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This Tantrum Is Good News for Emerging Markets

I do not have a trade for this week. With all the emotions weighing on stock markets globally, it makes no sense to dive in yet.

But I will say that significant opportunities are emerging, particularly in Hong Kong blue chips and in a class of Chinese stocks that trade in Hong Kong known as “China Enterprise” stocks. These are mainland Chinese companies that began as entrepreneurial companies rather than state-owned enterprises. They represent some of the best of China’s business community — and many are trading at very cheap, single-digit valuations today.

I will also say that the August panic has created the rationale for a new move higher in emerging-market stocks. Though that might sound crazy at this particular moment, remember that nothing in an economy happens in a vacuum. There are knock-on effects from everything, and the effects of the August tantrum will play out inside the halls of the Federal Reserve … and that, in turn, will provide the fuel for the next leg higher in emerging markets.

Investors are already coming to the conclusion that I’ve been talking about routinely for more than a year: The Federal Reserve doesn’t have any leeway to raise rates anytime soon because doing so would push the dollar even higher, thereby destabilizing emerging-market economies, causing a tidal wave of economic troubles around the world.

That’s precisely why the dollar fell on Monday in the biggest decline in seven months — a surprising move.

Normally in a global, financial/stock-market panic you would expect the dollar to rally strongly. It is, after all, the so-called safe-haven currency. It is one of the major currencies, along with the Swiss franc and gold, that investors typically flood into when times turn dicey. And yet the dollar fell.

Odd … until you realize that global currency markets are sending a message to the Federal Reserve.

The Dollar’s Days Are Done

The currency market is telling the Fed unambiguously that the dollar is part of the global problem!

The dollar is too strong already. It’s part of China’s problem, which has the market in an emotional tizzy, but more on that in a moment.

The Fed has the power to strengthen or weaken the dollar with its interest-rate decisions. Raise rates, as hawkish (and dead wrong) Fed governors think is necessary, and the dollar gets stronger. But if that happens, then U.S. multinationals will suffer because their overseas sales will suffer, and their sales at home will suffer since foreign products will be increasingly cheaper. Emerging-market companies and countries will suffer because they’ve loaded up on trillions in dollar-denominated debt in the last seven years.

And a stronger U.S. dollar means they’d have to raise even more local currency to buy the dollars necessary to repay those debts — likely leading to a currency crisis, à la the Thai baht crisis of the late 1990s.

In turn, that would send ripples through the region as other countries rush to devalue their own currencies to remain competitive … which would undermine the local consumer and local businesses, thereby crushing the local economy. And that would ultimately wash upon the economies of Europe and America, putting us back into a global recession — all because the Federal Reserve has painted itself into a corner from which it cannot easily extricate itself.

So the dollar sank because currency traders were collectively telling the Fed to back off — that raising U.S. interest rates now will harm the global economy’s resurgence.

And the thing is, the global economy is actually OK. Germany has been reporting good economic results. Spain, once one of the derided PIIGS nations, has been reporting Continent-leading results. The U.K. has been reporting good results. French unemployment is falling and business sentiment is at a four-year high. Here in the U.S., our economy isn’t wowing anyone but it’s not on life support either, and it is managing positive growth.

If the Fed heeds the message of the currency market, then it won’t raise rates until 2016. By then, there’s a good chance the world economy will look markedly better and then multiple central banks can raise rates simultaneously. That would give the Fed the cover it needs to raise rates here at home without the threat of a dollar rally.

And that plays directly into China…

China Wants Out of the Dollar Trap

As I’ve noted, China has long pegged its currency, the yuan, to the dollar.

That has proven problematic for China because our buck has risen 30% since mid-2011. As the dollar rose, so rose the yuan, which made Chinese goods less attractive overseas and boosted the fortunes of other Asian manufacturing nations that compete with China.

A decline in orders for Chinese goods meant a decline in factory output, which meant a decline in exports, which meant disappointing GDP numbers — all ingredients that prognosticators throw into their bouillabaisse of data to divine China’s future. And what popped out was: “China is slowing!”

But no one seems to have connected the dots between the rise of the U.S. dollar and the knock-on effects the dollar has had on China’s manufacturing and export economy. Like I said, though, nothing in an economy happens in a vacuum. Push the balloon here and you get a bulge over there.

China devalued the yuan (the proximate cause for this week’s August tantrum) to relieve currency pressures that were making its economy less and less competitive.

Yet that devaluation isn’t an omen of impending doom. It’s not a sign the economy is slowing faster than expected. It’s simply China’s way of managing itself out of a currency trap.

Apple has pointed out that China’s consumers seem to be doing just fine. E-commerce in China is booming, and that’s where a large slug of the Chinese consumer economy is taking place these days. Yes, there is a bubble in real estate, but the Chinese aren’t real-estate investors the way we think of it in the U.S. So we have to push past that way of thinking. Yes, Chinese stocks have plunged … but the mainland stock market (as opposed to Chinese stocks listed in Hong Kong) is a gambling den at best still, so volatility there doesn’t mean what it does in a market populated by investors rather than punters.

In the end, what we’ve experienced in Profit Seeker in recent weeks is an exaggerated and emotional reaction to exaggerated worries about the Chinese economy and what it might mean to the world.

We are now on the cusp of a rally in emerging-market stocks because the Fed cannot raise rates. So it won’t raise them — at least not until other nations are talking about raising rates too. That realization will see the dollar decline and emerging-market stocks rally.

A big upswing is coming.

OptioBiotix Update

OptiBiotix (London: OPTI, buy up to £0.42) jumped 4% in trading today in London. Management reported half-year results and told investors that it has “completed preclinical studies and gained ethics approval to start human clinical studies” for what is potentially a breakthrough cholesterol-lowering product that is tied to microbes rather than drugs. The microbes are incorporated into food products without changing taste or texture.

It also has signed an agreement with an unnamed multinational company that could soon see OptiBiotix’s cholesterol product incorporated into yogurt. And it has partnered with a company now developing a health care portfolio targeted at the rapidly expanding elderly market.

In short, the future is shaping up nicely for OptiBiotix. We’re up about 7% so far, but at £0.39 the stock is still below the £0.42 buy limit. Thus, OptiBiotix remains a buy.

Until next time, keep a global view…

Jeff D. Opdyke

Editor, Profit Seeker