The United States and China will soon run out of ways to positively spin the trade talks, writes Bil...
Will the market's luck hold out until the Fed moves in March?
10/21/2013 11:42 pm EST
Clint Eastwood is facing a piece of urban pond scum whose own gun is on the ground but within reach. Eastwood has got him dead in his sights but after a running gun battle, he could be out of ammunition.
“I know what you're thinking,” says Eastwood’s detective Harry Callahan. ‘Did he fire six shots or only five?’ Well, to tell you the truth, in all this excitement I kind of lost track myself. But being as this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you've got to ask yourself one question: ‘Do I feel lucky?’ Well, do ya, punk?”
The punk decides Harry’s gun is empty, reaches for his own, and winds up floating face down in the midst of a spreading patch of bloody water.
While not wanting to suggest that either you or I are equivalent to Dirty Harry’s punk, I do think Eastwood’s question is appropriate for us now.
The Federal Reserve, the People’s Bank, the European Central Bank, the Bank of Japan, and other of the world’s central banks have fired a lot of ammunition first heading off banking system meltdowns and second trying to stimulate their economies into sustainable growth. Global financial markets rallied on that action with some stock markets—the U.S. and German markets, for example--moving up to all time highs, and already low bond yields falling even lower as bond prices moved up.
Now, with global growth rates nothing to write Sister Sara about, with politicians in Washington D.C. about to begin another round of budget negotiations that may make “Riot in Cell Block 11” look like a shining beacon of good faith, and with some economies showing all the emotional bounce of the pod people in “Invasion of the Body Snatchers” (to continue and conclude this post’s Don Siegel homage) financial markets are rallying again on hope that the central banks have more bullets left in their gun.
Well, do you feel lucky? And if you do, for how long?
Let’s be clear, I hate investing when it resembles gambling. I like markets with clear macro trends behind them such as the falling yields that characterized the bond markets since the early 1980s. (But that’s a trend that over now.) And I like markets without trends and where the fundamentals drive individual stocks.
But I really dislike markets where the direction of macro trends is up for grabs; where traders and investors are trying to bet that that they can guess the results of an essentially binary decision; and where the results of that binary decision—in this case a taper/no taper decision by the Federal Reserve—will drive most drive stock prices in one direction or another, overwhelming the fundamentals of the vast majority of individual stocks.
And that’s exactly where we are right now.
Which is almost certainly good news through November and into December. After that, though, I’ve got to wonder how lucky we’ll be and for how long.
The consensus opinion, at the moment, on Wall Street is that the Federal Reserve’s Open Market Committee, the group that will decide when the central bank will start to cut back on its current $85 billion in monthly purchases of Treasuries and mortgage-backed securities, won’t start the taper at its October 30 meeting because it won’t have enough data on the economy to decide if U.S. growth is strong enough to stand up to a withdrawal of some purchases by the Fed. It’s not the direct effect on the economy of cutting purchases to $70 billion or $75 billion a month from the current $85 billion that concerns the Fed, but the effect of any follow on increase in interest rates and the potential that higher rates might slow sales in sectors of the economy, such as housing and autos, that rely on debt financing for sales.
Since there is no Fed meeting in November, the earliest that the Open Market Committee could begin a taper of the Fed’s purchases would be the December 18 meeting. And right now the Wall Street consensus is that the Fed won’t act at that meeting either. That consensus is based on the belief that the government shutdown and the debt ceiling crisis whacked something like 0.6 percentage points out of annualized GDP growth for 2013. That translates into drop in annualized growth of the fourth quarter from a projected 3%, according to estimates by Standard & Poor’s, to 2%.
Supporting that belief are scattered, so far at least, warnings of a weak holiday season for retailers and early reports of weakness in the housing market. For instance, eBay (EBAY) recently warned that fourth quarter sales would be a weaker than expected $4.5 billion to $4.6 billion (analysts were projecting $4.64 billion.) “We are not expecting any improvement in the fourth quarter from what we experienced over the last eight to 10 weeks,” eBay chief financial officer Bob Swan said in the company’s recent third-quarter conference call. “We have a cautious outlook for the holiday season.”
And on October 21 the National Association of Realtors reported that purchases of previously owned homes fell in September for the first time in three months. The sales rate fell 1.9% from an almost four-year high to an annual rate of 5.29 million homes. Economists surveyed by Bloomberg had forecast an annualized sales rate of 5.3 million. Prices climbed 11.7%, pushing affordability to an almost five-year low. That’s not good news for future sales
Part of the reason for that weakness may be what happened, or didn’t happen, in the government shutdown/debt ceiling crisis just before the Treasury’s October 17 deadline for a potential default. The “solution” didn’t really end the problem—a continuing resolution extended government spending authority until January 15 and raised the debt ceiling until February 7. In other words, we could go through the drama, uncertainty, and worry of October all over again in early 2014. The guessing on Wall Street and among economists is that these conditions aren’t exactly going to have consumers reaching into their pockets to spend.
