Overview: What Happened to the Doldrums?

The months of July and August were typically periods of low activity and early closes. This year should not have been different. The Chinese behemoth was ravishing the global supply of commodities, positioning the emerging market countries for another comfortable year. Many fund managers were taking advantage of the traditional slowdown to enjoy their summer villas. Others were decamping for the Costa Azure to take possession of their newly-constructed yachts. Unfortunately, the summer did not provide to be as dull as many of them hoped. The meltdown in the U.S. sub prime market and the increase in risk aversion made it the most volatile summer since the meltdown of ’98, catching many people by surprise.

The problems with the U.S. mortgage markets should not have been surprising. The reckless lending practices in the U.S. were commonplace. The unsustained increases in U.S. housing prices were well documented. The dangers associated with the unbridled increases in derivative issuance and the obscure nature of the instruments were warned by a variety of government officials and financial analysts. Everyone knew that a crisis was inevitable, given the tightening of U.S. monetary policy and the eventual impact on credit. It was also evident that the problems would spill into the financial sector and depress economic activity. Such a scenario would obviously dampen investor sentiment. The fact that the impact of the mortgage-sector problems has been muted is the only real surprise. Nevertheless, it is still having an effect on financial markets around the world, and on the emerging markets.

Argentina was the worst off. A-priori, this was logical. An increase in risk aversion is defined as a heightened differentiation between risky assets. In the credit markets, an increase in risk aversion is measured by the spread differential between rating groups. Argentina was one of the lowest-rated countries in the emerging markets, thus one of the riskiest. Therefore, it is logical that it should have suffered more than its peers. However, the problems in Argentina were exacerbated by a variety of internal factors, specifically the presidential elections and the energy crisis.

The 2007 presidential elections in Argentina should have been a non-event. The opposition was fragmented. President Kirchner’s popularity was high, and the economy was doing well. The president was so confident of his support that he allowed his wife to run for office in order to implement many of the reforms that he was politically unwilling to do. Unfortunately, a brutal winter changed the scenario, plunging the over-stretched energy grid to the limit and igniting a full-blown energy crisis. The shoo-in election scenario went up in smoke, as Argentina coped with blackouts, gas-rationing and petrol lines. The Argentine growth machine sputtered, as companies furloughed workers due to the lack of energy. Economists began warning about an economic slowdown by the end of the year—inducing some investors to dump their GDP warrants.

The current situation may seem bad, but there is no change for the global outlook. On the contrary, the problems in the U.S. are only accelerating the realignment of the global economic order. The ascendancy of China is a god-send for most emerging market countries. The rise of the Asian consumer is increasing the overall demand for natural resources, assuring strong income for commodity-based economies—many of them in the emerging market category. The problems in Argentina are also creating a unique buying opportunity. The ongoing crisis will only justify the urgency of the reforms needed to increase energy production and reign in the accelerating inflation rate. These changes will become more evident as the calendar grinds closer toward the October 26 election date.

In the meantime, some fund managers will have to trim their summer sojourns or take later delivery of their new nautical toys. But one thing is for sure, the recent sell-off is creating a very good buying opportunity, and it is sowing the seeds for a rally in the fourth-quarter.