After such a long period of quantitative easing, we have come to the close. The Fed will most probably end its asset purchasing programme this month, and the markets are trying to understand what will come next. The results have been barely rising real wages, quite low inflation, but a satisfactory drop in the unemployment rate currently down to 5.9 %. A massive amount of money will effectively be pulled out by the system, forcing dollars that left America to go back home, hence strengthening the U.S. currency and discouraging exports. Due to this drawback in the Fed’s initial plan, it will probably be a longer period than expected before we see rates hike in the U.S. Now, Europe: in the current economic landscape, rates are at their lowest and carry trades will return in the pursuit of yield. Obviously, investors prefer that such trades be put up in stable environments, with stable currencies (e.g. pre-crisis Japan). So when looking at some of the emerging markets, certain yields look attractive. We may want to break up our array of developing markets into a matrix according to whether each country runs a current account deficit, surplus, and is a commodity or a manufacture goods exporter. Now basing on the assumption that carry trades, in the light of the Q.E. ending and the long period of low European rates ahead, will be oriented towards more stable countries, the bloc of countries with the lowest in terms of volatility and risk seems to be the so-called South East bloc. The group is built around China and includes most of the East and South East Asia, including Taiwan and Korea. These countries have a high tech export profile, high FX reserves which result in self-financing external accounts. More importantly, they are not fully exposed to the liquidity cycle as are countries like India and Turkey, which heavily rely on global liquidity to fund their current account deficits and keep inflation and rates to a halt. Economic data from Taiwan has steadily been improving and expanding, and we believe this will continue in 2015. The stronger dollar will most certainly boost demand for foreign products, thus strongly enhancing Taiwanese economy. Also, these commodity importing countries will further benefit from the fall in commodity prices we have seen lately and that will continue in the future. What we suggest here is that we await this month’s Fed decision on Q.E., and if definitive, go long on the Taiex, the Taiwanese Stock exchange, which includes many of the companies that benefit from exports, but only after the markets have released some initial tension after the decision. At present we think it is quite undervalued, and it should gain strength once the dust has set. To buy some protection if volatility persists, we would recommend buying some ATM put options on the iShares MSCI Emerging Markets ETF, in order to protect ourselves from potential downside.
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