Why Turkey’s Bubble Economy Is About To Pop

Though Turkey’s financial markets have been struggling since the start of this year, the country’s currency and government bonds have been in an all-out freefall in the past week. A political clash with the United States caused the lira to lose approximately one-third of its value against the U.S. dollar in the last week alone. In an attempt to stem the lira’s plunge this year, Turkey’s central bank has hiked interest rates quite dramatically, which is a move that earned approval from many mainstream economists and analysts. Unfortunately, I believe that Turkey’s aggressive recent interest rates hikes are going to pop the country’s dangerous credit bubble that I warned about in Forbes in 2014.

The chart below shows the Turkish lira’s recent plunge against the U.S. dollar:

Turkish LiraSource: XE.com

As I explained in my original bubble warning, Turkey has been experiencing a powerful economic boom since the early-2000s thanks to ultra-low interest rates and the resultant rapid credit growth. The chart below shows how Turkey’s benchmark interest rate kept falling from the early-2000s until the mid-2010s. Extremely loose global monetary conditions after the Global Financial Crisis led to a “tsunami of liquidity” that flowed into emerging economies such as Turkey, which caused interest rates to fall well below normal historic levels. Now that the U.S. and other countries have been ending their QE programs and raising interest rates, emerging market currencies and bonds have been taking it on the chin.

Turkey Interest Rate

The chart below shows Turkish 10-year government bond yields, which have surged recently:

Turkey Government Bond

Unusually low interest rates have encouraged a credit boom in which loans to the private sector have sextupled since 2010:

Turkey Private Sector Loans

Consumer credit has increased fivefold since 2010:

Turkey Consumer Credit

The chart below shows domestic credit to the private sector as a percentage of GDP, which also confirms that a credit boom/bubble has been brewing in Turkey since the early-2000s:Turkish Credit Bubble

Low interest rates have also led to a housing boom/bubble in which housing prices have increased by 172 percent since 2010:

Turkey Housing Price IndexTurkey’s economy has become reliant on cheap credit, and the recent interest rate hikes mean that the country’s cheap credit era has come to an end. Higher interest rates are going to cause a credit bust in Turkey, leading to a serious economic crisis. While most commentators believe that Turkey’s current turmoil is the result of U.S. sanctions, the reality is that the country’s crisis was already “baked into the cake” years ago. The recent political clash with the U.S. is simply the catalyst for the coming Turkish economic crisis, but it is not the actual cause. I am also highly concerned that Turkey’s current turmoil will lead to further contagion in emerging markets, which have also similarly thrived due to ultra-loose global monetary conditions that are now coming to an end.

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