Following the declaration of Bernanke in previous May stating "I think we may exit QE", the emerging markets faced two small crises. Since the middle of March, the risky assets, i.e. stocks, emerging markets' F/X, and the bonds across the world have witnessed a strong rally. What will happen for the remaining of this year? Will the emerging markets face a major crisis or will they continue to see a rally?
The rally may continue until the end of September in the risky markets. In order to have a change in the guidance of the Fed which fuels the risk appetite in the markets, one needs a rise of 3% in the wages which in turn cannot materialize in the short term. The ECB may perform an additional QE during the period of September-October. Thus, we have a substantial liquidity present in the markets. The world economy has left behind the state of hibernation and the overall recovery has spread. 3Q profits from companies are expected to exhibit good performance. Valuations are expensive, but the "fury" or "bubble" stage is not present for the time being. There is still a large amount of cash present in the global funds. Volatility indices are in the bottom of the latest 5- to 7 years and with the exception of geo-political crises, there are no reasons for its rise for the time being. The momentum is very important in the financial markets: the momentum of the rally of 2Q is expected to continue in 3Q.
What is going to happen in the last quarter of the year?
Risks will increase geometrically as the end of the year nears. In October, asset purchases of QE of the Fed will stop. Markets will inevitably ask the questions as to the increase in interest rates once again as well as the time of the dose and how long it will last. While market players will be searching for the answers for a while, a profit taking is quite possible. How much inflation will cause the global growth? With the looming rise in food and oil prices while the output gap is closing around the world, central banks constituting the reserve currencies may be forced to withdraw the previous optimistic discourses. At the end of Q3, the financial assets will see a bubble in their prices and even in a small shock wave will set the stage for a hard sell.
The most fortunate of financial assets:
The Japanese and the emerging markets' shares are among those highly recommended. Both have historically low P / E averages.
What are the most hated assets?
U.S. and Euro-Zone (EU) "neighboring countries" (Greece, Portugal, Italy, Ireland and Spain) government securities premiums are excessive. The very low returns cannot be explained by economic or political developments. These assets are kept afloat with the generosity of the central bank and the carry-trade.
Euro, gold, and oil prices will trade how?
No one will earn any money in 3Q. It is likely that the EUR/USD will decline in the short term. But there are formidable barriers to the rise of the Euro; ECB does not want it. Thus, the EUR/USD will trade in the band of 1.35-1.40 during 3Q. This situation will provide a partial support to the gold and oil. The retreat of the gold till 1.000 USD/ounce has become a sort of a dream now. The gold is expecting the inflation to surface in the United States after which it will make its major move. The biggest support for the gold stems from the fact that the United States' real interest rates will remain very low for years to come. The reasonable goals for the gold in 3Q would be a trading zone of 1.350-1.400 and a year end target of 1.450. The decline in the oil prices is caused by the supply dynamics; for example, the United States has risen to the position of number one producer of oil after Saudi Arabia within two years. The world economy will never reach its previous power which sent the Brent barrel's price to 140 USD. The Brent oil may trade 100-110 USD but one has to consider the geo-political risks. The scary scenarios would be the failure to achieve a peace agreement between Iran and P5+1 and ISID's jihad in Iraq inspires terror and sabotage in the oil-producing centers of the Arab world.
Sales in the emerging markets will begin in October:
The Presidential election in Turkey do not cause a threat but the economic policy that Erdogan is going to apply in this position will look more like a time bomb. Professionals such as Babacan and Simsek will not be present in the new cabinet. The government will undertake a rapid economic growth campaign by forcing the Turkish Central Bank. We shall see a renewal in the rise of the current account deficit and inflation. With the Fed going out from the QE which will ignite the escape of the speculative funds, the Turkish Central Bank will be forced to raise its interest rates again. Turkey's dream will end by the end of this year and the nightmare will begin.
What are the greatest dangers facing the world?
Clear risks are no longer seen on the economic front. Dangers such as the failure to improve the economic growth and the transition to the deflation in the EU are present but they will evolve very slowly and the investors will adjust their positions by anticipation. But the political arena is a brewing pot. The war in Iraq may soon become a battle ground encompassing the whole Middle-East. Does Russia have another objective after the defeat in Ukraine? Will Argentina and Venezuela, which are the problematic countries of Latin America, have a balance of payments crisis which in turn will shake to the ground all the emerging countries? Will the dispute between China and the other regional countries over the continental shelf turn into an armed conflict? And the most important question: will the fundamentalist Islamic terror that took roots again in Afghanistan and Iraq, undertake a new tragedy of 9/11?
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