The bet on Wall Street, then, is that not only won’t the Fed begin to taper off its asset purchases in December, but also that the central bank will sit without acting until at least March. That’s the consensus among economists surveyed by Bloomberg.
Does that make you feel lucky? The U.S. market looks ready to continue a rally that has pushed the S&P 500 to record territory on that basis. Money is flowing back into risk on currencies, weakening the dollar and the safe-haven yen. Money that fled emerging markets when the world seemed a risky place is headed back into those markets.
Cash flows in and out of the ETFs (exchange traded funds) give us a good sense of what has been happening. About $725 million flowed into ETFs on October 16, the day of the deal in Washington. $6.9 billion flowed in on October 17 and another $2.5 billion joined the flood on October 18, according to Bloomberg. Much of that money has flowed into U.S. stocks with ETFs that specialize in U.S. stocks getting $12 billion in October, but overseas markets have joined the trend. The iShares MSCI Emerging Markets ETF picked up $4.5 billion, according to Bloomberg. But before you get too comfortable with that trend, notice how incredibly volatile the market has become lately. Those big inflows were balanced by huge outflows in August. In that month $14 billion came out of the SPDR S&P 500 ETF, the largest ETF. And that followed inflows of $13.8 billion in July.
To me, even with the possibility of data surprises such as an unexpectedly strong September
jobs report on October 22, this adds up to a strong macro trend that’s likely to rule the direction of the market through November and into December. In that period, I think betting on global central banks is a good and not terribly risky bet.
After that, the likelihood of the Fed staying out of the taper business depends on the data and on the economy and market’s reaction to any replay of the government shutdown/debt ceiling crisis in January and February. I think the likelihood is that the market will be even more blasé about this next round in the crisis than it was about the last one. U.S. financial markets hardly budged (well, OK, short-term Treasuries budged.) But I think the markets do need to see relatively weak holiday sales numbers, continued softness in housing sales, and solid but not rapidly accelerating economic growth from China for the Fed-stays-away-from-the-taper consensus to remain in charge of the market until March.
So what should you do?
First, to take advantage of the likely November continuation of the no-Fed-action financial market rally trend, I think you need to move now. Put money to work now and over the next week—not at the end of November when it will be time to re-evaluate this trend. Like me, you might have moved into cash at the beginning of October for protection and to have cash available to take advantage of any bargains on a pull back. We never got the pullback I anticipated, but this isn’t the time to mourn missed opportunities. They’re gone. What you do now counts and I don't think you should be 25% in cash over the next 6 weeks. Put some money to work.
Second, put that money to work in the U.S. market, in Japan (still my favorite) and in select emerging markets such as Mexico. I think U.S. stocks will move upon on the Fed consensus—but that the move won't be equally strong across the market. I’d avoid financials, retail, and consumer durables. Expectations for no-increase in rates should work to the benefit of dividend stocks—take a look at my Dividend Income portfolio http://jubakpicks.com/ for suggestions. Japanese stocks should get a boost, again, from a weaker yen as traders sell their safe haven positions. (For example, the Nikkei 225 index in Tokyo climbed 0.91% on October 21 on a weaker yen.) You can find some Japanese recommendations in my Jubak’ Picks portfolio http://jubakpicks.com/ Emerging markets will get a bigger bounce just as they took a bigger fall in any rally now. So far it looks like traders are avoiding “risky” markets such as Brazil and Indonesia on fears that current account deficits pose too much risk if the consensus on the Fed turns out to be wrong. I disagree with that view of Brazil—but the economy there is growing slowly and traders are likely to maintain a show-me attitude. (In other words, in the short run my opinion gets trumped by trader sentiment.) Mexico gets a thumbs up among traders on better finances and more work on economic reforms. It is my favorite emerging market at the moment. An ETF such as the iShares MSCI Mexico ETF (EWW) will work, although it holds more financials than I’d like. If you’re looking for individual stocks, you might look at Industrias Bachoco (IBA) or Grupo Televisa (TV), both of which trade as ADRs in New York.
And after early December?
Time to re-assess.
If the consensus that the Fed won’t taper until March remains intact and if the market looks inclined to shrug off the next round of the drama in Washington, I’d leave the recommendations that I made above intact—and possibly extend them by adding more exposure to emerging markets such as Brazil and China.
But going into December, I sure want to make sure I know how much ammunition remains in the central banks’ guns. Don’t forget to count.
December and into 2014 won’t be a time to hope that we’ll just be lucky.
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 own shares of Industrias Bachoco as of the end of June. 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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