Indonesia is nearly half a world away, its capital of Jakarta more than 10,000 miles from the New York Stock Exchange.
Yet the recent financial carnage in Indonesia and other emerging-market countries isn’t too distant to ignore for American investors, who have been scarred by financial panics that started in developing economies over three decades.
The Indonesian stock market fell 5.5% overnight, to a new 2013 low, Thai stocks dropped 3.5% and India slid 1.5%, bringing that once-surging country’s market losses over the last month to 18%. Stocks in large developed markets in Asia, such as Japan and Hong Kong, were dragged lower as well.
The stock selloffs are tracking steep declines in the value of emerging-market currencies, which in turn represents the flight of nervous capital from these riskier financial venues as investors anticipate the U.S. Federal Reserve’s eventual – and perhaps imminent – cutback in its stimulus efforts.
In times of plentiful, cheap money by central banks, investors’ risk appetites are stoked and the liquidity often flows to emerging markets, where bond yields tend to be higher, in search of juiced returns. Fears that the Fed might soon curtail, or “taper,” its $85 billion monthly pace of bond buying as early as September has capital exiting these trades. Government bond yields in the U.S. and other leading economies such as the U.K. and Germany have been rising, implying a tidal lift in the cost of money globally.
So far, the U.S. stock market has remained relatively insulated from the turmoil. While the Standard & Poor’s 500 index has fallen four straight days, it has slipped just a bit more than 3% from its all-time high set on Aug. 2, and is mostly pulling back after a strong run in response to domestic interest-rate and Fed-policy concerns rather than in unison with capital flight from emerging markets. Some commentators are even suggesting the U.S. market could benefit as a safe haven as money is rotated away from riskier countries.
Yet there are at least three reasons that U.S. investors should be mindful of the twitchy rhythms of these far-off markets:
Many American investors have pushed heavily into the emerging markets over the past decade, exposing them to direct losses as these markets struggle. The rise of China, Brazil and other industrializing heavyweights emboldened U.S. investors to direct a disproportionate amount of their portfolio dollars toward E.M. The most popular exchange-traded fund in the category, iShares MSCI Emerging Markets (EEM), has $35 billion in assets, even after losing 15% of its value this year. Emerging-markets stocks had lately bounced off their lows after vastly lagging the U.S. indexes, and stocks there continue to appear quite cheap relative to their corporate earnings and potential growth rates. But for now, investors are absorbing painful losses.
Eventually and given steep-enough losses in the developing world, global financial turmoil eventually washes up on American shores. Dating to the Latin American debt crisis of the early 1980s, the Mexican peso collapse of ’94, the Thai-centered Asian panic of ’97 or the Russian-default drama of ’98, violent market declines in hot-money regions have touched off significant U.S. market losses. As discussed in the attached video with Yahoo! Finance anchor Lauren Lyster, the core fear is financial “contagion,” in which big institutional investors who have borrowed heavily to invest in emerging markets need to liquidate in a hurry or sell even the “safer” assets they own to cover losses. This worry has already pressured shares of U.S. banks. Enis Taner of www.RiskReversal.com notes that each time since 2006 when the JPMorgan Emerging Market Currency Index has dropped at least 5%, as it has recently, U.S. stocks suffered at least a 7.5% pullback. So far, though, domestic equity credit markets have remained fairly calm. Watch indicators of Stateside risk appetites – such as junk-bond yields – for indications of financial stress crossing the Pacific.
The financial pressure on the developing world further threatens an already-vulnerable global-growth outlook. While U.S. growth is forecast to pick up modestly and Europe has just exited a long and painful recession, the developing world has been a key source of economic demand and production growth in recent years. As China has decelerated jarringly and capital has been pulled from emerging countries, central banks there have kept interest rates higher than they otherwise would in order to suppress local price inflation and attempt to defend their currencies. (Higher rates are meant to attract foreign money, which can support currency values, all else being equal). So relatively tight money threatens to further retard growth at a time when these countries, and the world, could use more of it. Even Australia, a beneficiary of the China and commodity booms in recent years, is in a fix. Its central-bank minutes reveal a stalled debate over whether policy makers there should even signal the kinds of rate cuts its slowing economy seems to call for, as the Aussie dollar has sagged.
Again, so far this dynamic hasn’t critically pinched the economic recovery here, but it is one more headwind for U.S. and European multinationals working to capture profits from growth around the world, outside their own mature markets.
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