I stroll along the stream up to where it ends.
I sit down watching the clouds as they begin to rise.
Commentary & Analysis
Emerging Markets: A train wreck waiting to happen?
Our Emerging Market Money Flow diagram seems now to be operating in reverse—money is moving back to the center away from emerging markets (EMs aka periphery); they once the darling sugar plums dancing in the heads of decoupling dreamers.
Notice in yellow at the bottom of the above chart I wrote: How does this dyamic change? Well, I wrote that back in 2006 or so when I created this, granted a bit convoluted, flow diagram to help me better get a sense of the moving parts which most impact funds flow as it relates to EM. Well, the dynamic has changed. The trigger was the credit crunch. Now, when you consider the following:
1) Deflationary forces growing
2) Global rebalancing continuing
3) US current account deficit improving
4) Monetary velocity globally falling
5) Global trade growth slowing
6) China’s growth slowing
7) Labor cost advantage for EMs falling
8) Dollar funding cost rising
I think it is fair to say things could get dicey for EMs very soon. Or to put it another way:
It seems the probability that a downside self-feeding vicious cirlce for EMs is rising by the day, as we approach Fed balance sheet reduction time. [aka the flow diagram above operating in reverse..]
I think this quote from GaveKal, taken from their special report done earlier in the year, “Too Different for Comfort,” sums it up pretty well:
We live in a world in which emerging markets will conceptually need more and more dollars (if we expect global glrowth to still be driven by emerging trade and consumption), while the US will be exporting fewer and fewer of them. This does not sound stable, unless, of course, the rest of the world gets its hands on dollars by selling assets (instead of goods and energy) to US investors. But needless to say, US investors will only be interested in foreign assets if those are cheaper than equivalent ones in the US.
I would suggest those foreign assets are not cheap enough yet, evidenced by the MSCI Emerging Market Stock Index ETF (EEM):
And yes, if EMs break there are implications for the US dollar. Money runs back to the center from the periphery faster; we will likely call it a “risk bid.” But of course, as I tried to point out above, there seem to be solid rationales which would support such a flow. And it may not be one-off as they say, it could be a new dynamic with legs.
Have a happy FOMC day!
President, Black Swan Capital