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Fed provokes run for the hills ... in China and India

August 20, 2013: 1:24 PM ET
Despite worries about the Federal Reserve tapering its bond purchases, the U.S. stock market has held up well. The same can't be said for emerging markets.

Despite worries about the Fed tapering, U.S. stocks have held up well. The same can't be said for emerging markets.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.

Stocks are in the midst of an August swoon. Is this finally the beginning of the long-awaited correction? Well, if I really knew the answer to that, I probably wouldn't be a lowly member of the Fourth Estate. I'd have a hedge fund up in Greenwich and I'd be trading verbal jabs with Bill Ackman on CNBC.

What I do know is this. Fears about the Federal Reserve getting ready to finally do something that rhymes with papering are once again causing stocks to slide. Just like they did in June. And as uncomfortable as it is to watch the market fall for four days straight (losing streak may end today though), we need a little perspective.

Sure, the VIX (VIX) is hovering near 15. That's the highest level for this measure of volatility since early July. And CNNMoney's own Fear & Greed Index, which looks at the VIX and six other market indicators, briefly flashed signs of Extreme Fear this morning. The last time investors were that scared was also early July.

Related: Don't be a bond Chicken Little

However, the performance of the U.S. stock market is not really as frightful as you might think. The Dow, S&P 500 and Nasdaq are only about 4% off their recent highs. And these aren't just your normal, garden variety 52-week highs either.

The Dow and S&P hit all-time highs as recently as a few weeks ago. The Nasdaq is trading near a level it hasn't been at since 2000 ... although it remains 30% off its all-time peak, which was also from 2000. The Dow and S&P are still up about 15% this year, while the Nasdaq is up nearly 20%.

That's not exactly horrifying. And if the economy continues to improve, earnings should be decent. That should trump any concerns about the Fed pruning its bond portfolio.

"This pullback has been modest. Interest rates should rise unless the U.S. goes back into a recession," said Tom Franks, head of equity portfolio management for TIAA-CREF.

If you really want to see abject terror, check out emerging markets.

India's stock market is in tatters lately as its currency, the rupee, hit a record low. Brazil's Bovespa is one of the worst performing markets this year. The Hang Seng in Hong Kong and China's Shanghai Composite are in the red this year. Smaller emerging markets, such as Turkey and Indonesia, have taken it on the chin too.

So instead of crying about the recent drop in the S&P, be thankful you don't own the iShares MSCI Emerging Markets (EEM) exchange-traded fund ... assuming, of course, that you don't own that ETF. If you do, feel free to turn on the waterworks.

Interestingly enough, it seems that fears of the Fed pulling back on its $85 billion-a-month of bond buying are having a more pronounced impact on these emerging markets than on the United States.

Call it the tapernado. Or #tapernado if you want to get it trending on Twitter. (h/t @SconsetCapital)

Related: The 'Septaper' is coming. Deal with it!

Simply put, worries about the Fed slowing its pace of asset purchases has helped push U.S. Treasury yields higher. That has led some investors to wonder if riskier emerging markets make sense as investments anymore.

Karim Basta, director of economic research and chief investment strategist at III Associates, a hedge fund, said the biggest issue is that India, Indonesia and several other emerging markets have large current account deficits. They rely on foreign capital. And that appears to be drying up.

Emerging markets, which tended to have bonds offering higher yields thanks to their stronger economies and currencies, are no longer as attractive to conservative investors hungry for income. Those investors can now seek safety in U.S. Treasuries, as well as stocks that pay big, fat dividends.

"If I am an investor and I can all of a sudden get yield in the U.S. with a hopefully more stable currency, then why not do it? That's not the only thing going on with emerging markets but it's part of it," said Franks.

Related: BRIC markets left in the dust

But here's the thing. This can't go on forever. If the stock markets in China, India, Brazil and other large emerging markets continue to suffer, that would be bad news for the U.S. -- especially if the economies of those emerging markets start to slow dramatically as well.

While the recent signs of life in the U.S. economy and the miraculous turnaround in Europe are encouraging, the developed world could be in for a nasty shock if emerging markets enter their own recession.

Large U.S. multinationals, such as Apple (AAPL), Coca-Cola (KO), Yum! Brands (YUM), Caterpillar (CAT) and Procter & Gamble (PG), are increasingly looking abroad for more growth opportunities.

Basta said that a big slowdown in emerging markets would not be good news for U.S. exporters. And China is the biggest wild card, added Franks.

Here's hoping that India and China do bounce back. Because if tapering winds up causing even more damage overseas, investors will eventually feel it here. And I guess the Fed will have to chalk that up as one of those unintended consequences.

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Paul Lamonica
Paul R. La Monica
Assistant Managing Editor, CNNMoney

Paul R. La Monica is an assistant managing editor at CNNMoney. He is the author of the site's daily column, The Buzz, and also tweets throughout the day about the markets and economy @LaMonicaBuzz. La Monica also oversees the site's economic, markets and technology coverage.

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