Monday, January 27, 2014

UPDATE: An Emerging Emergency?

By Matt Malick and Ben Atwater

Stocks were pummeled last week.  Or at least it felt that way.  Given the low volatility and high returns we saw in 2013, this week felt particularly grave.  The S&P 500 fell 2.6%, while the Dow Jones Industrial Average lost approximately 3.5%, its biggest drop since 2012.

The crisis du jour lies in emerging markets.  A Bloomberg gauge tracking 20 emerging market currencies hit its lowest level since April 2009; the index has tumbled almost 10% in the past year, the biggest annual decline since 2008.

More specifically, South Africa’s rand is at its lowest level since 2008, Brazil’s real fell to a five month low and has lost 28% in two years, the Argentine peso is at levels unseen since 2002, the Turkish lira set a record low and Ukraine’s hryvnia is the weakest it has been since 2009 amid violent protests.

After logging a relatively rotten year in 2013, emerging market equities are showing signs of a complete breakdown, losing more than 5% so far in 2014.  As you know, we do not have direct exposure to emerging market stocks, a conscious and, so far, wise decision.

More than $940 billion has been erased from the value of emerging market stocks since the United States Federal Reserve signaled in May the potential to curb its easing policy.  Fund tracker EPFR estimates emerging equity and bond funds have seen outflows of $5 billion this year and nearly $60 billion since the beginning of 2013.  Presently, there is a significant flight of capital from emerging market assets.

Whether or not U.S. equities can continue to withstand a meaningful correction in emerging markets remains to be seen.  Another question on our minds is when we might see a buying opportunity in emerging markets.

For now, the benchmark Standard and Poor’s 500 Index has fallen below its 50-day moving average, which is a poor technical indicator going forward.  Interestingly, though, the S&P is still just 3% below its record closing high.

One bit of good news, of the 122 S&P 500 constituents that have released earnings so far this season, 74% have beaten earnings estimates, while 67% have exceeded sales projections, according to Bloomberg.  The reason we own individual stocks is because the fundamental health of the underlying businesses is the only thing that ultimately matters in the long-term.  The current emerging markets “crisis” is merely a noisy short-term problem.

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