Wed | Dec 7, 2022

Midcourse correction

Published:Friday | June 13, 2014 | 12:00 AM

Walter Melano, Guest Columnist

Prior to the arrival of GPS and the wonders of micro-accelerometers, navigators would mainly rely on time, heading and distance in order to gauge their positions.

Often, the techniques of dead reckoning were as much as an art as a science. However, the elements of wind, tide and weather could wreak havoc with navigation plots. Crews would need to establish a fix in order to determine their actual position and make a mid course correction.

Although such techniques are no longer needed in terrestrial navigation, they are still required when piloting the rocky shoals of the marketplace

For the past two years, the plot was evident. The United States economy was embarked on a solid recovery, thanks to the recapitalisation of the banking system, the fracking revo-lution and the reshoring of manu-facturing activities.

stabilise fiscal accounts

On top of that, Europe was following a similar path. The ECB's commitment to do "whatever it takes" to preserve the unity of the Eurozone destroyed the market's doubts about the survival of the single currency. Many European governments also adopted draconian measures to stabilise their fiscal accounts and deflate their way back into realignment with the rest of the continent.

Given these two trends, it was only a matter of time until the central banks in the US and Europe would abandon their monetary largesse and hike interest rates.

Last of all, all signs indicated that the Chinese juggernaut was running out of steam. Therefore, the trajectory for the emerging markets was clear. The asset class was in for a rough landing. Hard-currency bonds and local-currency instruments would have to sell off, and that is what happened in 2013.

However, as is the case in navigation, things rarely move in a straight line. A midcourse correction is always needed.

The navigation track began to get messy about a year ago, when then US Federal Reserve Chairman Ben Bernanke began to talk about tapering. Suddenly, interest rates spiked and the emerging markets plunged.

Initially, events were holding to the script. However, the spike in interest rates also produced a corresponding increase in US mortgage rates, which began to depress the recovery.

Slowly, housing starts began to turn and consumer sentiment began to darken. Even though the equity market continued to reach new highs, the macroeconomic numbers began to underperform.

Likewise, the emerging market countries began to take measures to stabilise their currencies. Rates were hiked, monetary policy was tightened and some macro-prudential measures were introduced. By the beginning of this year, the valuations had changed so much that the emerging markets were looking attractive.

It is difficult to anticipate all of the actions and reactions of the marketplace. It would also be unfair to place all of the blame on Bernanke's tapering comments.

The effects of fracking were not enough to propel a behemoth, like the US economy. The reshoring phenomenon was also generating thousands of new jobs, not the hundreds of thousands or million-plus that had been promised by President Obama. Deflation in Europe and the US was also undermining nominal growth. Therefore, the economic recovery was going to be weak.

In hindsight, the optimism of the developed world was too strong and the pessimism of the emerging countries was too much.

Now, we are waking to a new reality. It is a reality of a shallow US recovery and an activist Federal Reserve chairman, who wants to use monetary policy to attend structural problems.

In other words, the ideas that are being floated in the financial press are of maintaining extremely low interest rates for the foreseeable future. This makes the small chorus of economists who called for lower rates in 2014, a group of financial savants.

Those brave fund managers who waded back into the emerging markets earlier this year are now looking like a pack of geniuses. And, it now seems that the emerging markets asset class has a new lease on life.

Does this mean that all of its sins have been erased or forgiven? Absolutely not! The Chinese economy is still on the skids, and the outlook for commodities remains grim.

Most of the emerging countries are facing anaemic growth rates, external imbalances and consumer credit bubbles. The decision by the Fed and ECB to prolong lax monetary positions will only further inflate the emerging market asset bubble.

However, that is beyond the concern of most fund managers, since they are only trying to avoid running aground before the end of the year.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities