For days after death hair and fingernails continue to grow, but phone calls taper off. – Johnny Carson

A new term has entered the vocabulary of investors – tapering.

Ben Bernanke, the president of the Federal Reserve Board of the United States otherwise known as the US Central Bank, suggested in a speech on 19 June 2013 that the time was coming when the United States would reduce the amount of bonds it was buying under the most recent Quantitative Easing scheme (QE 3), before finally ceasing these purchases perhaps at the end of 2014.

The investment markets, like jittery 16 year olds assisted by their computers, panicked and initiated a major sell off of fixed Income debt instruments without understanding the caveats attached to Dr. Bernanke’s statement. This was indeed expected, though the exact timing was unclear. This has been called a ‘Taper Tantrum’ by Michael Hasenstab from Franklin Templeton. Why spoil a good story with facts?

At the same time Chinese economic data announced a relative slowing of growth in the Chinese economy coupled with a tightening of the rules regarding the non-regulated lending sector. All of this was expected, but caused ructions anyway, even though the gradual changes in the Chinese economy from investment-led to consumer demand-led have been clear for a while.

Having started the panic (in truth Dr. Bernanke’s speech came after the Asian markets had begun their decline), Dr. Bernanke’s team made some effort to explain that what he had actually meant was that if unemployment figures in the US allow it, the bond purchase by the Fed would slowly begin to decline. Not only that, but clearly it is too soon for the similar schemes in Europe and indeed in the United Kingdom to be wound down. This is despite the fact that the most recent economic data from Germany and the United Kingdom is broadly positive, even if Southern Europe is still fragile at best.

Economists describe the panic as the markets pricing in the change in US monetary policy well before it actually happens. There is an expectation of higher interest rates in the USA which will reverse the capital outflows to the Emerging Markets and indeed to the high yield end of the debt markets.

Let’s get our retaliation in first.

The economies most likely to suffer are those that have large current account deficits and are therefore most dependent on offshore investment from sources of ‘hot money’. For instance, the Ukraine, Turkey, South Africa and India have been badly hit. In addition companies are more likely than governments to suffer from a tightening of liquidity. Corporate borrowers (according to the Economist intelligence Unit) are likely to roll over their debt more frequently than governments.

A shortage of liquidity will cause much higher costs and companies which have become used to spending and borrowing will have to return to the old days of abstinence. Not only that, but the available money will only be available for much shorter maturities than in the past. Governments that are facing social unrest will also find that sources of new debt are drying up. All this is due to happen in the future, but that is not (in the eyes of a panicky market ) an excuse for not pressing the panic button now.

The emerging markets, both governments and companies, are potentially very valuable areas in which to invest and should form part of all but the most conservative portfolios. It is however essential to select the best managers with professional research teams in order to make best use of the risks.

In China (so reports Professor Xiaozu Wang in the South China Morning Post) the fears of a curb on bank lending should in fact be seen as a shortage of equity financing to meet the demand for capital.

Chinese banks ran out of money last week. They had to scramble to find funds to meet their regulatory liquidity requirements and borrowing rates for overnight money briefly exceeded 30%. This also sent shock waves around the world, focusing attention on the health of Chinese banks and bringing calls for controls on Chinese bank credit.

The reality of life is that Chinese Banks had mismanaged their liquidity and their lack of belief in the central bank’s determination to control lending. Just as in the West, banks’ dynamic lending came about because it was tolerated. Chinese corporate growth has been faster than the ability of those companies to expand their capital base, leaving them with the easy option of increasing their debt. This works well as long as the banks can lend and then continually refinance the funding for their loans. While there is no loan crisis in China, the banks have growing non-performing loan positions on their balance sheets. This is acceptable at present, but a sudden forced reduction in lending would immediately affect investment in productive enterprises and be detrimental to future growth.

The Chinese government has not yet made equity financing a priority. This will have to come eventually as corporate growth continues and debt becomes more expensive.

In the meantime the US and European markets, seeing that the Chinese economic growth data had shown a slight decline to some 7.5% a year, decided that the boom times in China were over. It is easy to make such assumptions from the financial dealing desks of London and New York, but the reality is that the Chinese economy is moving away from being principally driven by large scale investment projects to a domestic consumer demand driven (and therefore more stable) system.

There is a lot of growth still to be seen in China and a lot of investment too; it will come from increasingly different sources than in the past, something that dealing room traders who are not even sure where China is will have to follow after it has happened.

Finally, we are seeing a new era of volatility, which is causing uncertainty, something that investors hate. The investment markets have over-reacted to this uncertainty by heading for the hills. Like a pendulum, the trend will return to where it started.

Company debt, especially that of the foremost profitable companies operating in the international markets, still makes a sound investment. Much the same thing can be said about the equity of these companies; the correlation between the two is very close whereas the yield on equity is normally higher.

Those who are not afraid of the present markets and believe in the future, will profit from the present uncertainty.