It is called the last mile, and it’s crucial to the future of all commerce. Yet most investors...
My all-around-the-world calendar for when to buy this market drop
06/21/2013 12:15 am EST
Good advice—even if the quotation and speaker are in historical dispute. (Rothschild is also credited with the advice to “Buy when there’s blood in the streets.”) If you can buy at the moment of maximum doubt or turmoil and when prices have been depressed by the certainty of further chaos, and then sell at the moment of maximum joy when disaster has been averted and all everyone wants to see is victory, then, yes, without a doubt, you can make a lot of money.
The problem is that the sound of cannons can be followed by the sound of even more cannons. And blood in the streets by even more blood in the streets. It’s hard to pick the climax of doubt and turmoil.
In the same way, it’s hard to pick the moment when the trumpets are to be trusted. Many the flourish has turned out to be maddeningly premature.
I bring this up because I think we’re at one of those moments when we can hear the sound of cannons and when blood (and tear gas) is indeed running in the streets, but when it’s hard to tell if we’ve reached the climax of the barrage.
In my opinion, it’s still early in the turmoil in global financial markets. The cannon are indeed still increasing their rate of fire. If your goal is to buy when prices are near their lows because chaos and turmoil have reached a peak, I think it’s still early. The trend in many of the world’s markets—yes, probably even in emerging markets, though they have clearly broken downward-- is still toward more turmoil.
Let me try to run quickly through the arguments for increasing turmoil in several significant individual markets. You can decide what the picture is for the global market as a whole.
The United States: I think Ben Bernanke’s performance on Wednesday, June 19, has left the markets deeply worried. The Federal Reserve chairman said that the Fed would begin to taper off its $85 billion in monthly purchases of Treasuries and mortgage-backed securities later in 2013. And that it would then gradually reduce its monthly purchases month by month until the Fed ended the buying program completely by mid-2014. IF, and this is the crucial IF, the strength of the U.S. economy is consistent with projections by the Federal Reserve that put GDP growth at 3% to 3.5% in 2014 and forecast unemployment to drop to as low as 6.5% to 7%. The market, if I can judge by the selling pressure on June 19 and 20, has taken this as a clear statement that the Fed will begin to taper on that schedule. The problem with that belief—and with the Fed’s policy statement--is that very few economists working outside the Fed believe in anything like that rate of growth for the economy and jobs in 2014. The median estimate among economists surveyed by Bloomberg calls for 1.9% growth in 2013 and an increase to 2.7% growth in 2014. The U.S. economy hasn’t growth by an annual rate above 3% since the four quarters that ended in June 2006. Either the Fed has got this right and just about everyone else has got this wrong, or the Fed is deluded in its optimism. But anybody who thinks the Fed’s statement on Wednesday put the When will they taper and by how much? market debate to rest is mistaken. The Fed has left traders and investors in the U.S. market wondering if the Fed’s optimistic economic projections are a reflection of the Fed’s desire to end quantitative easing as soon as possible rather than an honest appraisal of the U.S. economy. The Chicago Board of Options Exchange VIX Volatility Index has spiked in the last two days—and is now up 53% since May 17. And the market has been set up for further turmoil if economic data in the next quarter or two don’t back up the Fed’s optimism. Forecast: More cannon fire likely as the market tries to figure out the data and Fed policy. Hopes that the Fed will be right about growth make U.S. growth stocks a better bet than income stocks and interest rate sensitive stocks in the financial and housing sectors. I’d particularly look for growth stories that aren’t dependent on an increase in the rate of growth in the U.S. economy. Companies positioned to benefit from the boom in U.S. energy production come to mind. I’ll have some picks on that theme next week in a post on best stocks for the second half.
Brazil: It’s tempting to think of the mass protests now rocking Brazil as the sound of cannons—and therefore a signal to buy—and the end of the protests as the blare of trumpets—and a signal to sell. I think that’s a misreading of the extent of troubles in the Brazilian economy. The mass protests in the streets of Brazil’s cities were initially touched off by demonstrations against an increase in bus fares in Sao Paulo. But they’ve now grown into a protest against inflation—officially 6.5% but far more punishing in crucial categories as food and healthcare—against bad schools, economic inequality, and government corruption. There would be less anger to fuel these protests if Brazil’s economy were growing at the 7.5% rate of 2010, but growth fell to 2.7% in 2011 and then to 0.7% in 2012. The forecast for 2013 has been falling this year—it’s now down to 2.77% among private economists—and no one believes the Banco Central do Brasil’s official forecast of 3.1% growth. At the same time as growth has lagged, inflation has kicked up to an annual rate of 6.5% in May. That’s at the top of the central bank’s inflation range of 4.5% plus or minus two percentage points. Raising interest rates to fight inflation would reduce economic growth, but the central bank doesn’t seem to have a choice. Forecast: The cannon fire gets louder as we move deeper into 2013 and I don’t anticipate a drop in volume until we’ve seen a couple of further interest rate increases from the central bank. I’d look to Brazil’s domestic consumer sector after those rate cuts. As tempting as the price of shares of Brazil’s banks and exporters are at current levels, I’d still look for further drops in those sectors.
