So far in 2014, emerging markets have significantly underperformed Developed Markets. Turkey has been forced to raise their interest rates dramatically to defend the Lira while Argentina saw a collapse in its own currency. The Fed is expected to continue to taper in 2014, reducing the flow of funds to Emerging Markets and causing them to further weaken relative to Developed Markets. The MSCI Emerging Markets Index has failed to break above its 2011 highs and could soon break critical support right below 900. How long can this continue? The chart below shows the long-term relative performance of Emerging markets relative to Developed Markets. Global Financial Data has extended the MSCI Developed and MSCI Emerging Markets back to the 1920s so their long-term interaction can be analyzed.How far can Emerging Markets fall relative to Developed Markets? If the trend follows the pattern of the past, quite a lot. Whether it continues down to the levels of 1985 or of 2000, or even 1968, remains to be seen, but this chart does not bode well for Emerging Markets over the rest of the decade. This technical analysis is backed up by the fundamentals. The end of tapering, and eventually the end of Zero Interest Rate Policy will attract more money to Developed Markets. Assuming the worst of the Eurocrisis is over, growth may soon return to Europe. Many Emerging Markets will have to see their exchange rates decline in order to make their labor markets more competitive. In the coastal areas of China, wage rates have risen substantially over the past decade, reducing the future gains from trade. Countries like India struggle with providing the infrastructure necessary for economic growth. Commodities made a huge move over the past decade, and they are unlikely to continue their relative appreciation, reversing the improvement in the terms of trade that some Emerging Markets had enjoyed. In short, the chart and the fundamentals say that you should not see the current weakness in Emerging Markets as a buying opportunity. Instead, it probably foreshadows continued weakness for several years to come. Don’t try to catch a falling knife because you are likely to get hurt.
As can be seen by the chart, the Emerging-Developed Equity Cycle lasts around seven to ten years. Developed markets outperformed Emerging Markets from 1945-1968, 1979-1986, 1994 to 2001 and since the beginning of 2010. Emerging Markets outperformed Developed Markets between 1968-1979, 1986-1994, and from 2001 to 2010. We are now four years into the current market cycle. Based upon the past, you would expect the current underperformance of Emerging Markets to continue until 2017 or 2020 at the latest when the trend would reverse itself.
Global Financial Data is proud to announce the addition of almost 40,000 files that our subscribers can now access. The source of the data is the World Bank, which has made their data archives available to all users. These files cover every country in the world, and a wealth of topics from the environment to the economy. All the data files are annual with some providing data back to 1960. Global Financial Data has gone through these series and chosen the ones that would be most useful to our subscribers. The focus has been on choosing series that provide long-term data and supplement the 20,000 series in the original GFDatabase and the 45,000 series we provide from Eurostat. Between these three databases, subscribers now have access to over 100,000 data series that cover the world. Included in the series GFD has chosen are new series providing data on Gross Domestic Product, Exports and Imports, Debt, Education, Technology, the Environment, Health Care, Trade Barriers, Infrastructure, Defense and Income Distribution. In addition to these areas, we have expanded coverage of topics traditionally covered by the GFDatabase including Interest Rates, Price Indices, the Stock Market, Monetary Aggregates, Population, and Exchange Rates. To highlight the World Bank Data, we provide a separate tab in our Search Engine so you can find topics that will help you to do your research. If you would like, we would be happy to send you an Excel file with information on the series that have been added. Global Financial Data plans to provide a new release of data each month to its subscribers to the GFDatabase, US Stock Database and UK Stock Database. We will provide updates on these releases both through our blog and through e-mails. If you have any questions about these releases, please feel free to contact your sales representative.
Yields on United States 10-year bonds passed the 3% in January. The yield on the 10-year had reached its lowest point in history in 2012 at 1.43% as a result of the Fed’s policy of Quantitative Easing. Since then yields have doubled as the markets incorporated the impact of tapering their purchase of U.S. Government securities. This raises the question, how high could interest rates go from here? Could interest rates move up to 3% per quarter? U.S. interest rates were that high back in 1981 when the yield on US 10-year Treasuries 15.84% while 30-year mortgage rates hit 18.63%. What about 3% per month, per week, or even per day?
