By Jason Van Steenwyk
The stampede is on. Global investors are embarking on a massive flight to safety, according to readings of fund flows in the equity markets and currency price indicators.
It started with the Argentinian peso. As usual. The international whipping boy of currency speculators underwent a pummeling over the last few weeks that even had the Denver Broncos wincing in sympathy.
It wasn’t just the Argentinian peso, though. A near global panic also hit the Turkish lira until a decisive interest rate increase by the Turkish bank to defend their currency reestablished some credibility on the part of Turkish authorities and their willingness to defend their currency. The South African rand likewise came under severe selling pressure, in part due to fears of labor unrest. Reserves in Venezuela hit a ten-year low as the cash-strapped country resorted to desperate measures, slashing its currency for airline tickets and for foreign direct investment – for those still crazy enough to commit capital to the socialist economy there. Venezuelans are taking to the streets in mass protest as we speak – and the government is cracking down brutally.
The currency contagion of late January and early February of this year, though, reflects an investment climate that goes much deeper than technical Forex traders looking for short-term profits. Global investors appear to be pulling in their horns in a big way – migrating to a ‘risk-off’ strategy that is leading them out of emerging markets and even U.S. equities across the board, in favor of calmer waters.
For example, in the week ending February 5th, U.S. mutual funds experienced record high outflows from stock funds, and simultaneous record-high inflows into bond funds. Specifically, U.S. stock investors pulled $24 billion out of stocks and pushed $13 billion into bonds according to a Citi report- keeping interest rates down, but removing a support from stock process. Each was a new record high.
Simultaneously, we also saw some $6.4 billion fleeing emerging market funds in a single week, according to the same Citi analysis. Not that the increasing attraction to safe-harbor investments are a matter of a single week. That week was the 13th week in a row of outflows from emerging market funds – the longest losing streak for EMs since the U.S. was preparing to invade Iraq in 2002.
The pullout also wasn’t particularly focused on one region: All emerging markets were affected, with $4.8 million getting yanked of of general emerging markets funds. Asia lost just under a billion, and emerging Europe, middle east and Africa funds (EMEA) lost a third of a billion, and Latin America saw its markets stripped of $200 million. All in all, it was the most brutal rip tide of capital from emerging markets in years.
Look further: Foreigners sold off $3.6 billion of Asian stocks – a figure that dwarfs the slower mutual fund crowd. Taiwan and Korea lost a billion between them, and the troubled Thailand saw foreign capital draw down by $516 million.
And Japan? While it’s not an emerging market, its dismal debt picture, lack of regard for the integrity of the yen thanks to chronic near-zero interest rate policies, and tepid economic growth is causing it to be treated like one when the chips are down. Investors sold off $7 billion net in Japan during the last week of January, alone.
The MSCI Emerging Market Index fell 6.6 percent in January, though it’s staging a recovery now.
The carnage didn’t let up in February, either. Valentine’s Day was born amidst blood, violence and carnage – and this Valentine’s Day was no exception, with emerging markets investors picking up where Chicago gangsters left off. Another $4.6 billion of net selling hit emerging markets in the 2nd week of February. According to Barclays analysts, that adds up to a total of over $29 billion in outflows for the year to date as of February 15th.
All told, fund outflows from emerging markets for the first two and a half months of 2014 surpassed the entire negative fund flow from emerging markets for all of 2013.
These kinds of capital migrations don’t sound like much to investors reading numbers off of a piece of paper or a computer screens. But they’re a nightmare for economic planners in affected countries, because these foreign dollars represent real liquidity that both governments and businesses need just to make payroll, keep the trains running, and generally avoid unrest in the streets. If governments and businesses cannot borrow to bridge uneven cash flows, city busses cannot buy fuel – if there is any fuel in the cities to buy – and paychecks start to bounce, unless preceded by mass layoffs.
Meanwhile, the Argentinian people are staggering under an inflation rate of as much as 55 percent – making it exquisitely difficult for anyone to borrow at any price.
Remember the Confederacy
For Forex traders, of course, there’s opportunity in danger. As the famous emerging markets investor John Templeton said, the best time to invest in emerging markets is when there is blood flowing in the streets. This is true in some cases – but there is no telling when the blood will stop flowing – both figuratively and literally. If a modern Forex trade existed in 1863, a bunch of folks would have piled into Confederate dollars – with disastrous results. The Confederacy did not back its currency in gold, but only in the full faith and credit of the doomed Confederate States of America. Yes, the blood was flowing in the streets by 1863 and 1864. In great rivers, indeed. But pursuing risk, by definition. is no guarantee of profit.
“Gold might rise in the North to 2.80, but there came a time in the South, when a thousand dollars in paper money were needed to buy a kitchen utensil, which before the war could have been bought for less than one dollar in gold. Long before the conflict ended it was a common remark in the South that, “in going to market, you take your money in your basket, and bring your purchases home in your pocket.
Short-term traders and arbitrageurs will do what they will – and there are ways to make money even swimming against the tide. But in the long run, the stronger currencies go to countries with more rational, long-term thinking policies, better stewardship, and fiscal policies that don’t transcend Keynesian deficit stimulus to the level of absurdity.
Image credit: Freedigitalphotos.net
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