If there were any more sceptics still doubting the fundamental strength of the global economic recovery, the back end of January gave them a brief opportunity to crow about their prescience. A sudden crisis of confidence among the world’s largest emerging markets sent the equity trading centres of the world into a downward spiral that was still holding as the first month of the new year drew to a close.
And yes, the first week of February brought some respite. But how come it didn’t seem to be spreading very far outside the major marjets?
The immediate culprit, as far as many were concerned, was Argentina, which was forced to watch its currency drop by 16% in a single day after it became clear that the central bank no longer had the foreign currencies to make an effective intervention on behalf of the peso. Attention immediately switched to the other four members of the ‘Fragile Five’ group – the Turkish lira, the South African rand, the Indonesian rupiah and the Indian rupee. But also to the US dollar itself, which weakened on worries that Buenos Aires might default on its dollar denominated debts. In Argentina, black market dollars were changing hands at 50% above the official rate.
It might not have been a complete coincidence that Argentina, India and Turkey (plus Brazil, of course) had spent the last few years complaining about how US quantitative easing was pushing unwanted foreign reserves in their direction and boosting their currencies to unwarrantable levels. The point being that, by promising to slow the pace of QE from $85 billion to $75 billion a month, the Fed was effectively letting their currencies deflate.
But then again, perhaps it was Argentina’s inflation (30%), Turkey’s power struggles (between Prime Minister Recep Tayyip Erdogan and his Islamic mentor Fethullah Gülen), or the soaring economic uncertainties in South Africa and India that had turned the market’s head. You never can tell. As the month closed, Argentina, Turkey and India responded to currency the disaster with higher interest rates, but South Africa and Indonesia decided they couldn’t afford to risk it.
State of the Onion
Meanwhile, America’s President Barack Obama did his best to fight back against the tide of downbeat news with a State of the Union address on 28th January that was supposed to restore faith in his leadership but turned out to be an economics-free zone.
Although he hailed the expansion of US corporate profits, the President’s economic thoughts were limited to a 40% rise in the minimum wage for federal contractors, which he said he would impose by presidential order. He did talk about closing some tax loopholes and using the resulting cash for repairing the nation’s roads and communication links. But if anyone was looking for commitment on the crushing federal debt problem, or on foreign investment relations, they’d have searched in vain. (You can search the full for yourself at http://tinyurl.com/q4na3nj, by the way.)
Instead, the President was mainly pushing populist domestic policy ahead of next year’s mid-term elections. Which might be as good as it gets, for this year at least.
So What Now?
Let’s not be in any doubt about the fundamentally sound economic position, the bulls argue. There are clear signs of economic recovery in most of the Western world, and corporate profits are still moving ahead. What worries the bear commentators is that the pace of earnings growth is slowing – at least in the US – and it seems apparent that a lot of future earnings growth has been priced into today’s stock levels. Which would seem to imply that anything short of ‘more of the same’ will undermine today’s valuations.
The ‘slowdown’ in emerging markets still leaves a breathtaking rate of expansion in many. And even in China, where the last communist party plenum voted to turn decisively away from foreign funding in favour of a profound consolidation of the domestic economy, the news is actually good – especially if it leaves the Chinese banks in a more robust condition.
But what of other countries? Will the hint of an economic downturn translate cleanly into losses for the equity markets? It seems unclear, at a time when tens of millions of mistrustful investors are keeping vast quantities of cash on the sidelines. It’s clear to everybody that there is little appetite for bonds at their current low yields, which is why the failure to push vigorously into equities is all the more striking. Watch this space.