The Screaming Pen

Providing Global Insight, Context, and Perspective

The Stampede of the Global Herd

Yesterday marked the eleventh day in a row that the MSCI Emerging Markets Index fell, an event that has not occurred since August 13, 1998, the very same day that Russia defaulted on her foreign debt. Russia’s debt default marked the spread of the Asian Contagion, a financial crisis that swept across Asia after the devaluation of the Thai Baht. This time it appears that things are much different, as the fundamentals of many emerging market economies appear quite strong. And although Indian Brokers, who witnessed shares drop more than ten percent before the government intervened yesterday, will probably not find solace in solid fundamentals, it appears that the current drop in the emerging markets is due to investors fleeing risky assets in the face of a global tightening cycle, possible inflation, and cooling global growth. And although some investors are losing their shirts, it appears that this may be a price correction, not a crisis.

Seeing Red

Come On, Let Me See Ya Grill

Wait and See

While yesterday’s returns marked the end of an eleven day downturn in the emerging markets, it still did not end the doomsayers from predicting that today’s economic conditions are similar to either 1) the conditions preceding the October 19, 1987 crash or 2) the conditions that led to the Asian contagion. This could not be further from the truth, as there are crucial differences between now and 1987. In 1987, stocks were pricey, and treasuries were quite cheap. Today, equities are historically cheap, with investors paying a premium for treasuries. This is important because if investors flee equities all together, which would be required for a crash, they would have to pay a premium for treasuries as housing is showing signs of cooling, and the dollar is relatively weak. The spread of the EMBI+ to the Ten Year U.S. Treasury note still remains at close to record tights, signalling debt investor’s continued confidence in the fundamentals of the emerging markets. In 1998, the spread widened sharply, signalling falling confidence in the emerging market economies.

Conclusions

Although this is probably not a crisis, it could signal a change in investor sentiment, especially as monetary policy tightens worldwide. The managers of Large Cap mutual funds, some of whom have been predicting a return to their asset class for the past several years, may finally get their wish as investors may continue to flee assets that love loose liquidity such as emerging market stocks, commodities, housing, and small capitalization stocks. It will be important to keep an eye on the international markets, along with less risky asset classes that may benefit from the global herd fleeing risky assets in favor of traditionally safer bets. If there is not a change in sentiment, however, this may be a great buying opportunity.

-JPL
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May 23, 2006 - Posted by | Asia, Author: JPL, Emerging Markets, Financial Markets, Investing, World Markets

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