MONEY stocks

Could Another Sell-Off Be Lurking This Week?

Traders work on the floor of the New York Stock Exchange October 15, 2014.
Brendan McDermid—Reuters

Last week's tumultuous week in the stock market sets the stage for yet more nervousness and hand-wringing as a fresh set of earnings and economic data are due to be released.

When Wall Street opens for business on Monday morning, will bad news about the global economy be bad news for stocks?

That was the case for most of last week, when the equity market was hit with a frightening sell-off that reminded investors of the bad old days of the financial crisis.

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^INDU data by YCharts

Or will bad news turn out to be good news for the market, as was the case on Friday, when the Dow Jones industrial average soared more than 260 points?

^INDU Chart

^INDU data by YCharts

Friday’s dramatic rebound in stock prices reflected two forces that are likely to move the market in the coming days.

Keep an Eye on the Fed

At the end of this month, the Federal Reserve is slated to end its stimulative bond-buying program known as quantitative easing.

Investors are naturally nervous about this development, as quantitive easing, or QE, has been credited for the strength and length of what is now a five-and-a-half-year-old bull market. As many market observers have noted, Wall Street is about to lose a major psychological crutch.

Remember that when the Fed ended its prior two rounds of quantitative easing — in 2010 and 2011 — stocks sold off fairly quickly:

After QE round 1, which ended March 31, 2010:
^SPX Chart

^SPX data by YCharts

After QE round 2, which ended on June 30, 2011:
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^SPX data by YCharts

But late last week, when the market was in the throes of a selloff, St. Louis Fed president James Bullard said in a Bloomberg TV interview that “we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December.”

In other words, a member of the Federal Open Market Committee that sets the nation’s interest rate policy is openly mulling whether the Fed should postpone ending QE in light of recent market volatility.

Bullard’s remarks on Thursday were enough to give the markets a lift in the last two days of the week. And if there are more signs of a major global economic slowdown, including a possible recession in Europe and Japan, then the Fed may have to think twice about how — and how soon — it ends its stimulus efforts.

This week, investors will want to see if more members of the FOMC sound similar conciliatory notes of extending QE. So far, no one else has. Boston Fed president Eric Rosengren, a major defender of QE, said on Friday that he does not expect the Fed to extend the program at this juncture.

What else should investors look for?

  • Wednesday’s inflation report from the Department of Labor. If the global economic slowdown is starting to impact the U.S., we will start to see it in the form of lower prices for U.S. consumers.
  • Thursday’s report on the index of leading economic indicators from the Conference Board. The LEI is forward-looking barometer of economic trends, so if the global slowdown is likely to affect the U.S. in the coming months, this index should offer clues.

Keep an Eye on Earnings

Last week’s bloody selloff was peppered by major earnings disappointments on Wall Street. For instance, there was Netflix, which reported that subscriber growth wasn’t as strong as expected and saw its stock lose more than a quarter of its value on Wednesday. Google also disappointed Wall Street on earnings and revenue growth, as well as on paid clicks on ad links.

The idea is that if Wall Street is about to lose its QE crutch, it will have to fall back on the fundamentals — so corporate profit reports will have to look good.

On Friday, a slew of companies led by General Electric and Honeywell announced better-than-expected results, which helped drive stocks higher at the end of the week.

Yet the mood on Wall Street regarding earnings is somewhat pessimistic. The strengthening U.S. dollar, brought about by the global economic slowdown, is expected to crimp global profits for U.S. exporters.

This week, several high-profile earnings announcements are due to be released. Here are the major ones to look for:

  • On Monday, Apple is due to report its results after the closing bell. Everything Apple reports is news these days.
  • On Tuesday, Coca-Cola will reports its results before the market opens. No company is as exposed to the global economy as Coke is.
  • On Wednesday, Boeing is set to reveal its earnings before the market opens. The global slowdown is expected to hurt U.S. exporters, and Boeing could be a sign of how bad things have become.
  • On Thursday, Amazon.com will report after the bell. Amazon isn’t just a bellwether of the tech economy, it is now a key gauge of the health of the U.S. consumer.
MONEY stocks

Stocks Plunge Wednesday on Global Economic Fears

141015_INV_Stock_1
Spencer Platt—Getty Images

Volatility is back with vengeance, and it's being felt throughout the financial markets.

