September Market Update
Markets across the globe continue to be driven by the potential for tapering, (reduction in quantitative easing programs) by the Federal Reserve. The chart at right shows changes in the S&P from immediately after the Q&A session in front of Congress (May 22nd), in which Fed Chairman Ben Bernanke first mentioned possible tapering, through the end of August. After the market’s initial panic, the Federal Reserve quickly assured the world that there was no need to worry, as Ben’s got your back. While the assurances appear to have soothed the U.S. equity market somewhat, emerging markets have been ravaged.
As the taper tantrum caused tumult in the markets, all the excess liquidity that had been running into emerging markets suddenly did an about-face. The currencies of Indonesia, the Philippines, Thailand and Brazil were pummeled in the May 22nd aftermath, wreaking havoc in their equity markets. By the end of August the Jakarta Stock Exchange Composite Index had, in USD terms, fallen 30% from May 22nd. The Philippines, one of the best performing equity markets in 2013 before the taper talk, fell 25% from May 22nd. Thailand’s equity market fell nearly 30% as well during that time.
When asked if the Federal Reserve does or should consider the impact of tapering on emerging markets, the response was essentially that those affected, (Asia, Latin America, Africa and Eastern Europe) should mind their own business and stop whining. This unfortunately echoes the grave policy errors in 1998 as emerging markets, (representing about 50% of world GDP today versus 15% in the early 1980s when then Fed Chairman Paul Volcker’s interest rate hikes crashed Latin America) are now large enough to have a significant impact on the global economy. The recent rousting is forcing them to start dipping into their reserves, in part by selling U.S. and European bonds.
But isn’t the U.S. economy improving dramatically at least partially as a result of the Federal Reserve’s policies? According to a recent research report by the San Francisco Fed (click here to read), all that the Central Bank has accomplished with its intervention has been a net contribution of 0.13% per year to annual real GDP growth.
Bottom Line: The Fed’s enormous liquidity injections inflated, among other things, a bubble in emerging markets which inevitably had to pop. Net capital flows into emerging markets doubled from $4 trillion to $8 trillion after 2008. Central Banks in these markets find themselves trapped with no way out unless they can get some significant organic growth, and whether than can be achieved remains to be seen. The substantial increase in the size of these markets means that shocks emanating from the emerging world may have a deeper impact here in the U.S.
