Saturday, October 10, 2015

Emerging Markets - Opportunity or Money Pit?

What is really going on with Emerging Markets?

For the past five years the S&P is up over 70% and Emerging Markets are down 20%!  As an enthusiastic buyer of everything beaten it's hard for me to resist from buying even more of this wretched sector even though I already own a sizable investment.  No doubt, there are many people out there that have a much more sophisticated understanding of what is going on but anyway here are my two cents.

There is no doubt in my mind that the Fed’s unprecedented interest rate policy has something to do with this but more importantly how so?  If you take a look at a comparison chart of the S&P versus the Energy sector you'll notice an equally wide divergence.  A quick glance at the US Dollar index reveals an escalating currency war that is beginning to challenge Fed policy.  This tells me that these emerging economies which are heavily dependent on their energy exports as a primary means of income are being squeezed on multiple fronts.  

New fracking technology creating oversupply, an unfavorable currency climate, and slower global growth are all combining to create the perfect storm for these countries.  The key indicator that I am monitoring is for this persistent deflationary malaise to abate.  This may not be happening anytime soon as there is currently no generation equipped to borrow the money that is required to create inflation.  The Millennial generation is already overloaded with student debt, the Boomer generation is running out of years to reward risks and the Sandwich generation finds themselves supporting their own kids as well as their broke parents.  Regardless of how low the Federal Reserve makes rates, if there is no demand for the borrowing of money these economies will continue to deflate.

Technology which is currently the shining star is not inherently a capital intensive industry due to its automated nature and lack of large pools of hands on labor.  Unless an industry emerges that needs capital and labor once again we may never break the threshold required to spark inflation.  What does that industry look like...where will it come from?  I have no idea.