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Tuesday April 21, 2009 - 12:41:35 GMT
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Emerging Markets to Begin Out-Underperforming

Key News
• German Investor Confidence Index Is Positive for First Time in Two Years (Bloomberg)
• Asian shares fall on new credit fears Asian stocks fell and government bonds following a 41% quarterly increase in bad loans at Bank of America renewed fears of deteriorating credit, halting a rebound in risk taking (Financial Times)
“It breaks your heart.  It is designed to break your heart.  The game begins in spring, when everything else begins again, and it blossoms in the summer, filling the afternoons and evenings, and then as soon as the chill rains come, it stops and leaves you to face the fall alone.”

           A. Bartlett Giamatti

FX Trading – Emerging Markets to Begin Out-Underperforming

A quick note to start, the US Dollar Index broke above key resistance yesterday like a hot knife through butter.  Next target appears to be 8900-9000.

 (Chart unavailable in text format.)

Moving on ... I sifted through a couple news articles on emerging markets this morning – analysts seem to have a decent understanding of how these markets HAVE behaved. But are their expectations of how they WILL behave as precise?

Since the beginning of March, when risk-taking became cool again, emerging markets and emerging market currencies made good on market optimism; they rallied sharply. And emerging markets have outperformed developed markets (stocks, bonds, etc) for even longer than the last month.

(Chart unavailable in text format.) 

As one analyst from this morning’s articles pointed out: emerging markets tend to rally faster when times are good and fall faster when times are bad. Yes, true. But nothing new here – it’s the same ebb and flow of risk and the nature of emerging market investments that make this so.

The specific reasons for recent EM strength? Take your pick:

The smarties in the aforementioned articles say the outperformance is thanks to China. (Really, though, this should be taken as: “thanks to recent reaction to a few better-than-expected economic data points out of China.”)

Among other reasons, insulation from financial turmoil due to insufficient capital markets was discussed as an explanation for EM stocks outperforming.


It seems someone has it backwards. Insufficient capital markets actually pose the biggest problem for the emerging markets in question – now and in the immediate future.

Frankly, because the capital markets in the emerging world are far inferior to those in the developed world, trade surplus dollars fled emerging market economies for investment opportunity in developed capital markets (e.g. United States.) It’s this one-way flow of investment capital that left emerging markets exposed in the face of disappearing global demand.

Again, to paraphrase some of the comments I scanned this morning, emerging market stocks represent good value; they’re cheap at these levels.

But that doesn’t mean they can’t get even cheaper, right?

One analyst, touching upon several of these reasons in an effort to garner some contrived explanation for recent emerging market strength, did speak a few words of wisdom:

“As for decoupling [the view that emerging markets can perform independently of developed ones], I think that is wrong. Everything still depends on the US consumer. Any signs of improvement on that front and there might be more upside for emerging markets.”
Glory, glory, Alleluia. The truth shall set you free.

The bottom line: until these emerging markets devote some resources to the consumer side of their economies, until they work to improve their capital markets, they’ll be bound, for better or worse, to global demand trends. Basically, I say that because I think the US consumer won’t be coming back to the table anytime soon.

US Dollar/Hungarian Forint – Looks as though the 50% Fib retracement was sufficient support. A break above the late-March daily high likely would reduce any additional downside potential for this pair.

 (Chart unavailable in text format.)

If the lid is pressed shut on risk-taking (Bank of America and pessimistic stress-test expectations applied some pressure yesterday), then expect emerging market currencies to out-underperform.


John Ross Crooks, III
Black Swan Capital LLC


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