Updated: 4:30 pm

Volatility is back with a vengeance on Wall Street.

The Dow Jones industrial average plunged around 450 points on Wednesday afternoon before recovering to close at 175 points down, marking the sixth day in October that the stock market has suffered triple-digit losses. The Dow, which had been trading as high as 17,145 at the end of September, sank to below 15,900 before ending the day at 16,141.

^DJI Chart

^DJI data by YCharts

This capped off the worst three-day sell off for the broad market since 2011.

Small-company stocks — considered the market’s canary in the coal mine, since they’re more easily rattled by changes in the economy due to their size — sank around 1% on Wednesday and are in an official correction, defined as a 10% drop in value over an extended period. Micro-cap stocks, the tiniest sub-set of small stocks, also fell and they’re only a few percentage points off from an official bear market, or a 20% decline.

Why?

Wall Street is having flashbacks to the bad old days in the aftermath of the global financial panic, when there were real concerns that the global economy might slip back into a deflationary and recessionary spiral.

Right now, the big worry is that Europe and Japan will soon suffer their third recessions in the past six years. Policymakers in both countries are scrambling to find ways to jumpstart growth, yet their central banks are running out of ammunition.

Meanwhile China, once viewed as the engine driving global growth, has been slowing noticeably in recent quarters and can‘t find a way to reaccelerate, as it works through its own housing and financial crisis.

“While domestic growth is robust, slowing economies abroad have the potential to upset the recovery,” notes Jack Ablin, chief investment officer for BMO Private Bank.

Those global growth concerns are now being reflected in two troubling trends.

First, there’s the plunge in crude oil prices. While a barrel of crude oil traded above $100 a barrel as recently as this summer, prices fell to around $81 a barrel on Wednesday morning. Falling oil prices are often viewed as a good thing — since lower energy costs free up households and businesses to spend on other things. Yet the fact is, people aren’t necessarily spending that money on other things.

Michael Gapen, chief U.S. economist for Barclays Capital, noted that U.S. retail sales fell 0.3% in September. “The main downside surprise in this report,” he said, came in core retail sales — which strips out volatile food an energy prices — fell 0.2%. He said that was “against our expectation for a four-tenths rise.”

Moreover, the price of oil sometimes doesn’t cause good things so much as it reflects bad things already in the economy.

Right now, investors may be asking: “Is this the moment of truth when lower oil is signaling lower demand?” says Neal Dihora, an analyst with Morningstar.

Similarly, fears over the global economy tends to drive investors into slow-growing but safe assets, like Treasury bonds. And this morning, the yield on the 10-year Treasury fell below the 2% threshold for the first time since June 2013, a worrisome trend as MONEY’s Pat Regnier points out.

Even more troubling is the possibility that the market is telling us that the financial crisis may not be squarely in the rear view mirror.

BMO’s Ablin noted:

“Decades of debt accumulation touched off the 2008 financial crisis and critics argue that the solution, quantitative easing programs, simply shifted borrowing from the private sector to the public sector. The Fed’s primary lever since the Greenspan years, boosting asset prices and enticing borrowing by lowering interest rates, is no longer working now that short-term rates are effectively zero. Scarred by the financial meltdown and an underwater mortgage, households have had a change of heart and are now more interested in reducing debt.”

And as investors are keenly aware, reducing debt doesn’t help stimulate economic activity.

TIME Hong Kong

Hong Kong’s Protesters Are Fighting for Their Economic Future

Thousands of protesters attend a rally outside the government headquarters in Hong Kong as riot police stand guard
Thousands of protesters attend a rally outside the government headquarters in Hong Kong as riot police stand guard on Sept. 27, 2014 Tyrone Siu— Reuters

The city can't remain a global financial center without its own political process

The conventional wisdom about Hong Kong’s pro-democracy protests is that they are bad for business. Hong Kong has become one of the world’s three premier financial centers (along with New York City and London) because the city has been a bastion of stability in an ever changing region, the thinking goes, and therefore the tens of thousands of protesters who paralyzed downtown Hong Kong on Monday are a threat to its economic success. The Global Times, a state-run Chinese newspaper, used just such an argument to try to persuade the protesters to clear the streets. “These activists are jeopardizing the global image of Hong Kong, and presenting the world with the turbulent face of the city,” it said in an editorial on Monday.

