Emerging Market Crisis Not Likely …

Over the past few weeks, emerging markets have taken a hit. Currencies from the Russian ruble and the Thai baht to the Brazilian real have fallen sharply against the U.S. dollar.

Stock markets from Mexico and Asia to South Africa have also taken a nosedive, with the CBOE Emerging Market ETF losing as much as 24 percent of its value since the end of January.

As a result, everyone is now expecting another emerging market crisis, one they say will throw the entire globe into financial panic.

I disagree. 100 percent. The reasons are simple:

First, at its root, past emerging market crises were largely the result of large external debts, little or no foreign exchange reserves, very weak economic growth, intentional currency depreciation, and corporate and bank failures.

Though there have been capital outflows out of emerging markets, buying opportunities are shaping up in economies such as Singapore.

Most of those forces aren’t present today. Most emerging markets have reduced their external debts, which are now far less a percentage of gross domestic product (GDP) than they are in the developed countries of Europe and the United States.

In addition, most emerging market economies now have healthy foreign exchange reserves, even after the recent bout of selling and capital outflows.

As to currency depreciation, naturally, there’s been some of that. But it’s entirely different from the currency collapses of the last emerging market crisis.

Most emerging market currencies now float. During the last crisis, most currencies were pegged to the dollar and were seriously overvalued. So when emerging markets could no longer defend the pegs, naturally, massive devaluations occurred.

Second, most emerging market stock markets have already experienced rather large setbacks, anticipating the current market turbulence in the developed markets.

As a result, key equity markets in China, Brazil, Vietnam, India, Indonesia, Malaysia and even Thailand are bouncing along the bottom, forming long-term support levels, from which they can vault higher.

In fact, the MSCI Emerging Markets Index is trading at roughly 11 times reported earnings — a 40 percent discount versus the MSCI World Index, according to recent data from Bloomberg. That’s the widest gap since October 2008, which indicates emerging markets are undervalued.

Meanwhile, the equity markets of the U.S. and especially Europe, are largely overvalued and in topping formations.

Third, most emerging countries have budget surpluses and trade surpluses. In addition, their foreign currency debt as a percentage of GDP is way below levels seen during the emerging market crisis of 1997-98.

According to the most recent data, for instance, Brazil’s foreign currency debt as a percentage of GDP has fallen from 26 percent in 1996 to 17 percent today.

Indonesia’s, from 30 percent to 20 percent. Thailand’s, from 51 percent to 19 percent. Russia’s, from 19 percent to 13 percent.

This is not the kind of foreign currency debts that are indicative of a full-blown crisis, especially given the fact that in general, emerging market economies have far healthier balance sheets than the Western developed economies of the U.S and Europe.

Another important consideration: In past emerging market crises, the U.S. dollar soared against all currencies. That is not happening today. Indeed, the U.S. dollar remains weak against the euro, the Swiss franc, the British pound and even against the stronger Norwegian currencies.

Bottom line: Though there have certainly been capital outflows out of emerging markets, I do not see an emerging market crisis on the horizon.

Instead, I see buying opportunities shaping up.

I particularly like Singapore and believe it or not, Thailand. Singapore is forming a nice bottom, while in Thailand, even in the midst of its political crisis, the Thai Set has held major monthly support at the 1271 level.

Lastly, there’s another key market that I watch that often signals an emerging market crisis in advance: Gold. Yes, gold has rallied. But on my systems, gold has not even generated a weekly buy signal yet, nor a monthly buy signal.

In addition, the recent gold rally occurred with declining volume, and declining open interest in the futures market. That, and a host of other indicators I watch, tell me that gold’s recent rally is a bear market rally, and not the start of a new bull market.

If we were truly seeing an emerging market crisis, gold would be performing better.

Overall, market volatility in nearly all asset classes around the world will certainly be rising in the months ahead, but not because of the emerging markets. Instead, it will be due to what’s happening in the Western world, especially Europe.

Make no mistake about it: Though it may not seem that Europe is the problem, I can assure you it is. Just look at what’s happening in the Ukraine, where a full-blown civil war has broken out.

Europe is sinking deeper and deeper into a depression. Unemployment continues to rise, banks in Europe are getting weaker and weaker, and the strength in the euro is not a sign of health. Rather, it’s a sign of severe deflation taking root in Europe, a force that will eventually cause Europe to meltdown.

I urge all investors to stay out of European equity and bond markets. That’s where the real crisis is. When everyone begins to realize it, capital outflows from emerging markets will turn into capital inflows.

Stay safe right now. Several markets are reaching critical turning points and once the trends clear up, there will be wonderful trading opportunities.

Best wishes,

Larry