From 1/25/2014-
In light of the weakness experienced in US markets at the end of the week, I wanted to explore the potential danger areas in the global economy to assess where the current risk to financial markets and the global economy lies. In this article, I will analyze the relative demand for various emerging markets and currencies.
Argentina and Turkey
One of the rumors circulating the web is that Turkey and Argentina are experiencing a potential financial crisis. As you can see below, relative demand for Turkish equities (TUR) is plummeting to 2008 levels relative to global equities (VT). This chart verifies the current weakness of Turkish markets relative to the rest of the world. ARGT is the only Argentina specific ETF, but it was started after the 2008 crisis. However, we see that ARGT is still in a downtrend relative to the rest of the world equities since its start of trading. In order to compensate for the lack of a long term Argentina ETF proxy, I then pulled up the Brazil (EWZ), Chile (ECH), Latin America (ILF), and Frontier Markets (FRN) (with majority holdings in South America) to see their status. Alarmingly, as we can see from the blue trend lines below, the entire region has been experiencing weak demand relative to global equities. All the slopes are almost the same, with Argentina's slope showing the steepest downtrend. Its worth noting too how steep Turkey's downtrend is since mid-2013, which indicates rapid investment withdraw from the region.
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Why is this set of charts important? Well, it means money is flowing out of these countries and the Latin America region in general. If countries suffer a decrease in relative demand, it is safe to say that investors are concerned about the economic conditions of those countries and are putting their money elsewhere, seeing both a reduced reward to risk ratio in investing in the weakening countries and bluer skies elsewhere.
What About the BRIC?
Since Brazil is showing weakness and is also a member of the BRIC group of emerging economies, I decided to check the relative demand of the other BRIC countries, Russia (RSX), China (FXI), and India (EPI), to see if weakness is also present there.
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Sure enough, the other three BRIC member countries are also underperforming the global markets. The negative reaction to the decrease in China's manufacturing output this month makes sense in light of China's already weakened performance relative to the rest of the world. Moreover, we see both India and Russia also in a sustained downtrend. Interestingly, even though Japan is considered a developed nation, it too has been underperforming the global markets. Note: I have included a graph of American equity relative to the world as a comparison for what a country showing strong investor demand and performance looks like. As we can see, its graph is almost an inverted version of the other countries, reflecting investor confidence and demand for US equities as the US economy recovers and shows strength.
The MINT too?
Having looked at the BRIC countries, I then pulled up the MINT group, nations at a similar stage of economic development. Turkey is a member of the MINT, as well as Mexico (EWW), Indonesia (EIDO), and Nigeria (NGE). I have also included South Africa as it also is sometimes associated with this set of nations. Interestingly, we see parallel shorter term downtrend. Since late-spring 2013, the MINT countries have also seen a drop in relative demand, joining the BRIC nations. Putting the BRIC and MINT charts together, we see an overall weakness in many of the emerging financial markets. The emerging markets are in trouble, as widespread risk and lack of investment demand has spread through the major emerging markets. Could this be the global contagion that could spread to the US, an emerging market caused downturn or recession?
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Further Signs of Low Confidence in the BRIC: Currency Values
One of the downward pressures on relative currency values is a reduced faith and confidence in the government or economy of a nation. Fears over economic troubles in less developed nations particularly causes a run on that countries currency as the domestic currency is traded for currencies of perceived higher value and safety. The reason I am looking into currencies is that one of the rumors about current risks is a potential currency crisis in emerging markets. Unfortunately, the chart below confirms weakness in emerging market currencies (CEW) including the BRIC nations. For comparison, we can see the more healthy chart of developed markets currencies (DBV) as shown by the green line. Even though I do not have ETF proxies for these currencies, the Turkish Lira and Argentine Peso are losing value at an alarming rate. (see: http://thekeystonespeculator.blogspot.com/2014/01/argentine-peso-and-turkish-lira-fueling.html).