That worry isn’t merely Beijing propaganda. Andrew Colquhoun, head of Asia-Pacific sovereign ratings at Fitch, said one of the big questions facing Hong Kong over the long term is “whether the political standoff eventually impacts domestic and foreign perceptions of Hong Kong’s stability and attractiveness as an investment destination.” The fallout for Hong Kong’s financial sector from the Occupy Central movement was immediate. The stock market dropped, banks closed branches, and the Hong Kong Monetary Authority, the de facto central bank, had to reassure the investor community that it would “inject liquidity into the banking system as and when necessary” to overcome any possible disruptions.

But the real reason why Hong Kong has been so successful is that it is not China. When Hong Kong was handed back to Beijing by Great Britain in 1997, the terms of the deal ensured that the former colony, ­now called a “special administrative region,” or SAR, of China ­would maintain the civil liberties it had under British rule. That separated Hong Kong from the Chinese mainland in key ways. In China, people cannot speak or assemble freely, and the press and courts are under the thumb of the state. But Hong Kongers continued to enjoy a free press and freedom of speech and well-defined rule of law. The formula is called “one country, two systems.”

That held true in the world of economics and finance as well. On the Chinese side of the border, capital flows are restricted, the banking sector is controlled by the state, and regulatory systems are weak and arbitrary. Meanwhile, in Hong Kong, financial regulation is top-notch, capital flows are among the freest in the world, and rule of law is enshrined in a stubbornly independent judicial system. Those attributes have given Hong Kong an insurmountable advantage as an international business hub. Banks from all over the world flocked to Hong Kong, while its nimble sourcing firms orchestrated a global network of supply and production that became known as “borderless manufacturing.” While there has been much talk of Shanghai overtaking Hong Kong as Asia’s premier financial center, the Chinese metropolis simply cannot compete with Hong Kong’s stellar institutions, regulatory regime and laissez-faire economic outlook.

What happens if Hong Kong loses this edge? In other words, what happens if Beijing changes Hong Kong in ways that make its governance and business environment more like China’s? Hong Kong would be finished. The fact is that Hong Kong’s economic success, the nature of its institutions and the civil liberties enjoyed by Hong Kongers are all inexorably entwined. If Beijing knocks one of those pillars away, ­if it suppresses people’s freedoms or tampers with its judiciary, ­Hong Kong would become just another Chinese city, unable to fend off the challenge from Shanghai. Foreign financial institutions would be forced to decamp for a more trustworthy investment climate.

That’s why the Occupy Central movement is so critical for Hong Kong’s future. So far, Beijing has generally abided by its agreement with London and left Hong Kong’s economic system more or less unchanged. But when China’s leaders made clear last month that Hong Kongers would be able to choose their top official, known as the Chief Executive, from 2017 onward only from candidates who have the approval of Beijing, it became obvious that Hong Kong was going to face tighter control by China’s communists over time. That raises the specter that Beijing will at some point dismantle “one country, two systems” and along with it the foundation of the Hong Kong economy.

By fighting for their democratic rights, the activists in Hong Kong are fighting for an independence of administration and governance that will perpetuate their city’s economic advantages. Beijing should realize that ultimately a vibrant Hong Kong is in its own interests. China has benefited tremendously from Hong Kong over the past 30 years. It was Hong Kong manufacturers that were among the first to bravely open factories in a newly opened China, thus sparking the mainland’s amazing economic miracle. Chinese firms have been able to capitalize on Hong Kong’s stellar international reputation to raise funds and list shares on the city’s well-respected stock exchange. Even now, China continues to upgrade its economy by seeking Hong Kong’s expertise. The stock markets in Hong Kong and Shanghai are in the process of being linked to allow easier cross-border investment.

