Emerging Markets' Woes Only A Side Effect Of Conditional Strength

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Includes: DIA, EEM, FXI, IWM, QQQ, SPY, VWO
by: Carlos X. Alexandre

Summary

Emerging markets mindset is the obstacle.

China's on track to irreversible political collapse.

Markets' behavior goes beyond Russian/Ukrainian squabble.

Once in a while we embrace emerging market mania with lines like "there are a few gazillion people out there that want washing machines, automobiles and popcorn to go with Hollywood special effects." Yes, we all want our MTV, but it is not that simple! Greece has twenty times the population of Luxembourg, yet they're economic worlds apart, with Greece's GDP only six times that of Luxembourg, and they've been around for a long time, operating in the same markets. Perspective is everything, and in this case it goes well beyond economics. While there are always opportunities in the most remote locations of the world, knowing the limitations goes a long way toward investment decision making, as contrasted with the blah-blah-blah du jour emanating from some people that can't tell a croissant from a corsage.

One of the questions that I always ask, because political incorrectness is my middle name, is "Why did Vasco da Gama find its way from Portugal (my birthplace) to India by sea, and not the other way around?" Why is the Japanese word "arigato" derived from the Portuguese word "obrigado (means "thank you") and not the other way around? And what drove those sailors to find themselves 7,000 miles from home, and more, traveling on 84 foot long ships without GPS, while at the mercy of the winds? These are the mild, somewhat superficial questions that always cause people to lose their tongues!

The Portuguese were the first to reach Japan, a hell of a trip by sea that trivializes our complains that a 12-hour flight from Los Angeles to Tokyo is agonizing. Needless to say, the Portuguese, as a nation, have lost their way, and suffer from a complex of inferiority and a new found sense of entitlement. The problem? Where they used to think big, now they think small; where risk taking ruled the day, the lack of creativity, safe playing and complacency, especially during good times, became the norm. That mindset afflicts all emerging markets. When I tell a Portuguese citizen the exact same words, he or she will concur, but when an outsider conveys the same opinion, he/she will be scorned and insulted. As an example of looking big but thinking small, Saudi Arabia will build the world's tallest tower, which will measure 3,280 feet. Why do they do this, in a country with plenty of domestic problems? Because they have nothing else to show for, and have been thinking small ever since they found oil 76 years ago.

Recently Dr. Raghuram G. Rajan, Governor of the Reserve Bank of India, delivered a speech which centered on "the conduct of monetary policy in this integrated world." The point being missed is that the world started its integration process when Vasco da Gama arrived on Dr. Rajan's shores, and after 500 years we're still looking for scapegoats abroad that mask internal deficiencies.

America is often disparaged, not to mention envied, and despite its flaws, it grew from nothing to be the only world power, not empire, in a little over 200 years. Why would one think that China would take over, having been around for over 5,000 years and still feeding off the dollar store? Only misplaced pride, intellectual blindness or an undying state of denial would subscribe to such an erroneous theory. Must one be so politically correct, and factually incorrect, that one becomes utterly useless in a quest not to offend at any cost? What the vast majority doesn't understand is that, unlike homogeneous nations, America is a hybrid society, built by hungry, risk-taking individuals, where cultural alliances and bad habits ultimately play second fiddle for the greater good.

When culturally driven sensitivities take front stage, which has nothing to do with respecting one another, we get into trouble, and the biggest threat facing the U.S.A is complacency and safety, not to mention political correctness. One may dislike the facts, but that doesn't change the facts. We spend far too much time avoiding verbal conflict for the sake of harmony, which is extremely detrimental to the advancement of civilization. Constructive and factual criticism is a painful blessing.

The objective here is to simplify, not complicate issues, because if something cannot be deconstructed into understandable components, there's something amiss. Remember Mortgage Backed Securities and CDOs whose risks nobody understood, including the creators? In the world of finance everyone seeks to put in $1 and take out $1.10, and it doesn't get much simpler than that. Throw in mind boggling analysis, overly complex formulas that blur the horizon and excuses to mask shortcomings, and one knows that there's trouble ahead

Since we're on the emerging market topic and to illustrate another facet of the mindset, let's capture a bit of healthy humor, especially because it is derived from the words of a highly visible, pretentiously illustrious and clueless bureaucrat. I'm referring to comments by Christine Lagarde, the IMF's head, as it relates to the U.K.

Britain is still too reliant on consumer spending to drive growth and further action is needed to foster stronger exports and investment to ensure the economy is "three engines powered", according to the head of the International Monetary Fund.

Obviously Ms. Lagarde believes that an economy should always be dependent on outsiders, and the problem in the U.K., as she sees it, is that "at the moment [the recovery is] predominantly driven by consumption," as in domestic. One cannot make this stuff up! What does this lady think drives the global economy? It's American and European "domestic" consumption, and for the uninitiated and economically confused, exports must become the icing on the cake, not the perpetual cake itself.

