Caution Signals for Emerging-Market Currencies

The discussion and implementation of capital controls is a barometer for the currency market, and investors in emerging-market currency ETFs should take heed.

In the past month, Taiwan moved to block hot money from sitting in time deposits, and Brazil initiated a tax on foreign equity investors.

Hong Kong reports that in the six weeks between Oct. 1 and Nov. 13, close to $75 billion flowed into the country. To put that in perspective, Hong Kong's GDP was $215 billion last year. Stock market capitalization exceeds $2 trillion, but 50% of the market is made up of Chinese firms. Hong Kong's government is concerned about the huge inflows, and it is not alone.

Bloomberg also reports that, "Officials from India, South Korea and Indonesia are among those expressing concern over overseas capital stoking stock and real estate prices."

These nations remember the 1997 Asian crisis well and do not want to suffer a repeat. The main focus of their concern is the ultra-low interest rate on the U.S. dollar that is fueling the carry trade. Emerging markets are seeing increases in asset prices along with their currencies, and it may eventually cause global imbalances that will be corrected via another currency crisis.

While emerging-market equities still have room to advance, the easy currency gains are gone. It's impossible to know when the current currency trends will end, but the growing concern from South America to Asia is a sign that we are entering the middle phase of the current rally. Note that the policies are unlikely to change the market; rather, by the time the slow-moving governments finally act, the market has already shifted.

Today's comments by European Central Bank President Jean-Claude Trichet, stating that it is time for the ECB to begin reversing some support measures, echo similar concerns.

Investors in emerging-market currency ETFs, such as WisdomTree Dreyfus Emerging Currencies (CEW - commentary - Trade Now) do not need to sell now, but I would not add new positions.

At the time of publication, Dion had no positions in securities mentioned.

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Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.