Of course, Hong Kong’s economy is far from perfect, and here, too, the importance of Hong Kong’s democracy movement can be found. The SAR suffers from a highly distorted property market and one of the widest income gaps in the world. Such ills have bred more resentment in the city toward Beijing. Yet right now many of the people of Hong Kong simply don’t trust their Beijing-chosen leaders to resolve these issues. Hong Kong requires a popular administration that commands the support of the people in order to implement the reforms necessary to tackle these critical problems. Thus the battle unfolding on the streets of central Hong Kong is a contest for the city’s very survival. Perhaps Hong Kong’s pro-democracy activists will disrupt the usually sedate financial district for a few days. But that’s a tiny sacrifice compared to the long-term damage Hong Kong faces if its citizens do nothing.

Schuman reported from Beijing.

TIME

This Chart Shows How China Just Surpassed the US

But analysts warn that China's growing appetite for debt coincides with a growing appetite for risk

China’s corporate debt raced ahead of the US by more than $1 trillion in 2013, to $14.2 trillion, beating analysts’ forecasts by one year, according to a report released Monday by Standard & Poor’s. The new report highlighted not only the growing clout of China’s financial sector, but also its growing appetite for risk.

S&P estimates that one-quarter to one-third of the debt originated from China’s shadow banking sector, a system of informal lending that operates outside of government oversight. A series of defaults in that sector alone could expose one-tenth of the world’s corporate debt to a sudden contraction, the report warns. “Given the substantial share that shadow banking contributes in financing not just China’s corporate borrowers but also local and regional government financing vehicles, a sharp contraction would be detrimental for business generally,” the analysts wrote.

One graph in particular showed that the risks might be thriving in the shadows. S&P compared cash flows and indebtedness among China’s corporations to 8,500 of their global peers. These measures together offer a rough gauge of their ability to repay loans, and unfortunately here too, China surpasses the rest of the world.

getImage

 

TIME Asia

China’s Great Property Boom May Be Coming to a Desperate End

A laborer works on the scaffolding of a construction site for a new residential building in Beijing on May 8, 2014 Kim Kyung-Hoon—Reuters

Analysts have warned for years that China is in the midst of a gargantuan property bubble and the inevitable reckoning may have finally arrived as massive oversupply and a tightening of credit appears to be crushing the market—with consequences for the global economy

You know a property market is in trouble when developers stage long-jump contests to attract buyers. That’s what happened earlier this month in the eastern city of Nanjing. Looking to sell apartments in a new residential complex, a local newspaper reported that agents from the developer, Rongsheng Group, lined up potential customers behind a queue and asked them to leap forward. Those who jumped the farthest got the biggest rebates — up to $1,600.

Chinese newspapers these days are riddled with such tales of desperation. On May 9 in the central Chinese city of Changsha, pretty girls were enlisted to hand out 50,000 tea eggs to lure people into a housing fair. Developers in Shenzhen and Fuzhou are offering to sell apartments with no down payment. In Hangzhou in April, two real estate agents competing for buyers got into such a vicious fistfight that the police had to intervene.

Are we witnessing the end of China’s great property boom? For years now, some analysts have warned China was in the midst of a gargantuan property bubble, ready to burst at any moment, with dire consequences. But Chinese real estate defied the naysayers and continued to soar. Both developers and customers, bypassing restrictions imposed by policymakers to constrain the industry, continued to build, invest and propel prices higher.

Now, though, the inevitable reckoning may have finally arrived. Massive oversupply combined with a tightening of credit orchestrated by the government appears to be crushing the market. Government statistics show that the amount of unsold commercial and residential property hit an all-time record in March. “We are convinced that the property sector has passed a turning point and that there is a rising risk of a sharp correction,” analysts at investment bank Nomura commented in a May report.

Falling apartment prices spell bad news for China’s economy. Real estate is one of the main drivers of China’s growth, with property investment accounting for 16% of GDP by Nomura’s calculations. A downturn could dash hopes for a recovery of the world’s second largest economy, already suffering through its worst slowdown in more than a decade, and the impact would be felt across the world. Real estate investment in China affects global prices of commodities like iron ore, so a slowdown can send shockwaves from Australia to Brazil. Falling property prices could also subvert the wealth of the Chinese middle class, dampening consumption of everything from cars to coffee. That could hurt companies like General Motors, McDonald’s and Starbucks.

