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Comment: Asian Markets Correct/EM Rout Continues; Developed Markets Feel The Heat
February 4, 2014 6:57 amVideo
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Big correction for Asian markets overnight; Hang Seng, Nikkei 225 all in correction mode. Japan’s Topix fell 4.8% and down by 12.5% year-to-date after registering stellar gains for 2013. Asian markets followed the declines on Wall Street Monday after the US ISM manufacturing report slapped investor confidence by dropping to 51.2 from 64.4, the biggest monthly fall since December 1980 – quite a staggering fall. European stock markets are extending Monday’s losses although the selling pressure on Tuesday is not as severe as the previous session.
Though many are attributing the decline in the ISM manufacturing report to the severe weather conditions in the US last month, a drop of that magnitude clearly indicates the fragility of the US with other components within the ISM rattling cages; the employment sub-index fell to its lowest level since June last year. Not a helpful number given that we have the eagerly watched US nonfarm payrolls report due Friday.
With the Fed tapering again in January, cutting the bond-buying programme down to $65billion per month combined with faltering growth in China, traders are taking no chance and dumped risk assets across the board; equities deteriorate while core government bonds are in demand. Mix that up with the stretched valuations for developed market equities with large blue-chip companies sitting on elevated forward P/Es, and you’ve got the recipe for a global correction. Many in the market are of the view that the damp earnings season out of the US and Europe cannot justify the lofty valuations for equities so it is time to pull out cash and adjust asset portfolios.
What’s more, the rout in global emerging markets adds another dimension to this; Fed tapering, slowdown in China, structural problems within a number of EMs, political uncertainty in the likes of Thailand, Ukraine and Turkey, together with a lack of effective action by some emerging central banks to safeguard their currency, all trigger the mass exodus out of the EM space. This trend is likely to continue so long as these factors remain an issue – it’s unlikely they will be resolved any time soon.
China will continue to slow down as it transitions itself as an economy, new Fed head Yellen will not U-turn on tapering, not now, as the central bank is on autopilot and relying on forward guidance communication to quell market fears. Domestic dramas for EM nations will not clear-up overnight and more pressure will be on central banks in EM nations to do more but that comes with the risk of tightening monetary policies prematurely which could be a disastrous move if certain economies are slowing. EMs are no place to be at the moment due to the aforementioned reasons though many do believe that this correction will present buying opportunities in the mid to long term.
Developed markets, particularly the euro zone have to factor in another growth-disruptive trend; deflation. Weakening inflation in the euro area threatens to derail the economic recovery at an extremely fragile time where growth is tepid and recession risks remain high. Yes, there are signs of recovery in certain facets of the broader EMU economy, for example, Monday’s PMI manufacturing report warmed up the market with Germany again reaffirming its powerhouse status but that comes with questions as it would be unwise to think Germany alone can put the region on a path of sustainable growth. High unemployment which show no signs of budging and hard-hitting austerity measures in the periphery together with cyclical political instability fears all pose downside risks to the euro zone economy.
ECB meets on Thursday – markets are undecided on the outcome; refi-rate cut is expected, especially if this week’s inflation data is weaker but then, some participants do not think the ECB is in an immediate rush to resort to policy tools this month and would rather beef up forward guidance first. That being said, this year, the market is not ruling out further rate cuts, negative deposit rates if needed or even a QE/bond buying programme if the euro area’s prospects deteriorate in the coming months. On Tuesday’s data watch, look out for UK PMI construction, euro zone PPI and US industrial new orders.
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