Is this the long awaited Emerging Market Crash?

We reckoned that the long overdue ‘deleveraging’ of the financial markets has finally arrived. The risk of Emerging markets imploding seems to have heightened for the past month. Reasons being the following.

Japanese reflationary policy already runs its course

The Japanese Government under Shinzo Abe tried to rescue its economy from the  deflationary grip by employing the same strategy used during the 1930s,  to reflate the economy. By reflating we mean the government trying to achieve an inflation rate higher than the normal long  term rate so as to restore price level to pre deflationary level and in this case before 1998. As a result the Japanese government announced its objective of achieving an inflation target of 2% at any cost. The Bank of Japan is committed to buy into the Bonds and Equities market. Following the Bank of Japan’s intervention in the bond market the Yen fell to a seven month low.

As a result the Nikkei 225 had a tremendous run up from the low of 8,600 point  in October 2012 to 15,942 point in May 2013. This represents a 90% rise. The following chart shows the Nikkei 225 performance for the past year.

However as of late the Japanese economy has not been performing as anticipated and seems to be running out of steam. The is mainly due to the fact that the economy is no longer responding to further monetary easing. To put it another way, the effects has already worn out and failed to extract Japan out of it’s ‘liquidity trap’. Moreover, Japan is still running trade deficits for the past few years and huge Government Debts to GDP as shown below despite trillions of ¥ been pumped in.

What Japanese investors experiencing soon will be the remnants of monetary easing which is higher volatility in their financial markets. This is also a sign that the Japanese authorities has lost control over their economy. They are in a state of denial and in time we will see the USD/JPY moving above 150 , inflation, more bailing ins and bailing outs, fallout of the Nikkei and so on as a result of its recent policy. In short many Japanese investors is going to lose a lot of money when the dust settles.

China officially in Bear Market

China’s Shanghai Stock Exchange dropped most since August 2009. Today it dived 5.3% or 109 points to close below the psycological 2000 points since December last year. The Shanghai Stock Exchange has dropped more than 20% from February this year (2444 points) to 1963 points today. A drop of 20% or more confirms the Shanghai Stock Exchange in bear market territory. This can be shown by the following chart.

The following are the reasons for the sharp fall.

1. The downgrade of China’s economic growth prospect from 7.8% to 7.4% in 2013 and 8.4% to 7.7% in 2014 over the weekend by Goldman Sachs.

2. Recent announcement by PBOC (People’s Bank of China) that no more monetary easing in the near term. By running a tight monetary policy it hoped to tackle structural problems such as misallocation of funds in the near term. Evidence of credit squeeze can be seen from some major banks in China offering free gifts to attract term deposit customers.

3. Cancel of Bond sales. Due to PBOC’s tight money policy, attempts by a few Chinese companies to sell bonds to raise money has been cancelled. It include Chinese Development Bank and China Three Gorges Corporation.

4. Moody’s revision of Hong Kong’s Banking system outlook to negative due to its exposure to China.

5. This morning Bank of China announced that silver transfer service, online banking, moratorium on transfers fully suspended. A sign of bank run to come?

As a result most stock markets emerging Asia dropped sharply.

Hang Seng - 2.2%

All Ordinaries - 1.54%

Jakarta - 1.9%

KLSE - 1.01%

Nikkei - 1.26%

Straits Times - 1.6%

Kospi - 1.31%

As we have said repeatedly we are entering a new era where Volatility is the name of the game. With China’s implosion its effect for the rest of Asia is yet to be seen as China remains the top trading partner of most Asian countries. We reckoned that pain will be felt around Asia soon as China starts deleveraging.

How about our KLSE?

Again as we have warned repeatedly we are still in a state of denial. We are led to believe that our stock market is the strongest and our economy the most resilient. Our so-called Plunge Protection Team managed to shield us from the carnage that has been ripping through other markets. In our earlier article dated 13th of June on “Malaysia’s Economy and Stock Market Disconnect”, we have already detailed in length that fundamentally our KLSE will not hold and will have to correct soon.

We reckoned that the time has come for us to face reality. In the weeks ahead we will be expecting high volatility in the KLSE as loses mounts. In time we shall be able to see daily swings of 20-30 points instead of 10-20 points now. From the chart below it is obvious that our correction has just started and with the first support at 1743 point has just been taken out, we will soon be heading towards the 1700 point level where our next support lies.