Beijing’s leaders got themselves into this mess with their go-slow approach to reform. In the country’s tightly controlled financial markets, the average Chinese citizen has few options when investing his or her newfound wealth. That has made property option No. 1 for investors, pushing up the market to dizzying heights. Now the declining market presents some tough choices for policymakers. A sharp downturn in property could lead to serious financial problems at the nation’s indebted developers, causing bad loans at the banks to rise. Developers that borrowed from the country’s poorly regulated shadow-banking industry could cause even worse problems for the financial industry. Depressed property could also present the government with a major social issue. With so many Chinese families having invested their savings in apartments, falling prices could lead to widespread discontent.

There is ample evidence to suggest that the deflating of Chinese property could turn very ugly. A Barclays economist warned that the “risks of a disorderly adjustment are real and rising.” Nomura points out that new housing starts, an important indicator of where the market is headed, plunged in the first quarter of 2014. Property sales declined too in 2013. “It is no longer a question of ‘if’ but rather ‘how severe’ the property market correction will be,” the investment bank asserted.

The question now is: What will Beijing do? So far, the country’s top leaders have been (wisely) allowing China’s overall growth to slow while they focus on controlling debt and reining in the out-of-control financial sector. A tumbling housing market, however, will put more pressure on the government to reverse course by loosening credit to pump up growth — a strategy that might alleviate pain in the short run, but only intensify the economy’s long-term problems of debt and excess capacity. The central bank this week already issued guidelines encouraging banks to speed up mortgage approvals and offer reasonable rates of interest for some home buyers.

China’s problems with property shine a spotlight on how the country’s continued foot-dragging in liberalizing and strengthening its financial sector and altering its investment-obsessed growth model are creating major threats to its stability. And it is yet more evidence of how China’s role in the world has jumped from being a critical support for growth amid a disastrous downturn in the West, to becoming a primary risk to the health of the global economy.

TIME global economy

There’s a Class War Going On and the Poor Are Getting Their Butts Kicked

Orange Farm Residents Protest Over Service Delivery
A South African man hurls a burning tire in Johannesburg during protests over squalid living conditions in 2010. Conditions for the poor are worsening around the world Gallo Images—Getty Images

Although they say they're concerned about inequality, economic policymakers continue to pummel low-income families and the jobless, and that’s bad for all of us

A year ago I asked if Karl Marx was, in certain respects, right about capitalism, and argued that class struggle was making a comeback.

The German philosopher believed the capitalist system was inherently unjust. Capitalism, Marx predicted, would inevitably concentrate wealth in the hands of a few while impoverishing everyone else. There is ample evidence that Marx’s theorizing is becoming reality.

According to a recent report from the International Monetary Fund, income inequality has risen in nearly all advanced economies over the past two decades. In the U.S., the share of income captured by the richest 10% of the population jumped dramatically from around 30% in 1980 to 48% by 2012, while the portion grasped by the population’s richest 1% more than doubled, from 8% to 19%. Other data shows that since 2009, the 1% captured 95% of all income gains; the bottom 90% of people got poorer.

The good news is that more politicians and policymakers are waking up to the problem. “Inequality has deepened. Upward mobility has stalled,” U.S. President Barack Obama said in this year’s State of the Union Address. “Our job is to reverse these trends.”

There is an emerging consensus, furthermore, that such extremes of inequality are bad for overall economic health. “We now have firm evidence … that a severely skewed income distribution harms the pace and sustainability of growth over the longer term,” IMF Managing Director Christine Lagarde warned in a February speech.

But here’s the bad news. The talk hasn’t translated into action. Economic policy for the most part is still biased against the poor — in some ways, it is becoming increasingly antipoor.

The war against the poor may be most pronounced in the U.S. Washington sliced $8.7 billion from the food-stamp program in February, even though nearly 47 million people, or about 1 out of every 7 Americans, currently rely on it. A new bill to extend emergency unemployment benefits is almost definitely dead on arrival in the Republican-controlled House of Representatives.

The standard conservative argument against such welfare programs is that they make people dependent on “nanny states” and discourage initiative. But statistics say otherwise. According to the Center on Budget and Policy Priorities, more than 60% of families with children who receive food stamps have a member who works. The problem is that too many people with jobs don’t earn enough to buy sufficient food and other necessities — they’re the “working poor.” But don’t expect any sympathy from Congress. The Republicans are dead set against a hike in the minimum wage that would allow these folks to buy their own food.

