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Where Next For Emerging Market?

pen chartTwo points on a graph hardly constitutes a trend. But two successive months of money tightening by the US Federal Reserve might signal intent by America to start scaling back the amount the money that it will provide to American banks to do with as they wish.

In December, Ben Bernanke, the outgoing Federal Reserve, kick started tapering. In other words, he said the US Federal Reserve would pump $75b of cash a month into the US economy rather than $85b, which it had done in the past.

Last night, he said the amount would be cut by another $10b to $65b. It doesn’t take a mathematician to work out that by the second half of 2014, Quantitative Easing, or the creation of money from thin air by the Federal Reserve, could be brought to an close.

Quantitative Easing has had some unintended consequence, mostly pleasant ones for emerging economies. But tapering, or the reversal of Quantitative Easing, has had some unintended consequences too. But this time, mostly unpleasant ones.

It has caused an outflow of money from countries such as India and Turkey, which has in turn prompted those two countries to hike interest rates drastically.

The response was not entirely unexpected. After all, the major factor that determines the forward currency rate of one currency against another is the difference in interest rates between the two countries. And as much as India and Turkey would like to continue enjoying low cost of borrowing, economic conditions and investor response would suggest otherwise.

The point about Quantitative Easing is that it can make some bad economies look good. However, we also need to remember that tapering won’t make a good economy turn bad.

It cannot be denied that the supply of cheap money has lifted the shares of many companies – even the not-so-good ones. That’s because investors are more prepared to taken on greater risk when money is inexpensive to the point of being almost free.

But now that the cost of money is likely to be higher, it is important to be more discriminating about the types of shares that we buy.

Currently, every constituent of the Straits Times Index (SGX: ^STI) is down from its 52-week high. That should not come as a huge surprise. Some of the worst affected include Jardine Cycle & Carriage (SGX: C01) and CapitaLand (SGX: C31).  Others on the ropes are City Developments (SGX: C09) and Olam International (SGX: O32).

Some may see the fall in share price as disappointing. But the thing to remember is that tapering won’t turn a good company bad. It might make the shares cheaper. However, that should be seen as a good thing for us long-term investors looking for bargains to tuck away for the long haul.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.