I’m talking about two topics in this volume, the next installment of my 2019 forecast, which are emerging markets and financials. Starting with emerging markets, which are countries whose economies are developing and not quite mature like America, Japan, or the Eurozone. And their financial systems are shallow compared to developed markets because they just don’t have the depth or breadth of an economy like developed nations, especially their bond markets and financial institutions.

So on tap for emerging markets will be continued pain as long as the Fed continues hiking rates and selling assets, or at least only pauses. As I’ve said many times in the past, these countries and the companies domiciled within who have borrowed in dollars have two difficulties with rate hikes and Fed asset sales. The first problem is rising interest rates will cause these countries and companies to have to pay back their loans with rising interest rates, especially if they’ve borrowed with a variable rate or they are at or near the time to refinance.

The second problem facing emerging market countries and companies is that as the Fed continues to raise interest rates and sell its own assets, the dollar will maintain its strength if not rise. For any country or company that takes in revenue in its own local currency and then has to convert it to dollar, they’ll continue to need more and more of their local currencies to pay back a fixed or rising amount of dollars. This will add severe pressure to their balance sheets as the debt applies more and more strain to their income and cash flow statements.

The biggest banks in the world who have lent to these countries and companies, particularly American banks and other American financial institutions, will feel the pain of not being paid back. The Wall Street Journal has an estimated $500 billion of USD denominated EM debt out of over $40T coming due for payoff or refinancing this year. As rates continue to rise and as the dollar maintains its strength, these institutions will begin to see too many defaults, causing pain on their own balance sheets, cash flow, and income statements.

But by the time the Fed reverses its current policy trajectory and goes back to asset purchases and lowering interest rates, it will be too late for the banks, because the damage will already be done. To be sure, once the Fed reverses policy, those foreign currencies of emerging markets will begin to gain strength, and the share prices of their stronger companies will begin to turn around. Their revenues will look better, their debt repayment will be easier, and the bottom lines will be stronger. But like I said, the damage will be done to the financial institutions here in the United States. And what it will look like is wild volatility in both emerging markets as well as financials, and in fact we are already seeing financials lead markets lower since October 2018. And the fact that banks are so highly leveraged themselves, doesn’t help one bit.

Let me know what you think or ask your questions in the comments below. Until next time remember that there is always a bull market somewhere in the world, and on the opposite side of every crisis, lies opportunity.