February 20th, 2014
- Emerging economies have become a focal point for investors, as a handful of countries have experienced significant currency pressures over the past year. Some observers are questioning whether this development could be the precursor of a new bout of financial contagion.
- My own assessment is that a replay of the contagion that occurred in Latin America and Asia in the 1990s or during the euro-zone crisis is unlikely. The reason: Currency pressures have been confined to countries with large current account deficits and/or relatively high inflation. Moreover, the external imbalances, indebtedness, and inflation rates in most emerging economies are well below levels associated with previous crises.
- The risk of contagion cannot be ruled out entirely, however, as it is difficult to know how much leverage there is in the respective corporate sectors and banking systems. Also, a significant slowing of China’s economy or problems in China’s financial system would likely affect emerging economies adversely.
- In these circumstances, we believe investors need to pick and choose among emerging economies carefully: Compared to previous cycles when they moved up and down in tandem, we believe there will be greater differentiation of performance going forth.
Increased Pressures on Emerging Market Currencies
Over the past year there has been an ongoing build up in currency pressures for several emerging market countries. These pressures were linked initially to the Federal Reserve’s surprise announcement in May-June that it was contemplating phasing down its quantitative easing (QE) program of bond purchases. The announcement was accompanied by a surge in U.S. bond yields, and it spawned a wave of capital flight from countries that included Brazil, India, Indonesia, South Africa, and Turkey – the so-called “fragile five.” Read the rest of this entry »
January 29th, 2014
I wish to acknowledge the contribution of Zulfi Ali, Fort Washington’s emerging market specialist.
- Following very strong performance in 2013, global equity markets have sold off by about 4% since the beginning of this year, mainly due to worries about emerging economies. The catalysts for last week’s sell-off were currency depreciations in Turkey and Argentina and concerns about a looming slowdown in China.
- Economic news in the United States, by comparison, suggest fourth quarter growth was strong — in the range of 3%-4% – while Europe and Japan showed continued improvement. Nonetheless, the respective equity markets have retraced some of the gains at the end of 2013.
- Looking ahead, we expect the Federal Reserve will announce an additional $10 billion cutback in its quantitative easing program at this week’s FOMC meeting. This could place additional pressures on some emerging economies.
- We are monitoring these developments but have not altered our portfolio positioning, as we believe the recent market moves reflect a shift in investor sentiment more than a change in underlying economic fundamentals. Read the rest of this entry »
January 14th, 2014
As the New Year gets under way, consider the mixed emotions of investors today: Equity investors are jubilant, after the U.S. stock market returned more than 30% in 2013; however, their fixed income counterparts are frowning, as Treasuries and investment- grade corporate bonds posted small losses (see Figure 1). Globally, international equity markets generated stellar results with the EAFE Index returning nearly 23%; however, emerging markets fared poorly with the MSCI Index negative for the year. All of this occurred against a backdrop of continued moderate growth of the U.S. and global economy, a lessening of tensions in the euro-zone and tremendous uncertainty about the conduct of U.S. fiscal and monetary policies. Click here to read more
November 25th, 2013
- The Chinese government unveiled a series of proposed reform measures at the conclusion of the third Plenum of the Communist Party Central Committee. They serve as a blueprint for policy changes that grant market forces the determining role in China’s development over the coming decade.
- The reforms are truly comprehensive and far reaching – covering not only economic, but also political, cultural, social, environmental and national security issues. I have focused on the impact of the market-oriented ones and whether they will enable China to sustain relatively strong economic growth.
- After reading a variety of assessments, my take is that the reforms, if successfully implemented, will improve China’s overall economic efficiency. As such, they enhance the prospects for China to transition to more sustainable growth and are a positive development for the global economy and markets.
- There are also challenges ahead: Most notably, liberalization of the financial system, while necessary, could uncover problems with overly-indebted institutions. While skeptics believe this will spawn a crisis, the history of China’s reforms is to proceed gradually, which should lessen the risk.
Background on Chinese Economic Reforms
The origins of China’s economic miracle are rooted in a series of reforms that were implemented by Deng Xiaoping in the late 1970s. Deng’s vision was to transform China’s centrally planned economy into one that was more market-oriented, but which retained a prominent role for the central government in overseeing the evolution. The approach was to proceed by implementing a series of experiments with various sectors and studying the outcomes, rather than embarking on “shock therapy” as some Eastern bloc countries did after the collapse of the Berlin Wall. Read the rest of this entry »
November 5th, 2013
- The wrangling over the U.S. debt ceiling and the ensuing snafu over the government’s healthcare website has brought the launch of Obamacare to the fore. While the debate between the two political parties is largely a philosophical one about the role of government, investors eventually will be weighing its impact on the economy.
- Two issues are of particular interest: (i) Will Obamacare succeed in slowing escalating medical costs? and (ii) Will it encourage employers to shift more workers to part-time status to lessen the associated insurance costs?
- My own take is that it’s very questionable whether Obamacare will increase healthcare productivity and curb rising medical costs. More likely it will shift the burden of who pays to make the program “affordable.” At the same time, I doubt it will boost the share of part-time workers materially, as critics contend. That said, it is too early to form definitive conclusions considering the program is just being rolled out.