Meanwhile, in Europe, politicians and bankers are breathing sighs of relief that the region’s debt crisis has been quelled. But the reality is that, for tens of millions of Europeans, it hasn’t. Unemployment in the euro zone in February was a gut-wrenching 11.9% — almost unchanged from 12% a year earlier. In Greece, the latest rate is a staggering 27.5%. No wonder angry Spaniards protested in the streets of Madrid in March, more than five years after the economic crisis began. Yet the European Union remains wedded to a policy of austerity rather than growth. What happened to the emergency leadership conferences that were so common when the governments themselves were in trouble? Apparently, Europe’s impoverished aren’t worth such efforts.

In Japan, new policies by Prime Minister Shinzo Abe aimed at restarting a stalled economy are instead squeezing the Japanese people. In an attempt to shake Japan from damaging deflation, Abe is using the central bank to flood the economy with cash to raise prices. Meanwhile, to contend with giant budget deficits and rising government debt, he is also increasing the consumption tax. Yet even though corporate profits have soared — thanks to a weakened yen, also engineered by central-bank policy — those profits haven’t trickled down to the average worker. A combination of higher prices and taxes, and flat wages, means that Japanese families are getting poorer.

Even in China, policymakers talk about closing the country’s gaping rich-poor gap, but many of the necessary reforms have yet to materialize. Interest rates in the banking sector are still controlled in a fashion that punishes savers to subsidize industry, so the return on bank deposits is so meager it barely keeps up with inflation. That hurts China’s low-income families the most. Policy also continues to discriminate against the country’s 262 million migrant workers, who are deprived of proper social services.

Before anyone attacks me as a liberal opposed to free enterprise — the usual slander slapped on those who think the destitute deserve better — please be clear that I see pro-poor policies not as charity, but simply good business and smart economics. Improving the financial health of the average family can build a stronger foundation for economic growth. The soccer mom in Wichita, Kans., who stops by her local bakery to buy a birthday cake for her 5-year-old son, or purchases a new Ford from her local dealer, is every bit as important to the overall economy as any Manhattan tycoon.

What I find baffling is how business leaders and economists fret over retail-sales figures and consumer-confidence surveys, but then advocate practices and policies that crimp people’s incomes and ability to spend. Companies won’t pay a living wage and then wonder where their customers have gone. This isn’t just a matter of improving current economic growth, but our future economic potential as well. U.S. Congressman Paul Ryan recently lambasted America’s school-lunch program, which provides meals to poor kids, as offering “a full stomach — and an empty soul.” Yet is it fair to expect a student with an empty stomach to perform as well on exams as those with full bellies? Ryan isn’t encouraging hard work. He wants to tilt the playing field in favor of the wealthy.

The same is true around the world. Why Abe thinks a poorer population can restart Japanese growth is hard to fathom. China won’t be able to reshape its broken economic model and produce more sustainable growth without pro-poor reforms. With astronomical youth unemployment, Europe is looking at a segment of its population possibly facing economic peril for years, perhaps decades, to come. Is it any surprise euro-zone GDP is expected to grow a mere 1% this year?

The fact is that there is a class war going on, and the little guy is losing. Perhaps that won’t result in revolution, as Marx assumed. But until our politicians and CEOs understand that the average family on Main Street is as critical to the global economy as the bankers on Wall Street, our economic outlook will be just as grim.

TIME global economy

Russia, the Ukraine, and the Markets: Broken BRICs

Russia's President Vladimir Putin attends the opening ceremony of the Russian Pilgrims' House at the Jordanian side of the Jordan River
Ali Jarekji—Reuters

For a couple of years now, one of my very smartest sources, Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management, has been saying that the emerging market story was over. Coming from someone who makes their money trading those markets, that’s quite a statement. But the last few days of market turmoil and today’s tanking of Russian stocks makes me think once again how right he is. Even before the crisis in the Ukraine, the Russian economy grew at only 1.5 percent last year, and it will be lucky to grow this year at even one percent, despite oil prices being over $100 a barrel. (Some 70 percent of Russia’s export revenues come from oil and gas.) That says a lot about how broken this particular petro state is.