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One potential ray of hope for the situation is the relative quiet of the value of the US dollar (UUP). As we can see from the purple lines, the value of the US dollar spikes rapidly during times of economic crisis as the US dollar is seen as a safe haven currency and investors panic and rush to cash (something that should still be seen in a crisis considering the United States relative economic strength). Such a spike is not present as of now, signifying that global markets are not at a crisis point yet. Gold (GLD) and treasury prices (TLT) are picking up, reflecting short term fears that are coherent with the US stock market's recent drop, so worry is present, though not panic.
Further Issues with the Global Economy: Weak Commodity Demand
Another chart worth looking at is the price of commodities relative to the US dollar. This sort of chart can serve as a proxy for both inflation and, more importantly, economic demand for raw materials, the stuff that comprises the stuff economies thrive on. So what does the chart say?
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Since a local top in the first half of 2011 (sound familiar to the BRICs?), commodity prices have been dropping relative to the US dollar, forming a symmetrical triangle that likely indicates a major trend is about to begin in the next weeks to months. The trick about symmetrical triangles is they do not necessarily privilege one direction of change or another. This stockcharts.com article claims about 75% of all symmetrical triangles are continuation patterns, meaning commodity prices may be set for a leap upwards in continuation of the uptrend started in 2009, or interestingly from uptrend present before the 2008 financial crisis (depending on how you draw the triangle).
Another hint that commodity prices may be set for a leap is the positive divergence present in the technical indicators as marked by the green and red lines. However, an upwards move is not guaranteed and markets are indeed at a crossroads. US equities are already diverged from commodity prices, which is unusual as both asset types typically move in tandem. The divergence in an historical relationship typically demands a reversion to restore the relationship. Thus, if commodities fail to the downside, US markets will not be able to escape the gravity of decreasing commodity prices, which would also coincide with a global economic downturn. Alternatively, if commodities jump upwards, the relationship will be restored to the upside, supporting further US equity price appreciation.
It is interesting to consider this chart in relation to the currency analysis down above. A failure of the symmetrical triangle to the downside would coincide with a spike in the value of the US dollar, precisely what is currently lacking in the currency charts. However, we can predict that if a global financial crisis does occur, this triangle will fail to the downside and the dollar will spike as in other times of crisis. The markets are really at a crossroads considering the emerging market currency issues and weakness in commodities put together.
Where is the Money Going?
If the emerging markets and commodities are struggling, what areas are leading the world in a positive economic direction? Well the US is certainly doing well. Developed markets in general excluding the Asian-Pacific region as a rule are showing continued strength. Thus, US (VTI) and Europe (VGK) are doing well compared to the rest of the world and are safer places to have money. While money from the BRIC nations seemed to make its way to US and eventually European markets, the recent outflows from the MINT nations have seemed to make its way into the Middle East (MES). As shown below, the Gulf States ETFs (GULF) are showing bullish developments and increasing demand relative to the world economy as the MINT countries have begun to struggle. The MES ETF in particular is heavily weighted towards Gulf State financial institutions, so investors are showing favorable attitudes towards the development of Middle Eastern banks and other financial institutions.
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Current Implications
It is apparent the BRIC, MINT, and other emerging nations require a close eye to determine if their weakness will put substantial brakes on the global economy. Moreover, commodities are also at a decision point, and also threaten global economic activity. The US Dollar should also be watched as a rapid rise in its value will signal a panic situation is developing. Otherwise, it is best to have one's resources in developed markets, particularly the US and Europe, with the Gulf States constituting a potential wild card opportunity to make money in the current climate. If these currently strong options begin to lose value for extended period though, as commodities and emerging markets further drop, a global downturn could be occurring, at which point it will be best to be in cash, long-term government bonds, or shorts. However, the US markets have not entered a panic yet, so it is possible that more time is needed to play out the current developments. Alternatively, all these weakness could resolve to the bullish side, representing the positive and ideal situation. If this outcome occurs, the BRIC and MINT countries will likely become excellent investment opportunities as their prior weakened demand make them a better value if the entire global economy is moving to healthier outcomes.
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