China: This market is a buy—if you think the People’s Bank is about to throw in the towel soon. If, on the other hand, you think the central bank is likely to stick by its guns for a while longer in order to get lending in the shadow banking system under control, then buying now is too early. The banking sector is a mess right now with the country’s banks suffering a liquidity squeeze as inflows of foreign capital have slowed as money heads back to the United States on a strengthening dollar. Anything the Fed said on June 19 that increased expectations that it will soon start to taper off its buying of Treasuries and mortgage-backed securities will just make that liquidity squeeze worse. Of course, a rise in China’s interbank lending costs--the seven-day repo rate, an interbank benchmark for funding costs, reached a record high of 12% on June 19, the highest level since 2006, according to Bloomberg and then shot up to 25% intraday on June 20—plus the lack of liquidity will slow the Chinese economy further. So far the People’s Bank has refused to inject more than token amounts of capital into the markets—which is one cause of the huge spike in the interbank rate. Pressure is building from a string of bad economic data for the central bank to move to make capital more abundant and cheaper. For example, the June 19 release of the preliminary Purchasing Managers Index from HSBC and Markit Economics fell to 48.3. That was below the final reading for May of 49.2 and below economists’ projections of 49.1. In this index any reading below 50 indicates that the economy is contracting. May’s reading of 49.2 was the first below 50 since October 2012. Forecast: I think the cannon are firing very loudly and I’d expect growth initiatives from the central bank in the next few months. But this is a very volatile market and those few months are likely to bring a further retreat in stocks as the data continues to indicate slowing growth. Once central bank policy does turn, I don’t expect those moves to be enough to stimulate the export and commodities-producing sector: there’s just too much excess capacity in China’s economy. The big, quick bounce, as always, will be in the shares of financials and developers. But with the economy weak—for China—I don’t think the bounce in those sectors will turn into an extended rally. With a slightly more long-term perspective I would be interested in buying shares of domestic Chinese consumer companies on any further retreat of 10% of so.
Japan: Exactly where are we in the weak yen/faster growth/higher inflation battle? Currently financial markets are behaving as if they think the battle is over and the Bank of Japan and the government of Prime Minister Shinzo Abe have left the field in defeat. The consensus seems to be that the central bank is not going to come up with new moves to send the yen lower and the government has lapsed back into the kind of half steps that have doomed previous attempts to revive the Japanese economy. I think it’s more likely that what we’re seeing is a pause in the battle as the Bank of Japan takes a moment to understand the effects of its policy moves so far on interest rates for Japanese government bonds. If the polls continue to show Abe’s Liberal Democratic Party solidly ahead in its effort to win control of the upper house in Japan’s parliament in July elections, I think this pause could run through the elections on July 21. But I’d expect that a Liberal Democratic Party victory would unleash a spate of legislation as the Abe government pushes ahead on its structural reforms of the Japanese economy. Forecast: If the markets continue to see the current lull as evidence that the Bank of Japan has given up on its weak yen/higher inflation effort, I’d expect the Tokyo market to continue to move lower. And that would create a buying opportunity around the time of the July elections.
Europe: Are bond markets losing faith in Mario Draghi’s promise to do whatever it takes to defend the euro? I think it’s a distinct possibility as part of the increasingly pessimistic view of the ability of global central banks to move their economies. The canon fire is likely to increase through the German elections in September. At the worst, these next few months might deliver, besides more stories of negative growth and more political gridlock in the EuroZone, worries about the electoral prospects for the government of Angela Merkel. Merkel’s personal popularity remains high, but her ability to secure a majority for her government in the fall elections depends on the fortunes of smaller parties that are a part of her coalition. Merkel could wind up radically weaker in the fall if her party can’t find an appropriate partner. Forecast: I’d look for the canon fire to get louder through the summer with a likely crescendo in September. Rising political uncertainty and more news of slowing economic growth suggest that September or October might be the time to look for a buying opportunity.
ROW (Rest of world): I’d expect that cash flows out of emerging markets will continue to increase along with uncertainty about U.S., Chinese, and Japanese monetary policies and growth prospects. Commodity economies such as Australia will be hard hit on fears that China’s growth will slow even further and I think they’ll need an end of growth worries before they recover. Economies such as Indonesia and Turkey that are dependent on overseas cash flows to balance current account deficits are facing a need to raise interest rates to stem outflows. Those higher rates will take a bite out of growth. I’d use Indonesia as an indicator—when the central bank in Indonesia looks like it’s done raising interest rates, I think it will be time to talk of a buying opportunity. Forecast: Outflows and rising interest rates are likely to persist into the fall. Despite the big drop in these markets, I think the rate of canon fire is still increasing. Most of the damage should be done by the fall.
All time lines like this one are subject to revision. Biggest source of revision? The U.S. markets. I’d watch the U.S. market carefully to see if any potential return of confidence in that market might spill over to the rest of the world sooner than I now expect.
By this point, I’ll bet your asking, “But what specifically do I want to buy when the time is right?”
That’s the subject of an upcoming post on the 10 best stocks for the second half. Watch this space.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of any stock mentioned in this post as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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