'Be fearful when others are greedy, and be greedy when others are fearful' - Warren Buffet.
In the same vein as a newly elected politician, the latest iteration of central bank policy, or even a One Direction album, I have often found that financial articles disagreeing with the world's paramount investor, do not live up to their promise. In light of this observation, I would, instead, like to 'modify' the application of the Buffet thesis at this stage of the cycle for emerging markets. As I will go on to explain, such is the dependence on foreign capital for many quarters of the developing world that we should, rather, be 'fearful when others are fearful'.
JPM Emerging Market Currency Benchmark*
The negative sentiment toward the Emerging World has been heightened of late, with markets becoming even more certain of the course for US monetary policy. In its first unanimous vote since June 2011, the Fed agreed to cut the level of asset repurchases by $10bn for the month; this despite a very disappointing employment report. The consequence of this, and the read by markets, is that unless we get some persistently weak US data, the Fed will not deviate for its intended path of removing emergency stimulus (QE). This will 'likely' stir a gradual rise in bond yields, sending the cost of capital higher across the globe.
This outcome would prove particularly painful for the so-called ‘Fragile Five’ - Brazil, Turkey, India, Indonesia and South Africa - who run persistent current account deficits (import more than export) and, therefore, are dependant on additional external funding. Taking a closer look, the situation for both Turkey and South Africa, who have acquired large amounts of foreign denominated debt, is even more acute. For an economy to find its equilibrium, imports should roughly equal exports, and to achieve this 'current account deficit' countries should allow their currencies to weaken. This would inflate the cost of imports and encourage domestic substitution, as well as boosting exports. Not only does this generate higher levels of inflation however (cue civil unrest), it also makes the servicing of US$ denominated increasingly challenging. In order to defend their respective currencies, the South African and Turkish central banks have both enacted emergency, large scale, interest rate rises. It was hoped the increased yield on offer will stall capital flight. Relief proved only temporary, however, as markets looked through the noise and focused on the negative connotations of higher borrowing costs on domestic growth.
If we combine these issues with the increased scrutiny of the Chinese shadow banking system, in which souring loans are gaining increased attention from the markets, then the fear factor really starts to escalate.
Once again, best to sit this one out from the sidelines. Bargain hunting can wait; as is the case for One Direction albums: Up All Night is still holding on to £6.99 on iTunes!
*JPM Emerging Market Currency Benchmark: Nominal performance of EM currencies versus $US
Head of Fund Research