But it’s not the only emerging market in trouble. For the last couple of years, Russia, Brazil, South Africa and many other emerging markets have not only been growing more slowly, but they aren’t even doing as well as the U.S. That is quite a reversal given that countries that are “emerging” are supposed to grow faster than those that have already arrived. A big part of the problem is that the underlying growth models of these nations are simply broken. As Sharma pointed out in an FT op-ed this week, when Vladimir Putin took power in Russia a decade ago, he was part of a “populist turned pragmatist” trio that included other emerging market leaders like Luiz Inacio Lula da Silva in Brazil, and Recep Tayyip Erdogan in Turkey. These guys were supposed to be reformers, and for a time, their economies seemed to prove that. Emerging market growth doubled to more than 8 percent by 2007.

That era is over. The reformers have become strong men, many of their economies stalled, with capital moving out. Emerging markets will be lucky to grow half that rate this year, and countries including Turkey, Brazil, Thailand and even China are not only slowing sharply, but brewing up debt bubbles that could result in an emerging market replay of the 2008 subprime crisis. “Just like every hyped up theme of one decade, from Japan in the 1980s, to Tech in the 1990s, the BRICs theme of the last decade is fading fast,” says Sharma. “As the BRIC stock markets have lost at least half their value in dollar terms this decade as they have become complacent following their liquidity driven growth spurt.”

So where does the money go from here? Back to the West, or at least, to the U.S. As I wrote yesterday, U.S. blue chips and bonds will continue to look like pretty good bets in an increasingly shaky world. Although I must say that I was spooked by PIMCO chief Bill Gross’ monthly investment outlook, released today, in which he quotes William Butler Yeats’ dark poem, “The Second Coming.” If markets don’t buy into the Fed’s promises of low rates and a slow and steady retreat from quantitative easing, the center of U.S. markets, which have been skewed in recent years by the central bank’s $4 trillion money dump, may indeed not hold.

TIME global economy

What Ukraine Means for the Markets

Wall Street Premarket
Richard Drew—AP

Global markets have been falling on worries over conflict in the Ukraine. Is this the end of the multi-year bull market that has taken stocks to record highs recently? In a word no, but there are some important economic impacts that will be lasting; below, my top three market takeaways:

  1. Oil prices will stay higher than they should be based on demand. There’s been a lot of talk in recent months about the impact of the shale oil and gas revolution in the U.S. We’ve got so much more energy coming online at home, surely it will mean lower prices, especially when you consider that big emerging markets like China are slowing and buying less oil, right? Wrong.The lesson from the Ukraine is that geopolitical risk matters a lot in oil markets – prices were already over $100 thanks to worries over conflict in Syria and general turmoil in the Mid-east. They are now being pushed up further as the situation in the Crimea heats up, even though other commodities have been falling because of slow demand. The world has enough energy – but just the perception that some of it may be cut off is enough to keep prices higher than they should be.
  2. High oil and gas prices will allow Russia to play petro-politics with Europe, making effective sanctions difficult to implement. The U.S. isn’t dependent on Russian gas, but Europe gets about 40 percent of its supply from Russia, much of it via pipelines that flow through the Ukraine. Germany and the Netherlands in particular will be affected, in part because of bad energy policies that have already pushed up prices in those markets.German banks also have large investments in Russia, so Europe may not be able to play tough on sanctions. Why can’t the U.S. just export some of its gas to Europe if Russia plays hardball? Because unlike oil, gas is a localized market – and the first American LNG export terminal won’t be completed until next year.
  3. U.S. blue chips will likely rebound, but mainly because of the “prettiest house on an ugly block” phenomenon. I’ve been worried about frothy U.S. markets for some time .(U.S. large cap stocks are trading at 17 times earnings, close to the multi-year highs of last year.) Technology in particular feels like it’s in bubble territory ($19 billion for WhatsApp? What?).But look around – where else are you going to put your money if not in high quality U.S. stocks? Even before the trouble in the Ukraine, emerging markets were doing badly – Russia and Turkey are tanking, India and Brazil are stalling and China is brewing up a real estate bubble that could make pre-2008 Florida and Arizona look like small potatoes. Europe is trying to stave off deflation, double-digit youth unemployment and possibly now higher energy prices thanks to the trouble in the Ukraine. Meanwhile, the U.S. will grow faster than the world economy as a whole this year. Valuations may be inflated, but it’s only after this bout of geopolitical conflict is over that we will we see a correction that really reflects whether the Fed inflated bull run has come to an end.
TIME global economy

