Mark Dow’s Emerging Market Play

April 11, 2016

Emerging markets have been bouncing from multiyear lows in recent weeks. But there’s a lot to consider before buying into the notion that we have seen a bona fide bottom, according to Mark Dow. Dow is the founder of Dow Global Advisors, based in Laguna Beach, California. He is also the author of the Behavioral Macro blog and a frequent commentator in the financial media.

Dow has 20 years’ experience as a policymaker, investor and trader, focused on global macro and emerging markets. He began his career in Washington as an economist at the International Monetary Fund and at the U.S. Department of the Treasury. I recently read a commentary that said key central banks around the world—U.S., Japan, the eurozone and China—are seeking a currency truce. None of them wants to see the Chinese yuan devalue any more, or policies that pursue a stronger dollar. Do you agree with that?

Mark Dow: I don't. We tend to over-predict coordinated actions. Yes, central banks do talk to each other, but the bar for high levels of coordination is just way up there to actually see them change their domestic policies in the benefit of someone else.

If you look at what Japan did and what Europe did, both of them have been more accommodative after the Shanghai G-20 meeting than people anticipated. But the currencies went up. Personally, I was looking for the euro and the yen and emerging markets currencies to rally, just because sentiment and positioning had gotten so extreme. So, for me, it wasn't a surprise, and I was less inclined to think it was some kind of conspiracy theory.

The people who seem to be most strongly advocating a high degree of coordination among central banks are the same people who are most bullish on the dollar and who are probably most wrongfooted. The market was primed for a countermove in the dollar because people were so negative, and positioning was so one-sided.

Take the euro, for example. If you look at the charts, it was back in December when the euro came off its bottom. It had a big move up, and then it didn't retrace that move the way it had been in the downtrend, it went sideways for a while. From a behavioral standpoint, that usually tells you there are very few people left to sell. People are already maxed short.

I know anecdotally, from the messages I get from other hedge fund managers, they were all long dollars and asking me, "What do you think?" When guys like that ask you what you think, it's usually because they're uncertain about their own views. That's what I've seen over the past few weeks. Put all of those things together, and I think the story is dramatically overblown.

It's true that people were concerned about the dollar, but the dollar's been going sideways for maybe a year now except against the emerging currencies, and those have been bombed out. What’s your view on emerging markets right now?

Dow: That it's too late to short emerging markets. And it might be too early to buy, but it's just too late to short.

And if you want to get involved, get involved in local-currency sovereign bonds. Because you get good yield and you're not taking credit risk, because there's not good growth in emerging markets, and the currencies are pretty thoroughly bombed out. What’s been driving this recent resurgence in emerging market currencies?

Dow: It really started in January. When we had that second dip in the S&P 500 in February, emerging market currencies did not sell off nearly as aggressively as the S&P 500 did. That was a sign technically that emerging market currencies were stretched in the negative direction. This has been, then, a technical move? And has anything fundamentally changed in emerging markets?

Dow: The way these processes tend to work is that first you have an extreme sentiment and positioning reading. And you have a bounce. And then at some point, among the people who are playing the bounce, sentiment starts to change and some get outright optimistic. At some point in that process, we can see signs that the fundamentals are improving in a way that validates that move.

But that move can be quite violent, because so many people say, ‘OK, this is it, this is the big chance. We need to get in emerging markets. We know this is a multiyear trade when it turns. And we don't want to be left behind.’

But often these things turn out to be a false move. And then you retrace. And then people go back to the negativity they had before, but not as bad as the previous time.

You have these oscillations of relative pessimism and optimism until such point that the fundamentals start to change. That's what the bottoming process looks like—a series of false rallies until one of those upward moves gets validated by fundamentals.

That's where we are today. We're beginning a bottoming process in emerging markets in general, and the currencies in particular. It's going to go up and down from here. But it's going to do that until the emerging market fundamentals start to get better.

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