Some people think it was the 15% drop in the peso that triggered the recent selloff in the emerging markets… and back in the US of A.
On the last two days of the week, the Dow lost nearly 500 points. And on Saturday, after-hours trading signaled worse to come. It looked as though the Dow would drop more than 300 points when the doors opened on Monday.
That didn’t happen. Instead, the Dow fell just 40 points.
So, we sit tight, wondering if the beginning of the end is coming now… or later. And when it happens, we won’t blame Argentina.
Argentina seems much too quirky and particular to be a leader of anything. For example, it’s the only place we know where you get better banking services out on the sidewalk than in the bank.
Every time we go we take a big wad of green pieces of paper with Ben Franklin’s picture on them. Driving directly to the town square in Salta (close to the family ranch), we then simply stop the truck and beckon over one of the many black-market moneychangers standing in front of the bank.
This time a year ago, one Ben Franklin would bring you nine pieces of paper with former Argentine president Julio Argentino Roca’s picture, in purple.
Roca was no match for Franklin. Reports from Salta tell us that the rate has gone over 13.
The official rate changes, too. It was only five Rocas to a Franklin a year ago. As of last Friday, it is 8. But wait… There are more official rates. There’s one for savers – 9.2. And one for travelers – 10.8.
Printing Money to Pay the Bills
Why so complicated?
It’s a long story. But the simple version is that the city of Buenos Aires is big and sophisticated. And like New York or San Francisco, it has socialist tendencies.
Here’s how it works: The urban intelligentsia provides the ideas. The urban proletariat provides the votes. And farm exports provide the money.
But the rural productive sector can never quite provide enough money to satisfy Buenos Aires’ longings. Farmers and other producers labor under such binding restraints – such as import/export restrictions – that even in a roaring bull market, such as we had three years ago, Argentina lost agricultural market share.
Now, without much money coming in, the government prints money to pay its bills and lies about inflation. The money supply in Argentina has been increasing at a rate of about 40% a year. And yet, the keepers of Argentina’s official numbers maintain that consumer prices have been rising less than 10% a year.
When everyone had caught on that prices were obviously rising much faster than a 10% annual clip, the Argentine feds tried to control prices… as well as the statistics that measure them. Last year, they enacted a ‘voluntary’ price control measure at the supermarkets.
Keynes from a Marxist Perspective
This was the work of Argentina’s 42-year-old minister of the economy, Axel Kicillof. He is probably a decent guy. He taught economics at the University of Buenos Aires. The papers say he “reinterpreted Keynes from a Marxist perspective.” With this intellectual toolkit, he says he has the leaks under control.
Most likely, our man on the scene, Miguel, has a clearer picture. He reports:
“I dropped my Kindle reader and broke it,” he reports. “I wanted to order another one from Amazon. But the government just announced a 50% import tax. That’s in addition to the 35% penalty I would pay on credit card purchases from overseas. You also have to go to [an office of the tax collector] and wait for hours to do the paperwork. It’s not worth that much.”
So, Amazon lost a sale. And the Argentine economy lost a connection to sanity.
“This is just the beginning,” Miguel continues. “We’re headed into another real crisis. The people are restless and the government is desperate. We’ve got major union negotiations coming up. It wouldn’t be at all surprising to see riots… looting… and some kind of bankruptcy or default.”
Why We Love Emerging Market Pessimism
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
The big selloff in emerging markets has been the subject of much debate at Bonner & Partners Family Office, the family wealth advisory where Bill is Chairman and where I serve as Investment Director.
Our Chief Investment Strategist, Rob Marstrand, sent me this note yesterday:
Interestingly this emerging market sell off was triggered by the devaluation of the peso in Argentina. Interesting in that there is absolutely no connection between the Argentine government’s inflationary economic policies and other emerging markets – just a knee-jerk reaction.
Rob lived for many years in China. He now lives in Argentina. So, he knows what it’s like on the ground in the emerging world.
But I am less sanguine about this interpretation of events.
The switch flipped on emerging markets in 2012, not in 2014. The emerging markets were in a bull market for about 12 years prior to that. Capital flowed from the developed world to the developing one. Now, we’re seeing big outflows from the developing world again.
Emerging markets may be down 6.9% already in 2014 – their worst start to any year since 2009. But since the Fed started hinting at tapering QE in May last year, emerging market stock valuations have slid by nearly $1 trillion… for a drop of -11%.
So, clearly the recent selloff is part of a wider trend.
There are plenty of plausible fundamental reasons why emerging markets have been doing so poorly of late.
There’s the slowdown in China and worries over a collapse of the shadow banking system there, following a string of trust-product defaults.
There’s the big slide in the Turkish lira, which led the Turkish central bank to hold an emergency meeting last night.
There are strikes at three of the world’s largest platinum mines in South Africa… and weakness in the South African currency, the rand.
There’s also political turmoil in Thailand, Egypt and Ukraine.
And, of course, there’s the big devaluation of the Argentina peso, which recently hit a 12-year low against the dollar…
In short, there are plenty of reasons to worry about the near-term future of many emerging market economies.
But that doesn’t mean you shouldn’t invest…
As our friend and emerging market specialist Karim Rahemtulla asks in his book on the emerging markets, Where in the World Should I Invest:
How do you identify an emerging market? On the ground, it’s quite easy. The bathrooms smell, you can’t drink the water and if there’s smoke in an elevator, likely you’re the only one coughing. Those are the signs of opportunity!
Most investors forget it, but the problems in the emerging world create opportunities to buy corporate earnings streams at steep discounts to earnings streams in places such as the US, Europe and Japan.
If these problems didn’t exist, the emerging markets would be priced just like developed markets… and the profit motive would disappear.
The silver lining for long-term value investors (and we count ourselves among them) is that the emerging markets now trade on a forward P/E of 11 versus a forward P/E of 17 for the S&P 500.
This gives you an opportunity to heed the words of the great pioneer of stocks analysis, Benjamin Graham, who said: “Buy when most people… including experts… are pessimistic, and sell when they are actively optimistic.”
As I said yesterday, don’t back up the truck on emerging market stocks. Tread lightly. And stay diversified.
But don’t be put off by the wailing and gnashing of teeth over the future of emerging markets. To a seasoned value investor, this spells opportunity.