Emerging markets & QE taper

Written by Steve Ruffley

1) What is your take on the impact of emerging-market currencies on global stock-market returns?

It is always difficult when approaching what impact ‘emerging’ markets have on the more established existing economies. Emerging markets which arguable China is no longer one of these days consists of countries like India, Brazil, Mexico and Turkey. The world market is such a diverse and huge entity now the correlations between currency and stock are very hard to determine.

In my opinion the emerging markets all have the same two basics characteristics. A desire for growth, at any cost, and have the same resources being natural commodities and most importantly man power. Both the world’s need and the self-fulfilling nature of an emerging market is based solely on consumerism. As the US is the biggest consuming nation on earth this is the driver that sets the tone for the global economy, this in turn drives the emerging markets and their currencies. After the FED started the QE tapering in December of last year the markets had a mixed reaction. You don’t have to be an economist to know that putting $85bn of stimulus a month into the economy can’t carry on forever, and under the current course of action you certainly can’t be in ‘normal trading conditions’. When the cut was announced there was a small retracement in the main indices and then a continuation of the bull trend for the stocks across the board. It is only now as the FED continue with the £10bn a time taper that we will start to get a true idea of where the currencies and stocks will go.

My view is that the emerging currencies and their value comes from the wider global economy, so they in turn have less effect on stock values than the other way around. We can see that after the start the $10bn taper in December the S&P finishes the week’s trading on the high, and continues on to record highs at 1850.70. It is only then the S&P drops.

As a result of this tapering (red line) we see emerging markets, take the Mexico (MXN) Turkey (TRY) and Hong Kong (HKD) as examples, start to appreciate heavily in value against the USD. The correlation I predict is that both emerging currencies will fall and so will the main US and EU indices. This is because of the false and controlled market condition we have been seeing under the FED stimulus program. Now the FED have tapered twice totalling $20bn it looks like by the end of 2014 there will be no stimulus and the markets can function normally. However as soon as this happens there will be the impending question on when rates are set to rise, as forward guidance went this was the only point in the future that was set in stone. This may then set a whole new tone for the correlation for stocks and currencies going forward.

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2) Do you think the Fed stimulus destroyed this historical correlation and pushed equities up?

There is no doubt that the FED’s stimulus program has pushed the stocks across the world higher. QE has been described as cocaine for the markets, and as long as the FED were pumping in billions of dollars a month then no data, event or circumstances could really dent the markets. This led to a severe case of dip buying, whenever stock tried to correct naturally there was an influx of money pushing the stocks to record highs. Both the speed and aggressive nature of this mean that intraday trading became very difficult and meant that the volatility that could be controlled to some extent by many market participants was lost. Not that this was a bad thing, but it just another example of how the FED’s stimulus has changed the financial markets. I don’t think the FED’s stimulus has destroyed the correlation more as it has sped up the boom and bust cycle. This is not good for future generations.

The problem is that if the indices increase is built on sand and the FED’s stimulus we are living in borrowed time. The credit bubble was 30 years in the making and the FED’s attitude was we will buy ourselves out of trouble at all costs. The short term cost is just money, trillions of dollars that is, but this is all leverage against future growth. The lower interest rates have not done this and all the ‘growth’ we have seen is from mounting consumer spending and subsequent debt. Once the FED taper is out the markets there will be nothing to stop markets correcting normally and nothing to stop an almost inevitable stock market crash.

3) And now that the stimulus is being trimmed and will probably end this year, will stocks fall to catch up with the currencies
Currencies are not really an accurate measure of prosperity. With the long USD/JPY competitive devaluation or currency wars we have seen how the currency markets can be manipulated. There is more ‘money’ in the world than there has ever been. However the real value of this is lot with the disproportionate cost of other asset classes like gold and stocks. All the world markets look for some sort of parity and fair value. The problem is with this is with so much stimulus money still riding around the markets, when the taper is gone where will it go? This could mean a drop from stocks into currencies like the Swiss, or we could see a resurgence in gold.

The markets are so large and so complex that only one thing remains. What goes up must come down. When you look at the rapid rise of the stocks based upon borrowed time and money, one thing is for certain, there is not enough money in the world restart a stimulus program like the one we saw under Bernanke any time soon.

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