Financial News

Good vibrations

By Business & Finance
12 March 2014
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As we exited 2013, global equity markets were in buoyant mood having capped a year of strong gains that left many Western exchanges at, or close to, all-time highs, writes senior equity analyst at Davy Private Clients, Aidan Donnelly.

In the US, in recognition of the improving economic outlook for the country, the Federal Reserve announced at its meeting in mid-December that it would begin the process of reducing its bond buying programme known as Quantitative Easing (QE). Although investors had originally balked at the notion of tapering when it was first suggested by the Federal Reserve in May 2013 – leading to a sell-off in markets, coined the ‘Taper Tantrum’ – reaction to the actual commencement was greeted positively and it provided a final impetus to equity markets as they staged a ‘Santa Claus’ rally into year-end.

The ‘good vibrations’ spilled over into the early days of 2014, but since then the mood has taken a turn for the worse. One of the unintended consequences of the vast amounts of money that have been pumped into the financial system by the major central banks since the financial crisis began, has been that much of this liquidity has found its way into the stock markets, bonds and currencies of many of the developing or emerging markets around the world.

As investors sought greater returns, the higher interest rates on offer and the better growth prospects in these regions were appealing. Investors voted with their feet, so to speak, resulting in significant capital inflows into the different asset classes in these areas.

Turning off the taps

If the various incarnations of QE from major central banks provided a boon to the higher growth regions in the last few years, then reducing or removing it has the potential to create the opposite effect. And so it was over the last few weeks as the combination of capital outflows and political tensions has seen emerging market equities and currencies sell off.  The changing risk attitude towards emerging markets moved beyond their borders and began impacting sentiment in developed markets also. This situation has not been helped by a series of disappointing economic data from Europe and the US. Despite the fact that, for now anyway, much of this poor data can be explained by the severe weather conditions experienced in North America so far this year, the uncertainty that it creates does not lie easy with investors who are of a mind to shoot first and think later.

Not all bad news

At this point it is worth remembering that all emerging market countries are not created equal and there have been many positive developments in these countries since we witnessed the Asian crisis of the late 1990s. The governments in these countries have learned the harsh lessons of that crisis to the point that now, for many, the economic framework is more resilient, the balance of payments more favourable and the reliance on foreign currency-denominated debt has been significantly reduced.

There are still countries that remain fragile and susceptible to the global forces at play, but these are the exception rather than the rule. We are unlikely to see a re-run of past emerging market crises. The economic growth rates remain strong, particularly for Asia and Latin America, as domestic demand continues to grow and consumer incomes and living standard rise.

Given these recent worries surrounding all things emerging, it is not surprising that those companies in developed markets that have seen some of the large share price moves are those that are perceived as ’emerging market plays’, such as consumer product and luxury goods companies and industrials. But what has proved interesting about this situation is that sentiment can become divorced from reality. As we near the end of the Q4 earnings reporting season, we have seen many of these same emerging market plays reporting strong on-going growth in revenues derived from these regions, leading to modest rebounds in their share prices.

While there is no denying the impact that tapering is having on the financial markets of emerging countries – the evidence is there for all to see – what is less clear is the effect, if any, that this will have on these countries’ economies. Many of the secular trends driving the economic growth we are seeing will continue regardless of short-term capital flows or uncertainty. Therefore, the companies that are meeting the demands created as a consequence are best placed to benefit over the longer term.

Aidan DonnellyAidan Donnelly is senior equity analyst at Davy Private Clients. Views expressed in this article reflect the personal views of the author and not necessarily those of Davy or Business & Finance.