HYPERINFLATION AS THE NEW NORMALBrazil was one of the worst of the Latin American hyperinflators of the 1960s to 1990s. New currencies were introduced in 1967, 1986, 1989, 1990, 1993 and 1994. The Real, introduced on July 1, 1994, put an end to Brazil’s addiction to inflation, but by the time the Real was introduced, the new currency, was equal to 2.75 Quintillion (2,750,000,000,000,000,000) Reis, the original currency Brazil had used as a Portuguese colony. The impact of these inflations on the currency is illustrated below in the log chart of exchange rates between the Brazilian currency and the US Dollar from 1950 to 2014.
The Banco do Brazil uses the SELIC (Sistema Especial de Liquidação e Custodia – Special Clearance and Escrow System) to set interest rates for the economy, just as the Federal Reserve uses the Discount rate in the United States. The SELIC became the basis for all interest rates throughout the Brazilian economy as hyperinflation took over. At first the SELIC was adjusted every few years, then every few months, then daily. Along with the exchange rate for the SELIC became the primary indicator of inflation on the Brazilian economy.
What is most interesting about the graph is the exponential increase in interest rates from 1975 to 1993, rising steadily from around 16% per annum to almost 16,000% until the back of inflation was broken in 1993. Currency reforms are visible in the large drops in the interest rate as the government tried to reform the fiscal sector and stop the inflationary spiral, but the government inevitably returned to its inflationary fix to solve its problems.
HOW TO BANKRUPT BORROWERSAlthough 3% may not seem like a lot, compounding that on a daily basis adds up very quickly. If you take the 30 days from February 1 to March 2, 1990, the product of these interest rates comes to 167% in one month (inflation was 75.7% in February 1990). If you extrapolate that on an annual basis, interest rates in Brazil hit a high of 790,799% on February 19, 1990. In other words, if you had borrowed $100 on February 19, 1990, you would have owed the bank $790,799 a year later. Payday loans sound cheap by comparison. Obviously, this situation was unsustainable. The newly elected President, Fernando Affonso Collor de Mello, introduced his “shock” plan to cure the economy on March 16, 1990, closing banks for three days, the Novo Cruzado replaced the Cruzeiro, and 20% of overnight market funds were frozen for 18 months. A 30-day wage and price freeze, a new wealth tax, and a widening of the tax base were introduced. Although the currency reform slowed the rate of inflation, decreasing it from a monthly rate of 82% (135,000% annually) in March 1990 to 7.6% by May (140% annually), inflation picked up from there. Monthly inflation began its steady increase as the government continued to print Cruzeiros rather than raise taxes. Monthly inflation steadily increased to 47% by June 1994 when the introduction of the Real put an end to Brazil’s hyperinflation. Though the United States is unlikely to go the route of Brazil, it does show what can happen when quantitative easing becomes too easy.
Yields on United States 10-year bonds rose above 3% at the beginning of January 2014. The yield on the 10-year had reached its lowest point in history in July 2012 at 1.43% as a result of the Fed’s policy of Quantitative Easing. Since then yields have doubled as markets have incorporated expectations of Fed tapering the purchase of U.S. Government securities.What about a 3% per month increase in interest rates? That works out to 42% per annum. Although interest rates have never been that high in the United States, they have hit those levels in other countries. The yields on 3-year bonds in Mexico were over 50% back in the 1990s as is illustrated below. Other countries, such as Argentina, Brazil and Chile (the ABCs of hyperinflation) have seen similar interest rate levels.
$12,000 Mortgage Payments Anyone?What will happen in the United States when tapering and quantitative easing come to an end? How high could interest rates rise? Could interest rates move up from 3% per annum to 3% per quarter, revisiting the levels of 1981? When the yield on US 10-year Treasuries hit 15.84% in 1981, as seen in the chart below, mortgage rates hit 18.63%. And it was not uncommon during this time for home loans to be as high as 20%! Imagine a 20% APR on your mortgage. This would make a standard $3,000 monthly payment of 2014 rise to $12,000 per month. There are eerie parallels today with the experience of World War II when the yield on US 10-year bonds also fell below 3%. Bond yields had fallen below 3% in 1933 as a consequence of the Great Depression, but the government kept interest rates below 3% until the 1950s to reduce the cost of funding World War II. The Treasury pledged to keep the interest rate on Treasury bills at 0.375% or below while the United States was at war. Interest rate repression is nothing new for the Fed.
The problem with the Fed’s World War II policies was that interest rate repression eventually led to inflation of 14% in 1947 and 8% in 1948, making real interest rates negative. To stop this, the Fed put pressure on the Treasury to allow interest rates to rise to their market level, which the Treasury finally did in 1951. As you can see in the graph above, interest rates rose for the next thirty years.
The ABCs of HyperINFLATION