When Ben Bernanke set out last Wednesday to clarify the Federal Reserve's strategy for eventually getting out of the easy money racket, he couldn't possibly have known that his carefully chosen comments about a gradual withdrawal of stimulus would cause such an uproar in bond and currency markets, trash commodities and trigger a panicked flight from global equities, lopping more than $1-trillion (U.S.) off their value. Suddenly, better news about U.S. economic prospects became dreadful news for markets that have grown to love the Fed's massive infusions of money.
By Friday, North American markets had calmed down a bit. But emerging markets remained in a state of shock after a week in which bonds and currencies got hammered and equities suffered their worst drubbing in more than a year. It was just the latest in a series of setbacks for once high-flying markets like Brazil, India and China, as investors are lured away in droves to rising yields in pockets of the developed world and even some of the higher-risk frontier markets.
Emerging market bond funds experienced their biggest redemptions since September, 2011, and more than $3-billion fled from equity funds in the week ended last Wednesday – the day Mr. Bernanke inadvertently triggered the global rout – reports EPFR Global, which tracks international fund flows.
Allocations by U.S. fund managers to emerging markets had already reached their lowest point since late 2008, the latest survey by Bank of America Merrill Lynch shows. The fund crowd cited a hard Chinese landing and its impact on commodity prices as their biggest worry, followed by the possible failure of Abenomics in Japan. But the Fed's inevitable return to more normal monetary policies was obviously high on their list of fear factors too.
In any case, Michael Hartnett, the bank's chief investment strategist, declared that assets linked to the China story have become the "biggest contrarian play in the market" for those who don't buy the hard-landing shock. And David Riedel, a veteran emerging-market stock watcher, couldn't agree more.
"I'm more comfortable with a bullish call on China for the coming months than I am with a bullish call on emerging markets over-all," says Mr. Riedel, whose eponymous research oufit burrows deeply into emerging-market stocks in Asia, Latin America and eastern Europe.
"The emerging markets themselves haven't really done anything all that wrong," Mr. Riedel says. "The reality is that enthusiasm for U.S. dollar assets And emerging markets have been a victim of that."
But he acknowledges that some emerging markets fully deserve their lowly new status on the must-avoid list, and he names two in particular: Brazil and South Africa.
"We're very concerned about Brazil and we have been for a long time," Mr. Riedel says, noting that the populist government of President Dilma Rousseff has attempted to paper over such serious problems as rising inflation and sluggish growth "partly at the expense of the large companies that make up much of the Brazilian stock market. The mining companies, as well as the banks, have felt pressure from her to curtail their profits."
Meanwhile, public anger over rising consumer costs, poor social services, crime, corruption and the high cost of preparing for such showcase events as the soccer World Cup and the Olympic Games has erupted into the biggest demonstrations in 20 years.
South Africa has also lost its appeal to emerging-world investors because of the government's failure to tackle myriad labour, financial and infrastructure problems.
"Emerging-economy investors need to be aware of these societal and political pressures, which can erupt at any time. If one does have a period of economic dislocation, it's likely that you're going to see social unrest pop up in various places, often for different reasons, but triggered, typically, by economics."
But let's get back to China, where Riedel Research has been compiling its own monthly consumer sentiment index since 2007. The latest survey found that consumers are most optimistic about their personal finances, signalling an increase in consumption. But there was a marked split between lower- and higher-income groups.
The lower-income households are less confident than at any time since Riedel began compiling data, and that includes the global crisis in 2008. This unexpected level of pessimism likely stems from two factors: consumer inflation, which has been running hotter than official estimates; and weaker demand for Chinese exports, which directly affects factory employment opportunities.
Confidence is much stronger higher up the income ladder, and Mr. Reidel is convinced the lower-income rate will move up too. "The reason is that we expect an improvement in external demand. The levels where we are today are unjustifiably and unsustainably low among the lower-income households."
And that has little to do with what the Fed does or doesn't do down the road.