Remember the currency crisis of 1997 that affected Asia's emerging markets? Seventeen years later they're still "emerging," akin to a scratched vinyl record where the crescendo suddenly skips back to the beginning and then repeats in a loop. The glaring truth is that emerging markets feed off demand from developed nations, while failing to develop their domestic economies during good times.

It wasn't long ago that the BRICs -- Brazil, Russia, India and China -- were meeting as if the rest of the world didn't exist, discussing how they would rise above everyone else due to their new found economic power, while fueling talk of a new world order. Nope, the Earth is still round and the order is intact, and will remain so for decades to come. A BRIC here and a BRIC there, and before we knew it, an indestructible house would be built, although it lacked a foundation. Common sense would see it, but common sense is not as common as advertised. Well, now they're cringing and complaining only because they're not BRICs, as I've pointed out before; they're CRIBs, as in economic infants still in need of their bottles, security blankets and pacifiers. The emerging market song and dance is a fallacy because it fails to understand the root causes of why these countries are what they are. Once that riddle is solved in the privacy of one's thoughts, one will understand the economic dynamics of the world we live in.

There isn't a reliable definition of what constitutes an emerging market, and one could establish that unless a market's socioeconomic landscape is stagnant, a market is emerging. From "what" and to "where" is another story. Despite China being the world's third largest economy and the poster child for emerging markets, China is highly dependent on outsiders and no different than all others in the group. Thus, knowing the economic health metrics of its external economic supporters is far more important than knowing about China itself, although plenty of internal wheels keep turning, paving the way for the irreversible Chinese political collapse in about seven years.

China's "think small" mindset is best illustrated by the headline "Chinese automaker blatantly copies Ford F-150," a two wheel drive truck with a choice of an 140 hp gasoline or 105 hp diesel engine, and a top speed of 80 mph. Although the specs are almost silly, that is not the problem, but rather the "copying" and lack of originality which is pervasive and the modus operandi throughout Chinese industry.

As a quick side note, every month we get the official and Markit's HSBC China manufacturing PMI, and there's always the excuse that Markit's reading is less reliable, especially when the number is low, because it is "biased towards small and medium sized enterprises," according to Bank of America economist Ting Lu. Based on Markit's response, Lu's assertion is nonsense.

The structure of our PMI survey panel is defined by industry sector and company size as determined by the latest available value added data from the Chinese National Bureau of Statistics (NBS). As such, there is no bias in our sample to small and medium sized industries over large sized companies. Our panel covers small, medium and large sized companies in the proportions determined by the NBS data on value added.

So how's China doing, the largest emerging market there is? Li Ka-Shing, Asia's richest man, just sold Pacific Place shopping center in Beijing, and will be left without "any major property investments in mainland China." In short, "Li wants out of China. All of it." Meanwhile, a report highlighted that "China's bad-loan ratio rose "significantly" in the first quarter, increasing risks for the nation's banking industry, according to the nation's largest manager of soured debt," as Premier Li Keqiang is rushing to introduce deposit insurance, "meant to comfort the nation's savers as bad loans mount." Other issues, such as the headline "China: 20% of our arable land is polluted," illustrate how "thinking small" eventually catches up with you. And why the anti-graft campaign, as if the elite ever cared about anyone but themselves? Soothing the populace. Then, "China party mouthpiece says no Internet freedom without order," which means they're struggling to contain the discontentment. But the most telling development, as it pertains to domestic issues in China, was reported by WSJ.

Police forces here started carrying firearms for the first time in six decades in a program several Chinese cities plan to replicate in response to growing fears of violence from crime and terrorism.

Call it what you may, but there's something emerging, and it's not a market!

While every central bank is still convinced that they have the power to solve the global economic ills, the new idea put forth is that there should more cooperation on monetary policy on a global level. But that assumes that everyone would forego their best interests and play by the rules for the greater global good, and we know how that always plays out. I suggest that BRICs should get together again and move forward with their plans, whatever they are, rehashing old opinions that have been shaped by the same intellectual funnel. Please do so now, because the U.S. economic decline will gain momentum after Q2-2014, while global conflicts will expand, and nothing is priced in.

On the market front, interesting developments have taken place over the past couple of weeks. On April 24, as the markets were getting ready to celebrate Apple's (NASDAQ:AAPL) earnings, a tense 30 minutes ensued after the open with a sudden reversal of fortune due to elevated tensions between Ukraine and Russia, or so we're told, which is only a minor regional squabble and only the precursor of bigger and unpleasant things to come. June gold futures quickly reversed to the tune of $24 in 20 minutes, pricing the ongoing instability and war risk -- the real driver, not inflation and all the balderdash. False alarm, it turned out. Then the trip south resumed on Friday, although not quite sure why because nothing had materially changed. On Monday we had a repeat, which was reversed by reports that Russian troops were withdrawing from the border and returning to their bases. But declines among the majors in the Nasdaq 100 (NASDAQ:QQQ) have nothing to do with Ukraine -- we'll still watch Netflix (NASDAQ:NFLX) -- and the Russell 2000 (NYSEARCA:IWM), as most everyone has noticed, continues to bend over. Now put your thinking caps on, you bright bunch, and start processing the data.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.