Emerging markets: Batteries not
included By Walter T Molano
The fundamental conditions in the emerging
markets have never been better. The
reincorporation of China and India into the global
economic community increased the demand for raw
materials, sectors where most emerging markets
enjoy huge comparative advantages.
The
weakness of the US dollar exacerbated the rise in
commodity prices, as the value of real assets rose
in relation to the greenback. The relative decline
of the US created a power vacuum
for
some countries (such as Russia, Venezuela and
Brazil) to convert their economic might into
political clout.
The sea of liquidity
created by lax monetary policies in Japan, Europe
and the US generated copious resources to invest
in risky assets. All of this created an ideal
environment for the emerging markets, which
explained their performance in 2006.
However, the price action at the end of
this year became excessive, and the relationship
between risk and reward broke down. Unfortunately,
a break in the momentum could set the stage for a
strong correction - a scenario that may not be too
far away.
The emerging markets are
vulnerable. Thailand's attempt to impose new
capital controls, albeit to keep the baht from
appreciating, sent powerful tremors through the
emerging-market bourses. Ecuador's reckless
flirtation with an unnecessary default is
worrisome.
The problems in Ecuador raise
questions about the commitment of other
leftist/populist governments to service their
external obligations. The political problems in
Ecuador also highlight the inherent instability of
the Andean zone: for example, the expansion of
narco-fueled guerrillas across the Sierra region,
the uncertain future of the US military base in
Manta, and border relations among Colombia,
Ecuador and Venezuela.
Serious
manipulations in the Latin American bond market
are also reducing the level of transparency of the
asset class - making conditions unstable. There
are the rumors that the Venezuelan banks and
government agencies may be the principal buyers of
Ecuadorian bonds and credit-linked notes, and what
we may see is an abrupt reversal in
President-elect Rafael Correa's rhetoric -
producing a huge windfall for the holders of
Ecuadorian risk.
Not only is Venezuela
exercising its clout through the financing of
leftist political candidates, it is deploying its
vast economic resources in nefarious ways. There
are overt and covert market operations that are
sending powerful shock waves through the emerging
markets. The overt ways include the placement of
Argentine bonds through the Venezuelan banking
system as a way for the Argentine authorities to
access the international capital markets without
having to deal with the holdouts and for the
Venezuelan banks to avert capital controls. The
covert ways include the activities of the
so-called "velvet glove", the shadowy figure
operating out of Geneva that initially squeezed
the Argentine Pars and later made an equal move
against the Argie Discounts.
All of these
conditions make the market vulnerable for a
pullback. A correction would not be bad for the
emerging markets. A respite would allow investors
to define support lines for the major indices. It
would allow new entry points for investors who
were sitting on the sidelines.
Fundamental
conditions in the emerging markets are good, but
the momentum is frothy. Some commentators compare
the emerging markets to the "Eveready Energizer
Bunny" that "keeps going, and going and going".
However, the momentum can only be maintained as
long as the batteries are charged. Unfortunately,
batteries are not included, and there is a sense
that the juice in the existing units may be
running out.
(Copyright 2006 Walter T
Molano, The Emerging Market Adviser.)
