Thought of the Week

1. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser. All charts courtesy of Bloomberg as of 2/7/2014.
Thought for the Week (287):
Are Emerging Markets Really a Problem?
Synopsis
 Markets were spooked in the summer of 1997, when a currency crisis in Thailand sparked a contagion into neighboring emerging markets in Southeast Asia.
 This year began with news of several concerning issues in emerging markets across the globe, and some investors are worried that markets may experience another bout of contagion.
 We do not believe that history will repeat itself, but rather, we feel that the recent turmoil in emerging markets is merely an excuse to sell and take profits in U.S. equities.
The Asian Currency Crisis of 1997
Emerging markets have been attracting capital for decades with their higher growth rates vs. developed markets. However, the higher the expected return brings higher risk, and emerging markets reminded investors of this tenet back in the summer of 1997.
A currency crisis began in Southeast Asia after Thailand enacted a dramatic change to their monetary policy, and two years after it ended, anxiety still loomed over global financial markets. Although initially perceived to be a localized crisis in Thailand, contagion soon spread to other Southeast Asian countries including Malaysia, Indonesia and the Philippines.
By the fall of 1997, the contagion extended to South Korea, Hong Kong and China. In 1998, Russia and Brazil saw their economies enter a free-fall, and international stock markets hit record lows as investors' confidence was shaken by the volatility and uncertainty in the world's financial markets.
To make matters worse, a prominent hedge fund called Long Term Capital Management (LTCM) threw gasoline on this fire with a bet on Russia’s bonds that went sour. LTCM did business with nearly everyone important on Wall Street, and most of these top financial firms were investors that had a lot to lose if something bad were to happen.
As LTCM teetered, Wall Street feared that Long-Term's failure could cause a chain reaction in numerous markets, causing catastrophic losses throughout the financial system. In order to prevent further market volatility, the Fed bailed them out and ultimately eased the volatility in the market.
NOTE: Long Term Capital Management consisted of some of the smartest financial minds in the world, including a handful of Nobel Prize winners. However, their failure is a harsh reminder of what can happen when a firm does not manage risk properly. The story of their rise and fall is truly fascinating, and those who are interested in learning more should read ‘When Genius Failed’, by Roger Lowenstein.
The Asian crisis led to some needed financial and government reforms in countries like Thailand, South Korea, Japan and Indonesia. It also serves as a valuable case study for economists who try to understand the interwoven markets of today, especially as it relates to currency trading and national accounts management.

2. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser. All charts courtesy of Bloomberg as of 2/7/2014.
What’s Going on in Emerging Markets Today?
The chart below shows the performance of the MSCI Emerging Markets Equity Index (MXEF) over the past twelve months.
The red arrow indicates that the performance since the beginning of the year has been rather weak. We believe that there are four main reasons for the recent decline in emerging markets equities:
1. China Manufacturing: Investors were spooked back in January when China released weaker- than-expected manufacturing data. Given China is one of the largest customers to other emerging markets, investors feared that a slowdown would harm these suppliers.
2. Inflation Fears: Venezuela and Argentina are battling rising inflation due to poor fiscal and monetary policies. For example, Argentina’s inflation rate is currently estimated to be as high as 30%, and local merchants are being forced to raise prices on a daily basis just to keep pace.
3. Political Unrest: Thailand, Ukraine, and Turkey are all in the middle of political unrest, and markets dislike uncertainty.
4. Fed Tapering: Investors who flocked to emerging markets in search of yield (thanks to the Fed keeping interest rates artificially low in the U.S.) are now returning as the Fed begins tapering. Since the Fed is buying fewer bonds, investors are anticipating falling Treasury prices and more attractive risk-adjusted returns. NOTE: The green arrow in the chart above indicates the last time that tapering spooked investors. Back in June, Ben Bernanke indicated that the Fed may begin tapering in the fall of 2013, and the money that flooded into these markets in search for better yield quickly reversed course in anticipation of rising interest rates in the U.S. Traders believed that higher rates in U.S. securities that are also “risk-free” would do what is happening right now – attract money back to the U.S.

3. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser. All charts courtesy of Bloomberg as of 2/7/2014.
Talk of contagion and economic meltdowns, along with slower China growth, has managed to spook an already jittery Wall Street. As a result, many investors are simply dumping their emerging markets holdings and running for cover in fear of history repeating itself.
Fears Appear Overblown
Despite the dismal performance of emerging markets to start the year, we are highly skeptical of the possibility for any contagion or material impact to U.S. equities for three key reasons:
 Data is a Mixed Bag: We are suspect of the data that comes from China, and based on the recent earnings from companies highly levered to China, we argue that they are still spending plenty to maintain their target growth rate of 7.5%. China also has approximately $3.5 trillion in their bank account, so they have the purchasing power to hit nearly any target growth rate.
 Stronger and Smarter Economies: Emerging markets today have more sophisticated monetary policies and larger capital reserves, allowing them to better defend their currency from speculative attacks. Granted some may be doomed, such as Argentina, but the vast majority will get through this tough time because currency storms rarely last long.
 A Matter of Scale: The chart below shows the gross domestic product (GDP), a measure of all goods and services within a country’s border, in 2012 for the countries in duress vs. the U.S. The GDP from these countries combined barely represents 10% of our $14 trillion in GDP. Simply put, these countries are too small to make any fundamental impact to our economy.
We feel that this move from emerging markets back to the U.S. is nothing more than a normal cyclical rebalancing of capital flows from a region with less opportunity for future gains to one with more attractive risk-adjusted returns.

4. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser. All charts courtesy of Bloomberg as of 2/7/2014.
Furthermore, although there are legitimate issues in many of these emerging markets, we do not believe that any contagion could spread in a material way that would impact the long-term earnings of U.S. listed companies.
Implications for Investors
The market seems to be so fixated on the idea of a looming correction that we may simply end up talking ourselves into one. Why? Investors want to point to any excuse under the sun, including emerging market weakness, to justify selling equities after a year with such massive gains.
Only time will tell if we do actually see a correction over the coming weeks, but given our view that we are in a slow and steady economic recovery, the causes for a correction will likely not be fundamentally driven. Therefore, we will continue to be patient and look for opportunity with our cash balance to buy stocks when they go on sale.