One central theme that continued appearing throughout the second half of January was the elevated risks associated with the economies of ‘Emerging Markets’.
So, the big question on my mind since I heard about the dilemmas in both Argentina and Turkey has been:
1. Is this the start of a fundamental shift in global equities to a ‘risk off’ phase?
2. Just another blip on the wall of worry that the market will climb?
To summarise my concerns and highlight the need for prudence within a portfolio, here is part of what I wrote to my investors on February 1 which formed a portion of my monthly investor update:
A new cause for concern has become apparent to global markets. This new concern is the state of ‘emerging markets’ and their associated currencies in countries such as Turkey, Brazil, Argentina, Hungary, South Africa and Russia.
The concern has come as a secondary consequence to the US tapering their quantitative easing program. As the USA tapers their money printing and bond purchases, it is adding strength to the US Dollar. The consequence is that as the US dollar strengthens the majority of other countries currencies weaken including those mentioned such as Turkey and Argentina.
These ‘emerging market’ economies have debt and a large component of their debt is owed to stronger foreign nations such as the USA and Germany (foreign debt). As the currency of these emerging economies decline, they end up owing more money for the same loans. And, as the debt comes up for renewal to be rolled into new loans, nations such as Germany and the USA are starting to see the risk of not being paid in full and are not ‘rolling over’ all or part of the loan. The result of this has two concerns:
1. Emerging nations have higher debt servicing costs for the loans that are rolled over which weakens their economy; and the bigger concern is that
2. Emerging economies are at risk of becoming insolvent if stronger nations (USA, Germany, UK) do not roll over the loans and tell say a Turkey or Argentina that they want to repatriate their money back in to their own country.
In this scenario, an emerging economy would have no way of paying back this loan and default creating a currency crisis that would then spread from one weak nation to the next. A bit like during the Eurozone crisis started with Greece and Ireland and then spread to the next weakest Euro nations such as Portugal and Spain.
In response to this situation, the government of Turkey raised their interest rates from 7.5% to 12% in an attempt to defend their currency. My concern is that the ‘market’ is too smart for that and could possibly try to take the Turkish currency and potentially their economy down.
So, I don’t mean to scare you, I more so wanted to inform you. This has become the pertinent issue for global markets over the past week or so…..
So, with that said, is this a fundamental shift or a blip that will be forgotten soon?
Well, I wish I knew. I think global markets will answer this question over the next couple of weeks.
However, what I do think is that the current risk-return ratio for ‘buy-and-hold’ or being fully invested in shares is at its lowest point since mid 2011. My view is that now is the time for utmost flexibility.
At the Edge Fund, we have prudently reduced risk across our portfolio. While we will continue taking buy signals with quality companies as they occur, our time frames for holding new share purchases will likely be scaled back until this uncertainty in our mind is resolved one way or another. As the facts and the evidence change, we too will change.
This article is published by Dean Mico.
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