Some minor stabilization crept in at the end of Monday’s session but there’s no incentiv...
My relatively positive macro trend timeline for the fourth quarter
10/05/2012 8:30 am EST
I’d much prefer a normal market where what matters are fundamentals such as earnings and balance sheets. And where picking the right stocks is more important than making an educated guess on the speed of Chinese economic stimulus or when Spain will finally get around to asking for the European Central Bank’s help in driving down interest rates by buying Spanish bonds.
But for another quarter at least—and for much of 2013 I fear—a normal market—you know that quaint thing where stocks go up when a company is well run and well positioned and go down when a CEO makes bone-headed moves or a trend that was supposed to zig left instead zags right—will remain a fading memory.
Since the financial crisis that began in 2007, stock prices across most of the world’s markets have danced to the tune of big macro events. When it looked like economies were headed for hard landings or entire national banking sectors were about to freeze up, a pattern of trades called risk off dominated and stocks in general but especially emerging market and European stocks fell. When it looked like growth might be picking up and effective plans to support banks or deeply indebted governments were moving into place, a pattern called risk on dominated and stocks rallied with shares in the world’s emerging markets leading the way. If sometimes it felt like it was more important to catch the shift from risk on to risk off (or the other way around) than it was to pick the best oil, technology, or banking stock, well, it felt that way because it was.
I think the coming quarter is also going to be dominated by macro events. Stock or sector selection won’t be irrelevant but returns will be dominated by the way those big macro trends play out. So like it or not, I think you’ve got to spend at least a little time at the beginning of the fourth quarter creating a timeline of macro events for the next few months and sketching out the odds that these trends will break one way of the other.
Let’s get down to it, shall we?The big three macro trends haven’t changed: There’s still the Euro debt crisis, the slowing of China’s economy, and the twin problems of slow growth/big deficits in the United States.
Oddly, enough, I’m optimistic on each of those trends. Oh, not because the underlying problems in each case will get solved this quarter, but because I think the odds are good that we’ll kick the can down the road one more time for each. If that raises your hackles and increases your worries about 2013, it should. But global financial markets are likely to react positively to the illusion of a solution in each case just as they have for most of 2012.
In other words, I think the odds favor a rising stock market for the fourth quarter as a whole. Caveats on that statement later.
The European debt crisis will move from full boil back to simmer in the quarter. Greece will get its next payment from the bailout fund sometime in November and be able to keep the lights on for another few months and the Spanish government will make a formal request for a program of bond buying by the European Central Bank in November.
A deal that gets the money flowing in Greece again won’t, let’s be clear, move that country away from another bond default/restructuring. (To me the March haircut was a default and the next exercise in forcing bondholders to take less than the maturity value of their bonds will be a default too. But I’m sure it will be called a “restructuring.) In fact such a deal will move Greece closer to the moment when the International Monetary Fund and the European Central Bank will conclude that the trend line on Greek debt—projected to grow to 179% of GDP in 2013—requires another bond write-down and this time one that includes the ECB’s portfolio of Greek bonds too. But that restructuring won’t take place until the IMF has convinced the ECB that there’s no other way. I look for a second restructuring in 2013 sometime before the anniversary of the first restructuring in March 2012.
A November cash payment and a March 2013 bond restructuring, though, will be the last shot at saving any Greek government with the votes in parliament for staying in the euro. At the moment—with shipyard workers storming the defense ministry demanding that they be paid for the last six months work (The Greek government is keeping the lights on by not paying contractors for work performed for the government. The bill right now is 8 billion euros.)—the Greek government is clinging to office. When it’s clear that the Greek economy is headed for another year of recession in 2014 and that the EuroZone will have to throw yet more money at Greece even after a bond restructuring, I think the discussion will move to a Greek exit from the euro.
I think that’s the logic for 2013. For the last quarter of 2012, though, I think the financial markets will be able to convince themselves that they see progress.
Spain present much the same happy face to the markets in the final quarter of 2012. The bond markets continue to price in bond buying by the European Central Bank. On Thursday, October 4, Spain sold almost 4 billion in debt at yields of 4.77% for the five-year note (down from 6.46% at the last auction) and 3.28% for the two-year note (down from 5.2% in the last auction.) Those big drops in yield aren’t a vote of confidence in the economic policies of the government of Prime Minister Mariano Rajoy, but in the backstop plan proposed by the European Central Bank.
