Remember the Emerging Markets
Looking at the US financial markets at the moment, it reminds me somewhat of a circus. It almost seems that the concept of market within the phrase 'financial markets' has been lost and the very cosy relationship between the banks and the Fed continues to determine monetary policy for the US and by extension the rest of the world.
It is important for Central Banks to remember that they are the regulators of the banks, in other words, they are the adults in the children's party and their actions should focus on driving the whole economy to a place of equilibrium and not simply focus on the financial sector.
Rather, they utter the usual comment that their remit is limited to monetary policy and not fiscal or government policy. While that may be the case, it does not help when fiscal policy and monetary policy begins to diverge.
Much ink has been spilt on the new stance of the Fed to begin increasing interest rates and I do not want to add to those discussion except to say that it is likely to result in a conflict between the policies of President Trump which are expansionist in nature and the tightening of credit conditions that will result from higher interest rates.
This is true on many levels and one of the levels interest rates can hinder the US is its effect in emerging markets where demand for imports still remain subdued and the US being one of the largest exporter in the world will find its ability to compete with China, Japan and the EU hindered by its higher financing costs which impacts pricing.
In my opinion, it is a mistake to begin to increase interest rates so early in a new presidency especially with several reforms on the way including business regulations and taxation. It would have been prudent for the Fed to allow the President to lead in fiscal policy and economic reforms and then monetary policy becomes like the icing on the cake as opposed to being the cake itself.
This is why I said earlier that their overwhelming focus on the financial sector continues to give them a blinkered view of the US and the global economy. Demand remains weak in construction, manufacturing, international trade remains subdued and retail demand still remains sluggish.
In addition to this, significant investments needs to be made in infrastructure in the US and around the world. I do not believe in the jobs report at all for many reasons and I do not agree that this should be a barometer that regulates monetary policy, it is far too simplistic.
The reason for all the sluggishness is the high debt levels of nations, municipalities, companies and individuals around the world and to increase financing costs before significant investments have been made in the US economy is very risky to say the least.
It would have been better to wait until 2018 when the new administration's policies have begun to take shape because it would be easier to increase interest rates when growth has become established than to have to cut it because investments have stalled as companies become unsure of the future.
As an emerging markets investor, the Fed's stance continues to leave people like me around the world baffled especially as emerging markets have had to contend with low commodities prices for the last three years and most are in the midst of diversifying their economies.
Having said that, I believe that this is the best time to invest in emerging markets around the world.
The IShares MSCI Emerging Markets ETF EEM is up 15.92% this year and the red line is the DBC Powershares Commodities Index Tracking Fund which is a broad commodities index tracking ETF and the depressed correlation between the two is clearly evident.
This next chart is the same emerging markets ETF compared to the S&P 500 and as is very evident, there is significant divergence between the two and going forward, we can see the SPX flattening while the emerging markets index continues to rise.
Having said that, simply running off to buy emerging markets shares is very risky because for many, conditions will get worse before they get better. I will say this is true for Sub Saharan Africa which is in a necessary period of transformation to become balanced and mature economies.
Investing in emerging markets require us to have the correct perspective because for example people compare the US to Sub Saharan Africa but when one puts these two in historical perspective, the US will be 241 years old this year while Ghana which was the first independent Sub Saharan country will be 60 years old.
Another region to avoid right now is South America, the three largest economies which are Brazil, Mexico and Argentina. All three of these nations are also in transition as they struggle to bring prosperity to their middle classes and political stability.
The regions that I am most impressed with right now are the CEE, MENA, Central and South East Asia.
This chart is the Central Europe, Russia and Turkey ETF CEE and as can be seen, it has now stabilized and is now beginning to experience growth.
This ETF has a number of critical drivers going forward, firstly within Central Europe, we are beginning to see significant productivity gains in the manufacturing and services sectors. Secondly, the CEE region which includes the Baltic States is fast becoming the European centre for IT innovation and technology.
In addition, we await to see the gradual removal of sanctions from Russia and at this point, I believe that this chart can move up to 52.72 and trade in that 50-55 range.
In conclusion, what makes emerging markets so attractive to me is value. It possesses real economic value and also financial value going forward but it is a patient game where the investor has to select wisely and wait patiently.
While the ETFs are a good way to access these opportunities, directly buying the securities are even better. Most of these nations have Stock Exchanges and issue sovereign and corporate bonds. These are worth studying and participating in for the profit and also to diversify away from the US financial markets which I believe is about to experience a bearish season as the reforms in business regulations, taxation and also government spending start to be implemented.
Over the next few weeks, I will be doing a detailed study of the emerging markets theme and showing how to identify the underlying drivers and structuring the investments to take advantage of these opportunities.
Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.