Bubble trouble in emerging market stocks
Posted on 03 October 2009 with no comments from readers
Beware financial advisors trying to lure investors into emerging markets. They make a convincing case. It is not hard when emerging markets have delivered such outstanding performance. But beware. You should always buy at the start of a bubble, not after it.
Unscrupulous investment advisers do not worry about such trifles. Their only concern is to get a fat commission on your investment.
China crisis
It is not as if the warning signs are not obvious. The boom in Chinese stocks has been breaking down since mid-August when astrologers had pointed to a coming crash, and there was indeed a major correction in China. Is that the start of a downtrend? Well, what has gone up usually comes down in stock markets.
But stepping back a little what is really worrying about the 62 per cent surge in emerging market stocks since the beginning of the year, a 94 per cent recovery from the lows of the crisis last year, is the extent of this upswing.
It is so strong and so quick that the only word to describe it is a bubble. In China a stimulus package equal to half of GDP was injected into the economy in the first half of 2009 and this liquidity has been the main cause of the stock market rise.
Trade collapse
The fundamentals of a 20-25 per cent collapse in Chinese exports this year are clearly not the market driver. India has seen an even bigger collapse in trade. Russia is suffering from lower hydrocarbon prices. Winning the Olympics is likely a market top for Brazil.
Now liquidity driven stock market rallies are particularly prone to sudden and dramatic corrections without any warning. Basically somebody calls fire and everybody dashes for the exit. In the Middle East things look a little different.
For once the Gulf States are taking a more sober tack. Stock markets are way off their bubble peaks of 2006 and real estate prices have crashed over the past year.
But is this not actually a fairer reflection of the economic outlook and trade flows than the inflated financial markets of the BRIC countries? For the BRIC markets to keep going up they require the developed economies to recover back to their old boom levels, and this is just not likely to happen anytime soon.
No US recovery
Just look at the 263,000 extra jobless in the US for September, worse than forecast, or the 23 per cent fall in US car sales that month as the government’s ‘cash for clunkers’ program came to an end.
Clearly the fall in global trade is not going to be a passing phenomenon but a new economic reality for the emerging markets. In the Gulf States the financial and real estate markets are already beginning to reflect this vision of the future, but are probably still someway from bottoming out.
So would it not be foolish to invest in emerging markets at this point? The volatility of emerging market economies is notorious, and you should wait for the right moment which will only come when today’s investors have lost a great deal of money.
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Meanwhile, back in the US treasury market things are not what they seem, according to a post on SeekingAlpha.com today:
A little known fact (and one totally ignored by the mainstream media) is that the Fed accounted for nearly half of all Treasury purchases in the second quarter ($164 billion out of $339 billion). In fact, the Fed bought more Treasuries than the next three largest purchasers combined!!
The Fed’s purchases outnumber foreign holders (foreign governments), US households, and Primary Dealers (mega banks) combined. One should also note that foreign holders reduced their purchases of US debt from $159 billion in 1Q09 to $101 billion in 2Q09 (a 40% decrease).
In simple terms, these numbers indicate that if it were not for the Fed, the US Treasury market would have almost assuredly had numerous failed auctions in the second quarter. It also shows us that foreign holders (China, Japan, etc.) are reducing their purchases of US debt at an incredible rate. This tells us two things:
1) China and pals are putting their money where their mouths are: refusing to service our debt as they did in the past
2) Treasuries will have to become a lot more attractive (higher yields) for foreign investors to start buying again
I’ve often stated that the Fed will have to sacrifice stocks or the US dollar. If the Fed does in fact end Quantitative Easing in October (as it has stated it will in last week’s FOMC), then we’ll see what the market really thinks of US debt as an investment class. It’s clear from the above data that foreign holders want higher rates (yields) in order for them to start buying more heavily. However, as I’ve stated before, the Fed cannot afford higher interest rates without blowing up US banks.
Keep your eyes on the Treasury market going forward. This could very well be the next major crisis brewing. It will certainly be our first taste of how a market operates without life support courtesy of the Fed.
I’m guessing the results won’t be pretty.
My SPXU shares did well this week. For some reason the market did not tank on Friday like I had expected it. It was being held up pretty well by what seemed like an invisible hand. The strong oil prices was what kept it from tanking further on Thursday. Had oil not gained as much as it did on Thursday then markets would have had steeper losses on Thursday.
I’m curious as to how markets will do next week. I could see markets rebounding in Asia and the US if the S&P500 gets back over 1040. There has been all this talk about the USD getting weaker which seems like BS to me. If you look at the Korean WON, Thai Baht, Taiwan Dollar and Japanese Yen along with other Asian currencies which all seemed to have gained big time against the USD.