Last week we saw redemptions from the largest funds that matched those seen during the peak of the taper scare last year, the panic over the US debt ceiling in 2011, and even the Lehman’s crisis back in 2008. A couple more weeks of this and we will be in definite oversold/ buy Emerging Markets territory.
We also saw some strong moves by several central banks, most notable Turkey, India, and South Africa. The Turkish move, raising the benchmark rate from 4.5% to 10% and raising the top rate from 7.75% to 12% was particularly bold. Some people even suggested that they had gone too far and that such big increases were not credible; the exit of Sterling from the ERM on Black Wednesday (16 Sept 1992) despite repeatedly raising interest rates seems to the model for such thinking.
First of all I think this sell off is very necessary and very important. Emerging Markets are not going to be able to move forwards until this correction has happened for two important reasons. One obviously is that so many people have been expecting it that no one was going to allocate any capital until it had happened. They need to know, or at least tell their bosses, they are investing nearer the bottom than the top. The second reason is that I think it will end up showing that even the “Fragile Five” are not as fragile as bears have made out, and that this is NOT going to be a rerun of the Asia crisis of the late ‘90s.
That does not mean that this is a storm in a teacup. I think the differences from the Asia crisis are greater than the similarities, but there are problems that need to be addressed. To misquote Anna Karenina, All well managed countries are alike; each mismanaged countries are mismanaged in their own way.
Turkey’s rate rise will cut GDP growth significantly, and thus the skepticism about the rise’s durability. Rencap have already cut their GDP estimate down to 2% for this year, and others will follow – Merrill is still at 3.5%. Last week I described Turkey’s Finance Minister, Mehmet Simsek, as a “safe pair of hands”. I believe he has the ability to make Prime Minister Erdogan understand the gravity of the situation and that any attempt to force the Central Bank into reversing policy too soon risks losing control of the situation and making the crisis worse, jeopardizing Erdogan’s reelection hopes.
Indonesia, probably more so than any other country, needs to cut fuel subsidies. As the FT points out, the Government in Jakarta was predicting they would eat up 11% of the national budget even before the Rupiah fell 20%. In domestic currency terms, Brent is trading at or near record levels in local currency terms across several Emerging Markets, pressuring budgets.
Tackling corruption is usually a good plan; I have been highly critical of Dilma Rousseff’s handling of the economy, but she was left a huge corruption mess my Lula, and she has tried to address it.
In short, Governments need to follow up their stabilization plans with reforms. By and large, the countries that are suffering now have done very little to make their economies more competitive, preferring to sit back and collect the rents of the recent commodities boom and easy credit from QE. This complacency is not just a trait of Emerging Markets, as citizens of several Eurozone countries can attest, but currently the urgency is.
To present a wish list of reforms for each and every country would be pointless, instead I will comment in the future on any that actually get implemented.
So, what to do as we wait for those reforms? First of all, even if you believe they will happen at some point, you must remember they will probably come when politicians have their backs to the wall, meaning things could well get uglier first. If your career/ life savings depend on it, you should seriously consider waiting until you actually see something concrete happening.
The second thing to think about is at what price you are comfortable owning something. Bear in mind, if you say today “I’d fill my boots up $20 cheaper”, what is going to make it $20 cheaper? Would you be trying to catch a falling knife, or would you be buying a cheap asset? Make sure you really know why you would buy something.
As I mentioned last week, we had positioned some trades to benefit from the spike down, and we were able to close some shorts at really good prices on that day.
Some of our long positions also fell back to levels we were comfortable with, but we only added incrementally so that we had money left over if they continued to fall.
At every point you should ask yourself “What if I am wrong?” to make sure you are not being complacent.
Here is a nice video from John Authers at the FT.
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