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Dave & Donald Moenning

Mr. David Moenning is a full-time professional money manager and is the President and Chief Investment Officer for his Chicago-based Registered Investment Advisory firm, Heritage Capital Management (...

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Emerging Markets Mess: Blame It On The Fed?

It is yet unclear as to whether or not the current mess in the emerging markets will morph into a full-fledged crisis (remember the fun of 1998?).

However, it is safe to say the focal point of the stock market remains the currencies, economies, and equity markets of places like China, Argentina, Turkey, South Africa and Brazil.

The problem for a great many investors, though, is the reason behind the decline remains unclear. Sure, everybody "gets" that it's all about the emerging markets right now. Yet, the question of "why" may be the real issue. And since the primary objective of this oftentimes meandering morning market missive is to identify the drivers of the stock market, we thought it might be time to try and answer the question.

Lagarde Nailed It

International Monetary Fund Managing Director Christine Lagarde is on record as saying that central bank easing in the U.S., Europe and Japan may be responsible for what she calls the ticking time bombs in emerging markets. According to Lagarde, the extraordinary policies may cause damaging, though unintended, consequences -- as low interest rates push investors to take on more risk - in places like the emerging markets.

"When the tide turns, and interest rates pick up again, these hidden dangers will be exposed to the cold light of day," Lagarde warned during a speech last April at the Economic Club of New York.

Thus it would appear Ms. Lagarde provided investors of all shapes and sizes with a very timely warning. 

Should We Really Blame The Fed?

At the time, it sounded like Lagarde was arguing against further QE from the central bankers of the world. However, given the U.S. economy has encountered a speed bump of sorts each spring for several years running, the call to give up on QE fell on deaf ears.

Related: Will the Worries Stick?

The IMF chief stated the free flow of cash coming out of the U.S. Central Bank, the Bank of England, the ECB and the Bank of Japan, was beginning to find a home in places like China, South Korea and Brazil.

The thinking was that the flood of capital helped boost the growth rates in many emerging markets, perhaps artificially so. Investors loved the high yields from emerging market bonds. Investors loved the growth rates seen in the emerging market economies (remember, this was before #GrowthSlowing in China was a thing). So the fear was that, if and when the QE cash flow spigot was turned off, each and every one of these countries could suffer.

You see, big capital inflows can (and apparently did) create pressures on exchange rates (i.e. the currencies of the emerging market countries). In turn, the free flow of money fueled very rapid credit growth. And we all know what happens when countries take on too much debt.

It's About the Money Flows

Again, while the comment is nearly a year old, Lagarde's words ring true today. She told the Wall Street Journal last April that the greatest worry for the emerging markets "is a sudden reversal of large and volatile capital flows that can bring down the economy with it."

Anybody care to guess what is happening these days in the emerging markets? Yep, you guessed it; "volatile capital flows."

With rates rising in the U.S. and the widely-held expectation that such a trend will continue for some time, those massive flows into the emerging markets seen over the past couple of years are now reversing.

Why invest in Turkey or Argentina when you don't have to any more, right?

They Tried to Provide "Guidance"

Before you start blaming Ben Bernanke and the Fed's "taper lite" for the trouble in the emerging markets, please keep in mind the FOMC has been yammering on about tapering for quite some time. If you will recall, it was May of last year that "Gentle Ben" first started hinting about tapering the QE bond buying program. As such, the fact that the Fed is now actually doing what it said it was going to do shouldn't come as a surprise to anyone, anywhere.

Things Don't Matter Until They Do

But did investors connect the macroeconomic dots here? Uh, no. Remember on Wall Street, things don't matter until they do -- and then they matter a lot. And apparently artificially inflated currencies in Argentina, Turkey and South Africa didn't matter. Well, until last week, that is.

Will these issues continue to matter? Is a 3.5 percent pullback in the S&P 500 good enough to convince the dip buyers to continue to do their thing? Or is this the beginning of the meaningful correction that many analysts have been warning of?

Again, time will tell. So stick around, because the slow and steady march higher that marked the stock market of 2013 appears to be over. Nope, it looks like investors may have to work a bit harder in 2014 for returns -- especially if they own any emerging market stocks or bonds (we don't).

Tags: Ben Bernanke Christine Lagarde

Posted in: Broad U.S. Equity ETFs Emerging Markets Emerging Market ETFs Markets Trading Ideas ETFs