Something has changed in the market.
If you’ve been watching the recent sell-off in stocks, you know what I’m talking about. This change will have serious consequences.
In 2013, debt didn’t matter. Governments around the world were encouraged to take on debt to push cash money into the system.
Growing imbalances were also a good thing. If the American consumer would only spend more — via loans or credit cards or whatever means possible — we’d get that virtuous cycle of spending, hiring, and wage inflation cooking.
Monetary expansion would save us. If the Fed (and other central banks) could just get enough money into the system, again, we’d get that recovery in spending, hiring, and wages.
So long as the Fed was pumping money into the system, all of these things held true. Nothing mattered, and stock prices went higher and higher.
But the Fed started dialing back how much money it pumped every month… and that’s changed everything.
Warren Buffett once said that when the tide goes out, you find out who’s been swimming naked. Great quote.
Now that the QE tide is going out, we can see just that…
Emerging markets like Turkey, Argentina, Brazil, and Russia. The S&P 500. Treasury yields. The housing recovery. U.S. manufacturing.
Investors now see each a lot differently than they did a month ago. For the first time since the European debt problem reared its head, the stock market — and global economy — looks downright dangerous.
Emerging Market Crisis
Emerging markets like Turkey are in crisis mode. Hot foreign money, urged on by the Fed, has been fleeing Turkey all year as the QE carry trade reverses. A “carry trade” is where an institutional investor borrows cheaply in one currency and then buys higher-yielding assets of another country.
All through the ’90s, the big carry trade was to borrow yen from Japan (because Japanese rates were so low) and then buy U.S. stocks. Investors made a fortune.
And it’s easy money because it’s borrowed. They call it “hot money” because like a hot potato, it can change hands quickly.
The IMF says as much as $470 billion of hot money is directly linked to the Fed’s QE bond purchases. That money is coming out of emerging markets now. You can see it in the collapse of these currencies, and you can see it in Treasury bond prices, which have launched in the last few weeks.
Last week, Turkey raised interest rates from 7.75% to 12% to slow down the hot money stampede. That move helped support the Turkish lira — for about 6 hours. And the plunge renewed.
Now, Turkey needs to borrow around $200 billion this year, according to Barclays. The rates it may have to pay could be crippling.
South Africa raised interest rates last week. So did India.
Russia is reportedly spending $400 million a day to defend its currency. It will ultimately fail.
And Then There’s China
China has grown by investing. That is, the government has extended credit to build factories, empty cities, and so forth. Last year, it added $5 trillion worth of factories and other fixed investments. Investment as a share of GDP is now 48%.
Worse, private debt in China stands at 180% of GDP, according to the IMF. And Morgan Stanley says 45% of that debt has to be refinanced in the next 12 months. That’s around $6.7 trillion.
You see what’s happening here, right?
Growth in emerging markets is slowing. They are raising interest rates to fight currency problems. They also have to refinance a lot of debt, but at higher rates.
The Fed is pulling back on stimulus. Other central banks are raising interest rates. So where exactly is money to refinance debt going to come from? And what happens if they don’t get it?
We’ve seen firsthand what happens when people stop paying their loans. Banks fail; economies tank. If it happens in emerging markets, it will eventually come to the U.S.
It’s kinda bad out there right now. Kinda scary. But we have to ask ourselves — how will the Fed respond to this threat?
What Will the Fed Say?
I think we all know the answer to this question. We saw it in 2008 and 2009 as the economy melted down, and we saw it during the European debt crisis.
You may not want to hear this, but the Fed simply isn’t going to let the global economy fall apart and take the U.S. with it. So we can expect there will be even more stimulus in the future.
I can’t tell you exactly what the Fed will do. Maybe it will lend money to foreign banks like it did in 2008. Maybe it will actually buy up foreign government bonds. But rest assured — something will happen that will start flooding the world in money again.
I also can’t tell you exactly when it will happen. The U.S. and European economies were pretty far gone when the Fed finally said enough is enough.
One thing I can tell you, however, is what will happen when the next money-pumping operation begins. U.S. stocks will launch, and we will start hearing about inflation again.
I’m currently recommending a group of dividend stocks that perform extremely well in times of inflation. They are called REITs, or real estate investment trusts. These companies tend to own property and lease it to businesses.
Revenue for REITs is pretty stable, and they pay very nice dividends. Even better, they can raise rents according to inflation. So they always grow revenues in line with inflation… if not a little faster.
Not only that, but they are very attractive when stimulus hits because that tends to push Treasury yields lower. REITs performed very well after QE3 was announced, for instance.
So if you need a place for your money to hunker down and earn a good return until the next global rescue attempt gets underway, REITs are the perfect choice. You can learn about one of my favorite REITs right here.
Until next time,
Until next time,
Briton Ryle
@BritonRyle on Twitter
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
