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From Buenos Aires To Nashville: The Emerging Market Crisis Spreads From Periphery To Core

This is the last emerging market crisis story for a while, promise. But one angle – exactly how a plunging currency in a far-off place affects supposedly stable markets like the US – is worth exploring because it’s happening right this minute.

Let’s start with the choices facing an American or European investor who needs a decent return, but who finds that interest rates have fallen to the point where traditionally safe things like bonds and bank accounts no longer yield enough.

Such an investor has two choices: 1) Stick with what they know and accept sub-par returns (which might mean being fired if you’re a pension fund manager, or – if you’re a retiree – having to spend your golden years as a Walmart greeter), or 2) Branch out into more exotic but higher-yielding instruments and hope for the best.

Option number 2 has been pushed by financial planners and pension advisors for the past few years, with emerging market securities being the exotica of choice. The sales pitch went something like this: Developing country stocks are cheaper relative to earnings and dividend yields than their rich country counterparts, while their bonds yield quite a bit – frequently two or three times – more than US Treasuries for only marginally more risk, so they’re a great way to diversify while goosing returns.

Many, many investors swallowed this and bought emerging market stock and bond funds. And for a while they reaped the promised high returns, allowing retirees to spend time with their grandkids and pension managers to keep cashing their massive paychecks.

Then – in part because of all the hot money flowing in from credulous First World investors – the emerging market countries started to veer off course. They borrowed trillions of US dollars and, when the dollar started rising against their domestic currencies, went into tail-spins of varying severity. And now tens of thousands of American investors who couldn’t settle for 1% returns are looking at double-digit losses.

Here’s a chart from Saturday’s Wall Street Journal featuring the Tennessee public sector retirement system, which made (in retrospect) a really excessive bet on emerging market ETFs. Note the great early-2018 results followed by a sickening plunge.

Tennessee pension returns

And here’s a chart showing the Tennessee system’s exposure to various emerging market countries, as a percentage of its total EM exposure.

Tennessee pension EM exposure

To its credit, Tennessee focused on the cream of the emerging market crop so presumably isn’t too exposed to Argentina or Turkey. Even so, its biggest holding, South Korea, is down about 10% so far this year.

Korea stocks Tennessee

The impact of these sudden losses on normally risk-averse investors? It scares them, obviously, making them even more cautious. Pension funds start shedding risk (which in this market means dumping tech stocks and foreign instruments of all kinds) and individuals try to shore up their nest eggs by spending less and saving more. It’s “risk off” all the way down, and the economy starts slowing.

And that’s the best-case scenario. A system as leveraged as today’s developed world might not tolerate even a mild deceleration, so pretty much any deviation from steady growth is potentially destabilizing. Which means volatility might be the only safe bet in the year ahead, and a return to QE thereafter.

11 thoughts on "From Buenos Aires To Nashville: The Emerging Market Crisis Spreads From Periphery To Core"

  1. A friend of mine who is very ‘switched on’ says that a return to QE is inevitable as the global economy slows (see BDI for example). But what happens to the already vast gap in wealth disparity already in play? More and more people will enter distress territory, and if properly reported, unemployment climbs and we are in a recession yet again?

    I have written a book about all this and how and why it is happening, and where it will end up IMHO: https://www.gofundme.com/fnahvp-free-book

    1. AP: Inflation is suddenly wildly out of control, as hot as I have ever seen it and I was in the military watching my pay dwindle by 12-15% per year in the seventies. Example, I looked at 65″ OLED TVs in May, 1,800 bucks, but thought they would be cheaper towards the end of the year, so I waited, now, same TV $2,700. And while steel and Aluminum tariffs have hit household appliances, American manufacturers have used that as an excuse to raise their prices to match, NOBODY really thought they would keep prices down and go for market share, now we have the targeted tariffs on various countries and prices are skyrocketing, I got a sale ad in the mail from a furniture place that has appliances, and they are printing ads for refrigerators at 3,500, 4,500, and $5,500 for Frigidaire 22 CuFt side by side with ice and water in the door, I bought a similar model in 2013 for $1,250. Groceries, wow, stunning hikes for prices, a buck 39 for a lemon? What happened to three for 99 cents? This is harvest time for most foods but prices are higher than the dead of winter.

      Auto insurance; I have a 2013 BMW and in 2014 the insurance jumped up to $465 every six months, now I have a 2013 BMW 6 years old and no longer a $59,000 car, but 16k value, and I am over 60 (clean record), I had to trim the coverage and up the deductible and it is still $1,200 for six months. It is anecdotal of course, but I could go on and on, rent for a 2/2 townhouse apartment was $725 in 2014, now over $1,300. Utilities have doubled. These are not miscellaneous expenses one can cut out or substitute other things for and account for the majority of the average household budget. Gasoline has doubled in a year.

      My point is we all know that inflation is FAR higher than the BLS reports, and the fed does not even use the CPI anymore, but the magically mysteriously calculated PCE which is NOTHING but a plug number they invent to justify their policy moves in sustaining asset price growth for mostly the very wealthy top 10%.

      The reason why it is important is that almost everything else from GDP to real interest rates depend upon a deflator that is calculated from the CPI, if you have 12% inflation and you report/pretend you have 2% inflation then you are deflating GDP by a woefully inadequate number. If they were reporting inflation HONESTLY they would also have to use a larger deflator on GDP which would show we are in fact already in recession. The unemployment data has been sort of hot, but it always is just before a crash and besides, they have so redefined employment and unemployment as to be pretty misleading to outright meaningless.

      The powers that be are not worried about wealth inequality and never have been. They will again bailout banksters and the shareholders of corporate America, and government will keep increasing debt, cutting revenues from the rich, and corporations, the way it is going it is almost as if they expect an extinction level event within a few years, say before 2029. I am sixty and they already have devalued the dollar by so much in that time that it does not bear thinking about, you just get depressed, especially when wages have not kept up by half.

      We now live in a corrupt world where computers and internet make it so easy to hide the real rot, where accounting standards and practices mean NOTHING at all.

  2. I like the emerging market stories because I think their fascinating! IMHO keep em’ coming!

    If Tennessee gets 10% in the EM but losses force them to sell and pull out where else are they going to get 10%? They’re going to get 3% in the developed world and then it’s lights out for their pension math.

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