Monday, February 24, 2014

Thoughts on Current Market Events: Emerging Markets & Stimulus Wind Down

As sexy as "stimulus" sounds, investors are starting to worry what impact the pulling back of quantitative easing (the Fed's way of stimulating the economy by keeping interest rates low) will have on the markets, both in the U.S. and abroad. Easing up on stimulus should be a good thing, a sign that the economy is doing better, that the unemployment rate is improving, that roses are starting to sprout, and the sun is beginning to shine. But, of course, for every action, there is an equal and opposite reaction (thanks, Mr. Newton), so fears abound.

Pulling back on quantitative easing will likely mean an increase in interest rates here in the U.S. Generally, when Treasury rates rise, other interest rates, including mortgage loans and credit cards, go up, too. Part of the fear here is that the U.S. economy is still fragile. For example, while the unemployment rate has fallen to 6.6%, millions of people have been unemployed for so long that they have stopped looking for work; they are not included in that 6.6%. All told, the labor participation rate is only 63%, according to the Washington Post, the lowest it's been in a generation. Home sales are volatile at best. Consumer spending has been on the rise, but is nowhere near what it was pre-recession. The American middle class is slowly dwindling, which is displayed most simply in the consumer sector, where high-end luxury brands such as Kate Spade and Michael Kors, and low-end retailers like Dollar Tree, are vastly outperforming middle-of-the-roads like Abercrombie & Fitch.   

If interest rates rise too quickly, it could send the U.S. economy into a downward spiral. Credit card interest rates are already high, so consumers could be crippled by higher rates. High gas prices will only compound this effect. High food and health care costs would only make things worse.

Globally, the effect of relieving QE was witnessed recently. When the Fed announced its confidence in the U.S., investors fled emerging markets and ran straight into the arms of U.S. Treasuries. The run-up in the U.S. stock market over the past few years has taken a toll on emerging markets. EM stocks lost 5% in 2013, according to MSCI. EM sovereign debt performed similarly poorly. Leaders abroad have expressed concern about what continued easing will do to their countries' currencies, exports, and inflation levels

I like to think of myself as a contrarian investor, as following the crowd rarely leads one to buy low and sell high. That said, I think it's a great time to invest in emerging markets equities while prices are low relative to U.S. stocks. Keep in mind that, as quantitative easing is unwound more and more, EM stocks will likely get more volatile. In the end, I think it will be worth the wait. I'm of the belief that developing countries will not be wiped off the map, that they will continue to grow as time passes. 

I've expressed in previous posts that I don't think the record U.S. stock market levels are sustainable, as they do not reflect the true underlying health (or lack thereof) of the economy. (In fact, the S&P 500 just reached a new high today of 1,853.38.) I expect that they will come down as QE ends. Over time, investments in emerging markets may set off U.S. and other developed markets' losses.