By Anthony Mirhaydari
Although the U.S. markets are taking last month's surprise "taper on" decision from the Federal Reserve in stride, the same can't be said for the emerging markets. Bolstered by years of inflows from cheap dollars pumped into the system by Fed chairman Ben Bernanke's historic experiment in extreme monetary policy easing and a weak dollar, the beginning of the end of this era is reversing this dynamic.
The result is persistent currency and equity-market weakness overseas that, in many ways, shows similarities to the run up to the 1997 Asian financial crisis.
Look at the dichotomy. The Dow Jones Industrial Average is barely off of its New Year's Eve all-time high after finishing 2013 with no major corrective pullback or close below its 200-day moving average. Yet the iShares Emerging Markets (PSE:EEM) , which suffered a 9% decline in 2013, is in full breakdown mode as it falls away from its 200-day moving average and collapses through its lower Bollinger Band. That violates a five-month consolidation pattern and puts the summer 2013 lows back in play.
There's a lot to say about the structural issues hitting the emerging markets, especially China, as they reorient away from an export-led growth model and deal with large credit overhangs. All of this was enabled, over the last decade, by the constant flow of capital from the United States — via the trade deficit or by investors looking for investments not denominated in dollars — into countries like Vietnam and Indonesia.
With the Fed starting to pull back on the flow of stimulus a little, a stabilization in the U.S. dollar and a bump up in the 10-year Treasury yield over 3% is drawing that money back out. The results are potentially destabilizing capital flows — which is exactly what torpedoed emerging Asian economies back in 1997.
Another connection to the past is depreciation in the Japanese yen, which then, as now, was done to reinvigorate Japan's export sector at the expense of undermining the export competitiveness of more vulnerable neighbors.
Thailand and Indonesia led the way down in 1997. And they are leading the way down again now. Thailand's Set Index has dropped to 2012 lows as the selling intensifies. Indonesian shares have returned to the lows seen in 2011, 2012 and 2013.
While U.S. equities have enjoyed the benefits of the "yen carry trade" over the last two years — as hedge funds borrowed in cheapening yen to fund stock purchases — the good times could be coming to an end. Not only has it destabilized the region, but political pushback is growing as well. South Korean President Park Geun Hye said a weak yen burdens the economy.
Investors can't ignore the plight of the emerging markets forever.
To take advantage, I've recommended the UltraShort Emerging Markets (PSE:EEV) and the UltraShort China (PSE:FXP) to my clients — which are carrying gains of 10% and 13% so far this month part of the Edge Letter Sample Portfolio .
Disclosure: Anthony has recommended EEV and FXP to his clients.
