I am still on alert for a larger pullback in the market. The larger picture suggests the SPX will li...
What's next? What's next for global financial markets if Washington fixes the shutdown/debt ceiling crisis?
10/14/2013 11:09 pm EST
But let’s pry our eyes away for the moment—and look further own the road.
Assuming this crisis does get resolved short of financial Armageddon—and I think it will, although probably only after a near U.S. default has badly rattled global financial markets later this week—then what? Let me try to look ahead at the rest of the year and into 2014 to see what’s likely to happen in the markets.
First, and I think we’re all agreed on this, we get a relief rally whenever this mess is over. (Of course, the almost universal, it seems, belief in a relief rally has meant that stocks haven’t fallen very far and that the markets haven’t created very many bargains.) We’ve already seen a good example of that last week on Thursday and Friday when optimism soared that the White House and House Republicans were close to a deal. We got a very impressive 2.2% rally in the Standard & Poor’s 500 on Thursday, October 10, and a decent follow on of 0.63% on Friday, October 11.
Those markets and stocks that had been hit harder by fears of a U.S. default and by the consequent flight to safety rebounded even more strongly than the U.S. markets. This was particularly true for emerging markets, which had suffered their usual relatively larger decline when fear increased among investors—even if these countries weren’t the source of the fear. The iShares MSCI Indonesia ETF (EIDO), for example, rose 3.6% on October 10. The iShares MSCI India ETF (INDA) climbed 3.2% and iShares MSCI Turkey ETF (TUR) was up 2.8%.
How long the relief rally runs and how big it is depends on how quickly the economic fears that were preying on the market’s mind return to the front of investors’ thinking. Remember back before the U.S. budget and debt ceiling crisis? The fears then were 1) how slow would growth get in China, and 2) when would the U.S. Federal Reserve move to begin tapering off its $85 billion in monthly purchases of U.S. Treasuries and mortgage-backed securities.
Over the weekend, China’s government announced that exports unexpectedly fell in September. Exports dropped 0.3% from September 2012. Economists surveyed by Bloomberg had expected 5.5% annual growth in exports. In August exports had climbed at a 7.2% annual rate. (Imports climbed 7.4% in September, more than economists had forecast.) The worry, you’ll remember, is that China’s economic growth will fall below the government’s target rate of 7.5% for the year. Last week China’s Premier Li Keqiang said that China’s GDP had grown by more than 7.5% in the first nine months of 2013.
It’s unlikely that China’s official data will show any deviation from the government’s goal in the run up to the November meeting of the Communist Party’s Central Committee that will set economic policy and discuss how to integrate the country’s economic policy and socialism with Chinese characteristics. The official data is extremely unlikely to rock the boat before that meeting, but whether or not that data is reliable is another question. And if it isn’t, the true growth rate of the Chinese economy will show up in the performance of the global economy whatever the official Chinese numbers say. A forecast that China’s growth will miss the government target was a key reason that the International Monetary Fund cut its projection for global 2014 growth to 2.9% in 2013 and 3.6% in 2014 from a July forecast of 3.1% in 2013 and 3.8% for 2014.
On the evidence of what happened earlier this year when fears of lower than expected Chinese economic growth hit emerging markets hard, I think a return of those fears would cut into any emerging market rally. Worries about the speed of China’s growth would also put downward pressure on commodity economies and their stocks as well and could revive doubts about the speed of any economic recovery in the EuroZone.
Second, at some point markets go back to trying to predict when the Federal Reserve will begin its taper. Markets moved up very strongly in September as the markets increasingly convinced themselves that the U.S. economy was weak enough and the situation in Washington uncertain enough to put off any taper on the Fed’s asset purchases to October or later. (A view that was then vindicated when the Fed didn’t taper at its September 18 meeting.)
The markets haven’t really focused on what a new schedule for a Fed taper might be—they’ve got other things on their minds--after the Fed’s surprise no taper decision on September 18. The next meeting of the Fed’s Open Market Committee is on October 30 and it’s extremely unlikely that the U.S. central bank will move that quickly. Even if U.S. politicians wrap up the current mess relatively quickly, the Fed simply won’t have enough data by the time it meets to know how much damage the government shutdown and the debt ceiling uncertainty did to the U.S. economy.
There is no November meeting and so, realistically, the earliest the Federal Reserve could decide to begin winding down its current program of quantitative easing is its December 18 meeting.
That timing, plus the happy data likely to precede the November meeting of China’s central committee, is good reason to think that any post-solution rally could last into December.
Third, after that the direction of the financial markets is likely to depend on the balance between U.S. economic growth and Federal Reserve policy. If growth is slow, markets will start to believe that any taper might be pushed off from the Fed’s January 29 meeting to the March 19 or even the April 30 meeting. (The Open Market Committee doesn’t meet in February or May.) That will be supportive of global financial markets—the dollar will weaken or at least remain relatively weak and that will support emerging markets and the yen (and Japanese stocks.)
Unless, of course, U.S. economic growth is too weak. Surprisingly slow U.S. growth in the fourth quarter numbers delivered in early January (assuming we have functioning economic data feeds from the federal government at that point) would not be good news for a U.S. stock market that despite everything thrown at it remains near historic highs. Markets would respond favorably if growth is slow enough to keep the Fed from removing cheap cash from the system, but the markets would start to worry about U.S. and global growth (China exports a lot of stuff to the United States) if U.S. GDP looked like it was even thinking about dropping toward negative territory.
So where does that leave us—assuming, of course, that Washington pulls a solution out of its hat sometime in the next week to ten days?
Looking, I’d say, at generally bullish conditions into December for U.S. markets, for Japanese stocks, and for emerging markets. I think Japan is likely to deliver the biggest upward move at the lowest risk since most scenarios lead to a weaker yen, which is a plus for Japanese stocks. Emerging markets are likely to bounce the highest but they also have the biggest downside risk because of their close connection to China.
The end of December and into January is a lot harder to call since we don’t really know how badly the shutdown and the uncertainties about the debt ceiling have hurt a U.S. economy where underlying strength was hard to read even before the crisis in Washington.
Readings from my crystal ball get a lot murkier after, say, mid-December.
One final thought, I’d be a lot more enthusiastic about putting new money to work here if the government shutdown/debt ceiling crisis had produced a significant sell off and had created some real bargains in the process. Mind you, as someone who, while raising cash, remains long the equity markets, I’m not deeply unhappy at the lack of a big downward move. But the absence of a correction and the paucity of bargains does raise the risk of adding new positions here or adding to existing ones. To invest at this point we are still hoping to see U.S. stocks climb from historic highs to even higher levels.
That can happen. U.S. stocks are not terribly expensive if we’re still in the growth stages of this economic cycle. (On the other hand, they are expensive if growth is about to turn down.) But I think it is important to recognize—and to factor into your stock and asset selection—that as we move into 2014, as we move into the murkier regions of my crystal ball’s predictive powers, the risk/reward ratio isn’t jumping up and down for joy attractive.
We’re still counting on some version of the Goldilocks market—not too hot and not to cold—for gains from here.
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 June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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