The year has started with markets struggling for momentum as investor sentiment appears to have been dented by the tapering of quantitative easing (QE) in the US and subsequent pressure on emerging markets.
It was always expected that in an environment of reduced QE and the perceived momentum in interest rates in many developed markets moving higher, some emerging markets with weak politics or poor economic fundamentals would struggle.
The wave of cheap liquidity from central banks since 2009 has helped investors to ignore these issues. As the tide goes back out, albeit slowly, we are now discovering which countries are vulnerable.
There have been a number of issues that appear to have combined to send sentiment lower: slowing economic data from China and concern about the shadow banking system; politics in Ukraine, Turkey and Thailand; and pressure on emerging market currencies caused by what Brazilian finance minister Alexandre Tombini called the “vacuum cleaner” of flows towards developed markets on the prospects of higher interest rates. Turkey and Argentina have seen the brunt of the currency pressure, but Russia, Brazil, Indonesia and South Africa have also seen their currencies on the slide.
Emerging markets have struggled to perform since the US Federal Reserve confirmed the reduction of its bond buying programme back in December, but now we are seeing real pressure on currencies, particularly those in countries seen as having weaker politics, current accounts, low currency reserves, poor economic fundamentals or a combination of these factors.
The Turkish central bank spent $3bn (£1.8bn) – roughly 7.5 per cent of total reserves – in a day attempting to prop up the currency and has now opted for aggressive interest rate hikes.
Meanwhile, the Argentine central bank appears to have decided to let the Peso slide to avoid depleting its currency reserves of approximately $35bn too rapidly. We have also seen interest rate hikes in Brazil, India and South Africa aimed at both supporting the currency and suppressing inflation.
Chinese economic data continues to slow, with PMI data falling below the line that marks expansion from contraction.
This year has not started particularly well, with most markets struggling to go above their year-end cycle highs. Going into 2014, there seems to be plenty of complacency around, with investors expecting a repeat of 2013. With QE tapering in place thanks to improving economics in the US, other countries with political or economic weaknesses are being singled out.
Any significant hiccup in emerging markets will have consequences elsewhere and this is why equity markets are struggling to make ground. Recent economic data has been reasonable, but has not met elevated expectations in many cases.
Our view remains the same – broadly positive on the economics, but concerned that a lot of the good news is already priced, which means market levels have looked a little frothy. We still think progress will be made overall this year, but a correction or an extended period of markets going nowhere would not be surprising.