At some point that plan needs to go from proposed to real. That will require a formal request for intervention by the European Stability Mechanism, the EuroZone’s bailout fund, and the ECB. Those institutions will impose conditions for economic reform and budget restraint on Spain in exchange for their bond buying. (Without conditions, the package will never win the required support from other EuroZone government.) The financial markets believe that a request by Rajoy is inevitable and with that belief has been willing to give the Spanish Prime Minister enough slack to put off the request until after regional elections in October and November. But that’s about all the time Rajoy has to maneuver.
Spain has to raise 207 billion euros in the financial markets in 2013. That’s not possible without a European Central Bank backstop. I think we’ll see a formal request from Spain for that bond-market support in November or December. And until the market sees that the request isn’t forthcoming, it will be willing to buy Spanish debt at less than crisis interest rates.
In China the November 8 meeting of the 18th Party Congress will finally put a new generation of leaders headed by Xi Jinping in power. Speculation in the Shanghai market before the extended Golden Week holiday that the government and the People’s Bank would strew new economic stimulus in the path of the incoming officials before the congress had pushed up prices in a very depressed Shanghai market. I’d expect another flurry of stimulus measures after the congress itself. (For more on the nature and limits of that stimulus see my post http://jubakpicks.com/ )
Will that stimulus immediately accelerate China’s economic growth? Of course not. Anything announced in November 2012 won’t have any impact on the real economy until 2013.
Will the expectation that new stimulus measures will accelerate growth have an impact on stock prices in China, in markets such as Australia that are dominated by companies that export to China, and in emerging stock markets as a whole? You bet. I think expectations and announcements of Chinese stimulus will drive stock prices higher in those markets in the fourth quarter.
Do those announcements solve the big bad debt problems in China’s banking system or get rid of the huge inventories of unsold goods now clogging China’s export sector because of slow growth in the global economy? No way. And I think we go back to worrying about those problems in 2013. The degree of that worry—and the degree to which it depresses global stock markets in 2013—will depend on when/if these stimulus announcements start to show up in improved GDP growth in China.
In the United States the assumptions in the market as we begin the fourth quarter are that a) the U.S. economy is showing signs of growth accelerating from very sluggish to moderately sluggish, and that b) Washington won’t really drive the country off a fiscal cliff and back into recession in 2013. Both of those assumptions could turn out to be completely wrong, but—and this is a critical piece of timing—investors aren’t likely to have evidence that they’re wrong until the very end of the quarter or until the beginning of 2013. Investors don’t see third quarter GDP numbers until October 26 and unless those numbers fall off a cliff, investors will look past them to the fourth quarter numbers that arrive in January for signs of any strengthening in U.S. growth. Nobody expects anything on the fiscal cliff and the U.S. budget deficit until after the November elections anyway and then investors are expecting the typical Washington scenario of posturing and finger pointing until Congress is right up against the deadline. So I don’t expect any real market-moving effects from the fiscal cliff debate until December.
What I’ve sketched in is relatively rosy—at least for these times. A simmering EuroZone debt crisis, lots of stimulus propaganda from China, and no evidence that things are getting worse in the United States. I think that’s enough to give the fourth quarter a modestly upward tilt given the continued flow of money into financial assets produced by monetary policy at the world’s central banks.
But this isn’t guaranteed. I’d give this scenario about 65/35 odds.
What could go wrong?
Greece could blow up with no deal with the Troika and a disastrously unplanned exit from the euro. Spain’s regional elections could run massively against the Rajoy government and that government could over-react and precipitate a constitutional crisis in Spain. Economic numbers in China could show growth falling faster than anticipated. (Unlikely given how the numbers are controlled by the government.) Or, more worryingly, Xi Jinping could really have a serious medical problem as his two-week disappearance from public view led some in China to conclude. In the U.S. jobs numbers could turn savagely bad, the housing rebound could turn out to be a mirage, and one party or the other in Congress could react to the elections by throwing a massive fit of spite and petulance.
And then, of course, hanging over this all is the possibility of a post-U.S. elections attack by either Israel alone or by Israel and the United States on Iran’s nuclear program and the inevitable Iranian retaliation on world oil traffic.
In other words, if you’re looking for a quarter with a guarantee of peace and tranquility, the fourth quarter isn’t it. But then when have investors ever had a guarantee.
I’d sum up the outlook for the quarter this way: I’ve seen worse, much worse, recently.
Do remember, however, that this is just a near-term outlook. The calendar turns to 2013 in less than three months.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. 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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