Background on Obamacare
When the Patient Protection and Affordable Care Act (PPACA, also known as “Obamacare”) was passed in March of 2010, the stated objectives were to make healthcare coverage more secure and reliable for Americans, make coverage more affordable for families and small business owners, and reduce skyrocketing healthcare costs. The Act recognized that more than 45 million Americans lacked access to affordable health insurance, and many who had insurance were not covered for pre-existing conditions. Read the rest of this entry »
October 22nd, 2013
In a pattern that has become all too familiar, the two political parties were able to reach a last minute agreement to reopen the government until January 15 while extending the debt ceiling until February 7. While markets rallied on the news that a technical default on Treasury debt would be averted, most people were left wondering if there will be a repeat of this month’s saga early next year. That possibility certainly exists, as Senator Ted Cruz and other Tea Party members have made it clear defunding ObamaCare remains their top legislative priority.
Nonetheless, I suspect there will be less brinksmanship in 2014 for the following reasons: Read the rest of this entry »
October 16th, 2013
- It now appears the two political parties may not reach an agreement to extend the debt ceiling before October 17, when the U.S. Government no longer can issue new debt to finance its obligations. Despite this, financial markets remain remarkably calm.
- There are two reasons: (1) investors understand the Government has flexibility to service its debt until the latter part of this month; and (2) they also believe the political leaders will reach a compromise before then to extend the debt ceiling into early 2014.
- The risk, however, is that politicians could miscalculate and wind up with a technical default (or missed payments). If so, it could unleash ripple effects in money markets and short term funding vehicles, as the use of short-term Treasury debt for collateral would be hindered. Consequently, we have eliminated any exposure to near-term Treasury obligations.
- Given the fluidity of the situation, we will send out updates as circumstances dictate.
Negotiations May Extend Beyond October 17
In a script that could only be written for television comedy, the two political parties may not reach an agreement to extend the debt ceiling before October 17 – the date when Treasury Secretary Lew has indicated the U.S. Government runs out of “extraordinary measures” and can no longer issue debt to finance its obligations. While the Senate is drafting a bill to re-open the government and extend the debt ceiling deadline until early 2014, reports we are receiving indicate negotiations with the House of Representatives will likely drag on over this weekend. Read the rest of this entry »
October 14th, 2013
With investment results now in for the third quarter, the odds are 2013 will go down as an exceptional year for the stock market and a poor year for the bond market: Year-to-date returns stand at nearly 20% for the S&P500 Index and minus 1.9% for the Barclays Aggregate Index. During the third quarter, financial markets greeted the Federal Reserve’s announcement that it would delay tapering its quantitative easing (QE) program favorably. The stock market set a record high in mid-September and went on to post a 5.2% quarterly return, while the bond market rallied on the news and ended the quarter on a positive note Read the rest of this entry »
September 24th, 2013
- Equities and other risk assets rallied following the Federal Reserve’s surprising decision to delay the start of its tapering program. Amid the euphoria, investors are now left wondering what the Fed’s game plan is.
- Chairman Bernanke cited two reasons: (i) financial market conditions are less supportive of the housing market; and (ii) a fiscal showdown in Washington poses a threat. My own take, however, is these reasons are not compelling for it to have rejected a modest reduction in bond purchases.
- The decision achieved one important objective – namely, it helped convince market participants that the Fed is in no hurry to tighten monetary policy. While some observers believe the Fed’s credibility has been hurt, the test of its willingness to risk higher inflation will occur when the economy gains traction.
- In the wake of the Fed’s decision we are increasing exposure to investment-grade corporate bonds in fixed-income portfolios, but we are not altering equity portfolios or our stock-bond allocations.
Factors Influencing the Fed’s Decision
The announcement that the Federal Reserve would continue purchasing $85 billion of bonds on a monthly basis surprised the markets, considering that three months earlier Chairman Bernanke indicated the Fed was contemplating scaling back the program later this year and eliminating it by mid 2014 if the unemployment rate fell below 7.0%. The consensus view was the FOMC would likely begin the tapering process in September assuming the economy and job picture did not deteriorate, although some commentators thought the Fed would hold off for a while. Read the rest of this entry »
September 13th, 2013
- Five years after the onset of the worst financial crisis since the Great Depression, the Fed’s program of quantitative easing (QE), which was the focal point of this year’s Jackson Hole Economic Symposium, remains highly controversial. The Fed’s leadership believes QE has bolstered the U.S. economy, but the program has been questioned by academic economists and policymakers abroad.
- My own take is the initial round of Fed purchases of Treasuries and mortgage backed securities in late 2008-early 2009 was pivotal in stabilizing the financial system and establishing the preconditions for economic recovery. However, subsequent purchases of securities appear to have been less effective in stimulating the U.S. economy.
- The next test of the program lies ahead, as the Fed is expected to begin tapering its monthly purchases of securities by $10-$15 billion. The most likely outcome is that bond yields will rise by about 50 basis points over the next year as the economy gains traction. However, the risk of more significant increases in bond yields that could hurt housing and soften the economy cannot be ruled out.
Two Phases of Quantitative Easing
The theme of this year’s Jackson Hole conference sponsored by the Kansas City Fed was “The Global Dimensions of Unconventional Monetary Policy.” It turned out to be very timely as market participants are now focused on a looming cutback (or tapering) in the Fed’s asset purchases. Several of the academic presentations challenged the Fed’s contention that asset purchases have been effective in promoting stronger economic activity, and other presenters argued the Fed should take into account the external impact of its policies, especially the spillover effects on emerging economies. However, no consensus emerged on these issues, and there was no broad-based review of the quantitative easing program. Read the rest of this entry »