Global Investors Got High on Emerging Markets: Now for the Comedown

Pedestrians walk past a Citibank branch in Mumbai Dhiraj Singh / Bloomberg / Getty Images

The world is now paying the price for irrational exuberance over developing economies

You’d think that the world’s investors would be in good spirits right now. The U.S. economy finally appears to be recovering. Japan may be stirring back to life. Both the IMF and World Bank recently upgraded their projections for global growth. But as we get started on 2014, financial markets are in turmoil. Emerging markets from Argentina to Turkey to South Africa are seeing their currencies get slammed as investors flee. The jitters ricocheted to the U.S. last week, pummeling stocks in New York City. What in the world is going on?

Call it coming down off an emerging-markets high. During the Great Recession, when the U.S. and Europe became crushed under debt, joblessness and recession, the developing world appeared to be the future of the global economy. Growth in countries like China, India, Brazil and Indonesia shrugged off the woes of the West and supported the world economy through this toughest of times. Money flowed generously into many of these markets as a result, especially since anxious central banks in the U.S., Europe and Japan flooded their economies with liberal amounts of cash to prevent an even worse downturn. What’s happening now is that global investors are starting to realize the developing world has its own issues, and that it hasn’t detached itself from the West’s problems either. Simply, we’re waking up to the fact that many of the most promising emerging markets are facing difficulties that dim their prospects. The bubble of exuberance that has surrounded the developing world is bursting.

Take a look at China. Though its GDP growth, at 7.7% in 2013, is nothing to sniff at, it is far cry from the double-digit expansion that had been so common, and many economists believe growth will slow further. That’s because its current, investment-obsessed growth model is sputtering and the leadership in Beijing is embarking on a major reform effort to build a new foundation for future success. In fact, a good part of the strong performance China experienced during the downturn was due to a massive surge of credit that has left China burdened with lofty levels of debt. That expansion fueled consumption of everything from iron ore to Prada handbags, but it wasn’t sustainable. Now that Beijing is trying to cool things down, countries that export a lot to China, like Brazil, could see a knock-on effect to their growth as well. Despite warnings from many economists that this was coming, investors only now seem to be adjusting their thinking to a world with a slower China, and that’s affecting their sentiments towards other emerging economies.

(MORE: China’s Economy Is Slowing, and We Should All Be Thankful)

Investors are also coming to realize that many developing nations are facing political pressures that are dragging on growth. India, plagued by political gridlock and distracted by upcoming elections, has allowed the free-market reform that has been driving growth to stall. In Thailand, an ongoing political contest between the ruling party and its opponents is weighing heavily on the economy.

Still other problems have been exacerbated by the global downturn itself. All the cheap dollars spilled out by the U.S. Federal Reserve in its efforts to stimulate the American economy has made it easy for countries like Turkey and India to finance consumption and, in essence, live beyond their means. The fear is that as the Fed scales back that largesse, these countries will have a harder time getting cheap money, and that will drag on their economies. Some companies in emerging markets like Indonesia built up significant amounts of dollar debt that now could become more expensive to service. Those jitters are causing some investors to get out of some of these markets before matters get worse. Perhaps these fears will prove unfounded, but since the cash-creating programs of the world’s major central banks are so unprecedented, the impact of winding them down is uncertain as well.

This isn’t to say that all emerging markets are disasters. The IMF expects Nigeria to grow at a very China-like 7.4% this year, while the Philippines remains surprisingly buoyant. “The real lesson from recent events is that the need for investors to discriminate between individual [emerging markets] has never been greater,” noted research firm Capital Economics in a recent note. Still, while we detox, expect a bumpy ride.

MORE: The BRICs Have Hit a Wall

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