Fed Rate Hike Will Mean a Calmer Market

 

The Fed has finally (seven years!) taken the first small step in getting U.S. interest rates back to sane levels. And despite nervous commentaries in the past months about the possibility that a rate hike might squash the strengthening U.S. economy, investors seem to be taking it the right way.

The Fed has been extraordinarily careful about its return to a tightening mode, delaying a widely expected hike earlier this year when the collapse of the Chinese stock market raised the possibility of negative global consequences.

So investors now trust that there was nothing hasty in the Fed’s decision. This rate increase is a pure vote of confidence in the strength of the U.S. recovery, and that makes for a calmer market.

So, what are the implications for emerging markets? Not much. The U.S. dollar strengthened in anticipation of the rate increase, and will likely continue to strengthen. Capital flows will shift somewhat toward U.S. markets, which may slow EM growth slightly.

China has already taken the step of shifting its yuan valuation away from an exclusive focus on the dollar. The yuan will now be pegged to a basket of currencies, which will prevent the strong dollar from pushing the yuan higher, which might have put pressure on exports.

The health of the global economy has always relied on having at least one major national (or regional) economy showing good growth and importing at a good clip. The U.S. has played that role more often than any, but China carried the ball for a while and Europe has done it in the deeper past. A healthy major economy consumes more of everything, including commodities, and provides a safe place for investors.

The health of the Chinese economy is likely to continue to worry investors well into 2016. While any developed economy would be over the moon with joy at the prospect of growing anywhere near 7% a year, China’s requirements are special. It needs that much growth to create sufficient jobs and power past minor fluctuations.

We have been writing about the eventual transition from a Chinese economy based on labor, manufacturing and exports to one based on internal consumption of goods and services. When the government’s attempt to finance that transition via a bull market in stocks failed earlier this year, the situation got more complicated.

The Chinese administration has had to ramp up its money supply and take steps to encourage lending and property investment. We’re still waiting to see if that campaign has the desired effect.

For now, however, we expect the Chinese stocks that trade on U.S. exchanges to continue to show wide divergences. Most ADRs are either down or flat, and the only money being made is in a few stocks with attractive stories.

Fortunately, we have been finding those stocks.

So, while we don’t ever believe that our stocks are immune from the broader trends in their markets, we are riding strength when we find it. And so far it’s working. And it will work even better if global markets calm down a bit, which is what we anticipate the Fed rate hike will accomplish.  


This is an excerpt from Cabot Emerging Markets Investor, which seeks to capitalize on the enormous potential in emerging market countries. Chief Analyst Paul Goodwin has been a researcher and writer for over 30 years and a member of the Cabot investment team since 2005.

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Paul Goodwin can be found on Google Plus.

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