With so much political action in Italy, the White House, Germany and Brexit Britain, we’ve been neglecting the global financial markets.
Against the dollar, the pound is down almost 8% from its peak in January after a 17% rally that lasted more than a year. The FTSE is back to where it started the calendar year.
The Dow Jones is back to where it started 2018 too, but after six down days in a row. The tech focused NASDAQ is up 10%.
The Italian stock market is back to where it began the year as well, although banks have fared worse with a 16% plunge from April highs.
The Chinese stock market has taken a real tumble thanks to Trump’s trade wars. The Shanghai Composite fell 4% on Tuesday and the Shenzen Composite 6%.
Shanghai Composite over the last year
Source: Google Finance
There has been plenty of chaos in emerging markets like Argentina, Brazil and Turkey. They find themselves at the centre of a financial storm.
Argentina is already working with the IMF on a record breaking bailout. Brazil’s central bank has admitted defeat as its currency tumbles. And Turkey’s President is hurling desperate threats around after taking control of their central bank.
Bloomberg reports that investors are running for the exits on emerging market ETFs.
As you can see, the further you get to the fringes of global financial markets, the worse things look.
There is one single explanation for all of this. And it suggests things will get worse for emerging markets in coming months. Eventually their problems will spill into our own markets and the US’s, too.
But what’s actually going on?
The symptom or the cause?
The US dollar is like the denominator of all prices. Usually it remains fixed while everything else shifts relative to the global reserve currency.
But what if the denominator itself goes haywire? Such as during a trade war. Or an emerging market crisis. Or monetary policy moves in the US.
At the moment, we have all three bearing down on us. And the symptoms are increasingly in the news.
Countries and companies looking to access capital often borrow money in US dollars to lower their interest costs. International investors don’t trust local currencies and it’s tough for individuals to hedge currency risk. And so the companies and governments take on this risk by issuing their bonds denominated in US dollars at lower yields.
It’s not unusual for countries which rely on such foreign funding to get into trouble when the Federal Reserve starts to tighten monetary policy. In fact, the history of Fed tightening cycles is a repetition of hikes followed by a crisis somewhere.
Last time around it was in the US mortgage market, but before that it was the Latin debt crisis, the Asian Financial Crisis, the Rouble Crisis and others.
Countries with trade surpluses are usually spared from such a panic thanks to their ability to earn dollars from exports. Their own tumbling currency matters a little less if US dollars are still flowing in from trade.
What makes things interesting this time around is that, if you add trade wars into the mix, even countries with trade surpluses could be in trouble too. And by “could” I mean “are”.
India is a good example, reports my colleague Shae Russell in Australia. Each rate hike at the Fed seems to put the rupee under pressure. It’s not immediately clear why until you take a look at Indian corporations’ US dollar denominated borrowings.
India’s total external debt is almost half a trillion US dollars. Half of that is denominated in dollars, meaning it has to be repaid in dollars. Almost 80% is non-government debt.
Every interest rate increase in the US directly affects Indian companies. And the currency only makes it worse.
But it’s Trump’s trade war arch-enemy China that is copping it from all sides. Ambrose Evans-Pritchard explained in the Telegraph:
“The move came as the People’s Bank of China (PBOC) announced that it was setting up a special “financial risk tracking unit” to monitor local and international conditions after a surge in the number of corporate defaults in the country.
“The PBOC described the Chinese bond market as “generally under control” but nevertheless instructed the new task force to “stabilise market expectations”. There is mounting concern that monetary tightening by the US Federal Reserve and higher global borrowing costs could spill over into the Chinese economy at a time when growth is already slowing markedly.
“HNA Group racked up $94bn (£71bn) of debts in break-neck expansion when quantitative easing was still in full swing and the world was awash with easy money. “They were splashing the cash in the most egregious way and now they are nursing very serious wounds,” said George Magnus from Oxford University’s China Centre.
“It became heavily reliant on short-term US dollar debt, leaving it at the mercy of the Fed monetary cycle and the 100 basis point rise in Libor rates since September.”
The bond market is “generally under control”!? That doesn’t sound good at all…
In an era of debt blooms financed by incredibly low interest rates, currency moves are a pressure point that debtors are vulnerable too. Central banks have less control over currencies than interest rates.
If Trump manages to reduce America’s trade deficit, the country will be exporting fewer dollars to the world, leading to a shortage. When the US dollar rises against other currencies as a result, it will trigger a crisis for places like China, India, and others, who cannot repay their US dollar denominated debts.
So far, the FTSE is holding up well in the face of trouble in China, Argentina, Turkey, Brazil…
So what do you do?
Buy and hold on for dear life?
In a world of sabotaged markets, any investor who forgoes profiting from crashes is making a deep mistake.
You can’t control monetary policy, budget deficits or corporate mismanagement. And the incentives of the corporate and political system are hardly geared to doing the right thing.
Remaining a “long only” investor in times like these is a strategic error. Especially given how straight forward it is to profit from downturns.
This evening and tomorrow, Southbank Investment Research is hosting a free educational seminar on how to actively trade the market. On the long and the short side.
Adrian Buthee, whose company Trendsignal won the International Financial Awards “Best Trading Education Provider” in 2018, will show you how to profit from moves in both directions. And what signals to look for.
The Webinar is designed to be simple and practical. You can express your interest here, and decide if you want to be a victim of, or investor in, coming crashes.
Until next time,
Nick Hubble
Editor, Capital & Conflict
Category: Economics