Friday, January 31, 2014

EM rout? Or Intervention Sunday?

The negative stories on emerging market economies are coming hot and heavy. Consider this New York Times article entitled Dark Side of Capital in Emerging Markets, where they quoted Morgan Stanley's bearish views:
Morgan Stanley, which has been among the most bearish on emerging markets in recent months, looked at a variety of indicators this week and concluded that the most exposed countries were Brazil, South Africa, Ukraine and Turkey. It pointed out that a third of Turkey’s external debt was short term and that the country’s foreign exchange reserves were smaller than the amount of its short-term external debt...

Morgan Stanley warns of a possible “suddEM stop” for one or more economies, a play on the abbreviation for emerging markets. But even if you are sure that is going to happen, forecasting the timing is far from easy.
Izabella Kaminska at FT Alpahville recently highlighted Societe Generale's dire forecast, citing that a loss of confidence could be just around the corner:
SocGen’s cross-asset research team believes that when it comes to EM outflows they may have only just begun:

What puzzles me is that these risks have always been in place. So why is the market so worried now? Is this the start of a full-fledged panic?

Bearish tripwires
Indeed, one of the two tripwires outlined in my recent post (see The EM line the sand) has been tripped. The relative performance of EM bond ETF (EMB) to US junk (HYG), which is a junk vs. junk measure of market appetite for EM assets, has violated a key relative support level. In fact, this relative return ratio is now back to the levels set in the panic lows of the Lehman Crisis.

However, my other indicator of EM risk appetite, the performance of EM currencies (CEW), is still testing a support zone. For now, that market confidence measure is still holding - so far.

Meanwhile, global equity prices have been spooked as European and US stock indices closed lower for the week. Official intervention was largely ineffective. As an example, Turkey's surprise hike of interest rates was able to turn the market around for only a few hours.

The current environment suggests a high degree of volatility ahead for all asset prices. On one hand, the bulls should be aware of the possibility of an emerging market currency crisis is very real and we could see a real rout in asset prices starting with EM assets.

On the other hand, the markets are setting up the pre-conditions for massive intervention. The possibility of an Intervention Sunday, where a coordinated effort by G7 central banks to stabilize markets, should be in the back of the mind of every bear.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

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