As a kid, nothing could pique my interest more than being told not to do something. And apparently, not a lot has changed, because to hear hedge fund manager Mark Dow of Pharo Management tell it, the contagion of fear sweeping through Europe is nothing to mess with. "As an investor you need to stay out," warns Dow.
"At the end of the day, this is about confidence. People aren't confident that the deleveraging process has proceeded far enough in the banks in Europe for them to weather the storm."
It wasn't always like this. In fact, up until a few weeks ago, there was a rising Euro and good money to be made. But Dow says that all changed, and changed quickly, once policy-makers began openly discussing a Greek restructuring. "That triggered a psychological mechanism amongst investors. They said, 'now it's a free short..there's no reason I should hold these bonds' and that accelerated the slide...and contaminated both Spain and Italy," says Dows.
What happens now is a mix of psychology and maintaining confidence, which is no small order for the ECB and other regional leaders. According to Dow, "the Europeans know what to do. But to coordinate the mechanism, since there are so many cooks in the kitchen, they have a hard time staying ahead of market sentiment." Dow believe Europe needs comprehensive measures that they may not be able to pull off, thus the "stay out of there" advice.
So with Europe effectively scratched off the list, we dove into Dow's other area of expertise, Emerging Markets (EEM). Here, the former IMF and US Treasury economist sees almost boundless long-term opportunity, in almost all of the big emerging markets, once there is some clarity that the current rate tightening cycle is ending.
Strategically, Dow is as committed as ever to the Emerging Market story saying, like never before, developing countries have decoupled financially and economically from the developed world and that the economic malaise of the U.S. and Europe will be enough to "derail that secular process."
Equally noteworthy is Dow's take on China and its latest report of 9.5% second-quarter GDP growth, a number most feel is certain to spark further right hikes. "That's a market risk more than an economic risk. If you think you need to tighten to slow down the economy, you don't have an economic problem, it might cause a hiccup in the markets but that's a different issue. So I think the (Chinese) economy is going relatively well."
So what sort of market risks are we talking about?
Dow says "China faces some challenges from the law of large numbers, that's going to reduce the growth rate, and the fact that they are trying to move from a model that was driven by investment to one that is driven by consumption."
What's so bad about a billion hungry consumers? He says "consumption is something that is endogenous. It kind of just comes out from the system. You can't turn that on and off like a light switch the way you can with investment and that is going to mean growth will be more uneven and probably at a lower level.. and the greater tension between inflation and growth will make it harder for the policy makers to make the right decisions."
He's not trying to scare you away from China, but is simply telling you how and where to manage your expectations. Like inflation, which by some accounts is running rampant and could prompt street rioting if not reined in, especially food prices. Dow doesn't believe it's as bad as fear. He explains that "if your income is growing robustly, you notice inflation less. In the U.S., if we have 4% inflation that's a big deal because our nominal income is growing at a very slow rate. But if your nominal income is growing at 15%, as may be the case in China, and inflation goes from 3 to 7%, it's not a big deal. It's not great, but you can deal with it."
In the meantime, whether it's in China, Brazil, or Mexico, Dow likes to own consumer names, "the kinds of products that are under-penetrated." He says, "that's a good theme throughout the emerging market world."
What about you.. Are you ready to dive back in to Europe and chase fat yields and ratings agency tweaks? Or does a roll of the dice in the developing world make more sense to you?