Friday, June 21, 2013

The Market Swoon: It's Not About Fed Tapering.

Some of my good friends and former colleagues, like Ward McCarthy, are Fed watchers and fixed income market analysts who command the attention of traders and investors worldwide.  I had to go back through my notes about what they've been saying about Fed tapering of the bond buying program.  Here's what I came up with months back as their consensus view.

Given their forecasts for the U.S. economy made in the fourth quarter of 2012, the Fed was not likely to consider tapering before the first half of 2013, and more likely to consider doing so between September and December 2013, assuming that the economy started showing signs of sustained recovery in GNP.  Comments about changes in the unemployment rate being a trigger divided some of the forecasts.

If the economy didn't improve, then this scenario got pushed back into the spring of 2014, on the same basis of GNP sustainable improvement.  An end to the program?  Don't even think about this until 2015.  This is the educated layman's summary of mountains of text and charts.  So where are we today after the dust has settled and markets all went down with high correlations?

Nothing the Fed Chairman actually said, even with the reinterpretations of his statement, contradicts the consensus outlook.  He even said that if the Fed began tapering and the economic conditions reversed themselves, then the Fed might reinstitute the bond purchase program.  So what gives?

Fundamentals around the world suddenly seem to cast doubts on the investment shibboleths spouted by investment strategists from all the major brokerage houses.

1. Diversify your portfolio away from the U.S. markets, particularly equities.  Recommended: European equities.

  • The relatively few, larger high quality, global Western European companies, e.g. Nestle, are probably overowned in most institutional portfolios already.  Mid and small cap companies might offer possibilities.
  • European bank balance sheets are weaker than their own published numbers and fudged stress tests show.  Of course everybody know this, but the issue was papered over by discussions about Greece and Cyprus.  Some of the larger Italian and French banks may be accidents waiting to happen.
  • The issues with the Eurozone itself and the common currency remain as they were, although they have been out of the news.
  • If an investor has made money in developed European equities or corporate bonds, why not take a profit and get out? Putting money in at this point seems problematical, despite what the brokers have been saying until this week.
2. If you're looking for a big score, think Emerging Market equities.  
  • The only problem: the emperor has no clothes.
  • China's fundamental issues with its economic model of state managed capitalism and unlimited funding of state and local governments is showing cracks in the monolith.
  • Brazil and Australia's booms were largely driven by commodity cycles, which are now receding, mainly because of China's slowing growth.  Brazil's social problems and its dependence on government largesse and subsidies is now evident in the World Cup protests.  The Australian currency's rise against the dollar since 2010 has been driven by the metals boom, which is receding. These don't seem like places to put fresh money or to leave money at risk.
  • Russia?  India?  Not necessary to discuss these as choices for an investor who wants returns, liquidity, transparency, and governance. 
3. The U.S. markets may be in Bill Gross' terminology, the "cleanest dirty shirt" among tainted economies around the world.  What are our issues, apart from valuations?
  • An amateurish and self-referential foreign policy which only exacerbates potential damage from hot spots around the world.
  • Obamacare
  • Dodd Frank's costly apparatus which is not even rolled out, while "Too Big to Fail" is still in place.
  • Both political parties pandering to their small, overly influential radical wings.  
Take all these issues, add a few more, and there you have the backdrop for market pessimism.  It's much, much easier for our New Normal model of causality to use a short phrase, like "the Fed," or "Ben Bernanke" to explain changes in sentiment about the fundamental, global economic landscape. 

Relatively speaking though, the U.S. markets, both equities and fixed income, may still represent a good, safe haven with modest returns for both asset classes. Maybe our markets stabilize and come back? Who knows?  I'll watch for Cramer's latest rant to find out.  

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