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With U.S. stocks posting their worst monthly decline since May 2012, many everyday investors are asking: What’s going on? Why the turmoil?
It was Mark Twain who said that “history never repeats itself, but it does rhyme.” And, once again, we are faced with the threat that chaos overseas will jeopardize the Federal Reserve’s aggressive money-printing policies and, in turn, cause the world’s financial markets to unwind.
First, it was the PIIGS — Portugal, Italy, Ireland, Greece and Spain. Now, it’s the Fragile Five — Brazil, India, Indonesia, Turkey and South Africa. And, next, it could be the Exposed Eight — the Fragile Five plus Hungary, Poland and Chile — that finally bursts Ben Bernanke’s bubble.
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| China’s first decline in its manufacturing sector in six months could set off a ripple effect throughout the emerging world. |
Recall that in 2012, the PIIGS were blamed for the euro-zone crisis that almost derailed the global financial recovery as economies climbed out from under the great collapse of 2007. Had it not been for some quick, easy-money sleight of hand by the European Central Bank, led by Mario Draghi, it’s almost certain that the world economy would have ended up crashing onto the rocks because of the PIIGS financial indiscretions.
This time around it’s the Fragile Five and, possibly, the Exposed Eight that could prove to be our undoing. That’s because emerging markets are facing an unholy trinity: a slowdown in China, tapering by the Fed and political instability as well as social unrest in developing countries. And it’s the Fragile Five and the Exposed Eight that are causing the most concern — and they should be especially worrisome to you, too.
After years of rapid expansion, and relative calm, what’s going wrong in these countries?
First, economic growth has slowed. As a group, developing countries grew on average about 6.5 percent over the past decade. In 2013, their economic growth rate was about 4.5 percent, with economic activity forecast to rise very little, if at all, in 2014. What’s more, China recently reported its first decline in its manufacturing sector in six months, which means Beijing will probably have difficulty delivering on its 7.5 percent target growth rate.
Second, political upheaval is another thing they have in common. All face political elections during 2014, which means much-needed economic reforms are even less likely. The Fragile Five have seen their currencies fall 15 to 20 percent over the past year, exposing such disturbing issues as corruption, lack of corporate governance and lending practices that favored the political and economic elite.
Third, cheap money is drying up. Last week, the Fed reaffirmed that it would continue pulling back on its bond-buying program in the amount of $10 billion. That means the U.S. central bank will pump $65 billion a month in the U.S. economy, $20 billion less than in December. The Fed’s actions, combined with reported instability in China’s shadow-banking system, could set off a ripple effect of tight credit throughout the emerging world, which is still reliant on foreign sources of capital.
Considering all of those factors, it’s the threat to global economic growth that Wall Street is most concerned about. That’s because real economic growth is vital to support the current lofty price-to-earnings valuation at which the stock market currently trades.
It’s become a widely accepted economic belief that about 70 percent of world economic growth will come from emerging markets over the next few years, with China and India alone accounting for 40 percent of that. With emerging markets now under pressure, Wall Street is growing increasingly concerned that economic expansion in the developing world may fall well short of expectations.
In this environment, I agree with Stephen Jen, a former economist for the International Monetary Fund who now manages a London hedge fund, that it’s best to keep it simple. In a recent New York Times article, he advised: “Steer clear of currencies with four letters: the South African rand, the Brazilian real, the Turkish lira and the Mexican peso.”
To Jen’s comments, I’ll add that to protect and grow your portfolio in uncertain times like these you should invest in companies with real earnings power as I described in my Money and Markets column last week. That way you have the best of both worlds: You can sleep at night because you have the relative safety of the world’s best companies supporting your portfolio and you can profit as they boost their earnings through these chaotic economic times.
Best wishes,
Bill
Bill Hall is the editor of the Safe Money Report. He is a Certified Public Accountant (CPA), Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP). Besides his editorial duties with Weiss Research, Bill is the managing director of Plimsoll Mark Capital, a firm that provides financial, tax and investment advice to wealthy families all over the world.