The Daily Prophet: Emerging Markets, Gold Bugs and Costly Hedges

Connecting the dots in global markets.

Remember when everyone said to get out of emerging markets because Donald Trump's protectionist policies and a stronger dollar would decimate their economies? Well, that's not happening.

Today, the MSCI EM Index soared 2.09 percent, the most since July, on relief that the Federal Reserve is unlikely to raise interest rates at an even faster pace than it predicted in December. Christopher Brightman, the chief investment officer at Research Affiliates who called emerging markets the “trade of a decade” in early 2016, says they remain "an enormous bargain" relative to the prices being paid for stocks in developed markets, especially the U.S. Economists surveyed by Bloomberg News expect emerging-market economies to expand 4.7 percent this year and 4.9 percent in 2018. By comparison, growth in the Group of Eight will be unchanged at 1.8 percent.

Some of the better performing emerging-market stocks can be found in Mexico, Brazil, China and even Turkey, which have all roared back from a terrible 2015 and a brief post-U.S. election dip. "One has to go back and ask how did it ever get so cheap?" Brightman told Bloomberg News' Ben Bartenstein. "People finally realized that the world economy is not coming to an end, and that’s what made a bottom for emerging markets."

Gold bugs, rejoice! The precious metal jumped 2.16 percent to $1,226 an ounce in its biggest gain since June. Just like their brethren in emerging markets, gold traders are thankful that the Fed sees no reason to hike rates at a faster pace. Since gold is priced in dollars, a stronger greenback that might result from higher interest rates would tend to damp the metal's appeal. The top three most-actively traded gold options are bets on further price gains, according to Bloomberg News' Luzi Ann Javier. The price and volume on the option giving holders the right to buy bullion futures for April delivery at $1,250 an ounce more than doubled.

Fed Chair Janet Yellen has bond traders right where she wants them. She managed to signal yesterday that the central bank is still on track to raise rates three times this year without roiling the market. In fact, far from predicting bondageddon, traders are showing more confidence in the markets ability to weather higher rates down the road. That can be seen in Bank of America Merrill Lynch’s MOVE index. The measure of anticipated volatility in the market for U.S. Treasuries has been trending lower, and is now at levels last seen before the U.S. election in November. That dovetails with other bond metrics that show the market's confidence in the Fed's ability to keep inflation from accelerating and eroding the value of fixed-income payments.

It's fashionable to declare that traders are too complacent and that measures of volatility are too low -- or even broken. Such pronouncements seem to ignore the fact that markets have come through the European debt crisis, Brexit and the surprise U.S. election just fine, and that there is always some event on the horizon, whether known or unknown, that could topple markets. But being extra cautious can be costly. That's the case with traders who chose to hedge against European equity volatility heading into the Dutch parliamentary elections, where the Liberals' victory removed some stress from the markets today. Investors worried about European national elections began protecting early this year against the potential for greater stock swings, according to Bloomberg News' Aleksandra Gjorgievska . By February, the cost of VStoxx Index futures maturing around the first round of French voting has surged, a rise that occurred much earlier than the move seen in June just before the British vote on European Union membership. Now, volatility bets have eased, and the Stoxx Europe 600 rose today to its highest since the start of December.

Part of the bull case for U.S. stocks goes something like this: Don't worry about the nosebleed valuation levels of equities because Trump's fiscal stimulus plans will be a boon to corporate profits. The problem is, earnings estimates are being cut. Current forecasts for the S&P 500 Index is for profits of $131.28 a share this year, down from $133 on the eve of the U.S. election and $134.50 in September, according to Convergex, citing FactSet data. Net profit margins are at peak levels, or 9.5 percent versus a 10-year average of 8.8 percent, it said in a research note. Without a corporate tax cut, margins will likely narrow in coming years either because wage and raw material inflation picks up or because the economy cools, the firm said. When it comes to fiscal policy, the Convergex said the market is "essentially flying blind. It is a very unique situation, something akin to when the Fed first launched quantitative easing. It all sounds great, but no one knows exactly how it will work."


Will the real U.S. consumer please stand up. Although most measures of confidence have soared since the election, consumers don't seem to be following through with actual spending. The latest evidence came yesterday when the Commerce Department said retail sales rose 0.1 percent in February, the smallest gain in six months. Just four of the 13 major retail categories saw gains in sales. While purchases may have been restrained by a temporary slowdown in individual tax refunds, markets will get a fresh number to digest Friday when the University of Michigan releases its preliminary consumer confidence report for March. The median estimate in a Bloomberg survey is for a slight gain to 97 from 96.3 in February and up from 87.2 in October.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Contributors to Bloomberg Prophets may have a stake in the areas they write about.