The markets will be laser-focused on what Ben Bernanke (BB) has to say on Wednesday afternoon after the two-day FOMC meeting. And if there's any doubt that BB is in fact the 'King of the Street', just scan headlines or tweets for a couple of minutes and try to find one commentary (this post is guilty as charged!) that doesn't point to BB's decision as being the defining moment in determining which direction markets choose to journey!
But is the Fed decision on tapering really the defining moment? Or is something far more insidious going on?
It's noteworthy to consider market activity in the past eight weeks. The chart below shows the daily moves of the S&P with a demarcation line annotated at approximately four weeks ago when the market peaked and started its more intraday, volatile moves lower, and then, sideways.
This kind of excessive intraday volatility is clearly symptomatic of a market in search of direction....in transition from what has been a nearly one-way ride (up) since just before the start of the year.
The uptrend has been fueled by a number of things including continued strong earnings performance overall and expectations that global growth would continue to improve, helped by a recovering housing sector in the US, a Eurozone that seemingly put out their fiscal fires and stands ready with fire trucks to douse any financial flames that erupt, and an Asian economy that holds the prospects of resurgent strong growth on the heels of a revitalized Japan under 'Abe-nomics'.
The markets rallied YTD with the help of all those factors despite the many geopolitical risks that loomed large....North Korea's maniacal leader's threats to use nuclear weapons, Iran's sprint to the finish line of nuclear weapon capability, and a sequestration in the US which was not only viewed destructive in and of itself, but also as a harbinger of more fiscal irresponsibility coming out of Washington on the debt ceiling, budgets, etc.
So was the 'peak' four weeks ago, and the seeming 'transition' period that we've been roller-coastering through since, really just a response to BB's "tapering" comments?
As we noted in early posts, it would seem counter-intuitive to suggest that the Fed's lean towards tapering, which would be indicative of an economy that could run on its own, is cause enough to sell stocks in haste, thinking that the transmission mechanism of Fed tapering, leading to higher interest rates, leading in turn to higher costs of doing business, would be imminently effective. To the contrary....the Fed's slow release of their foot from the accelerator would more likely only happen when they are convinced that their efforts would be replaced by self-sustaining growth in the demand side helped by additional hiring, improvements in housing and stronger growth overseas. In addition, many companies have taken advantage of the low interest rate environments of the past to refinance debt and improve the financial strength of their balance sheets, so it's unclear that 'tapering' and the resultant higher rates would be that immediately detrimental to many businesses.
Therefore, one might ask, is it possible, that the volatile, transition period that the equity markets have been going through is indicative of something far more troubling for stocks than the longer term impact of 'no more easy money' that 'tapering' suggests?
Is it possible that equity valuations have reached levels that would require earnings growth rates in coming quarters and years that now seem unrealistic in the face of a US economy that, albeit growing, is still only plodding along at roughly 2-ish% GDP?
And is it possible that Europe, though seemingly containing their financial crises, is really a powder-keg at risk of blowing up as higher rates in the US lead to higher rates in Germany which in turn leads to higher rates in the peripheral countries...already choking from debt loads that are unsustainable?
And is the rise in popular unrest throughout Europe, not so much manifested this time around with riots as we've seen in the past in Athens or Madrid, but more visible in the rising popularity of extreme political parties and in growing 'anti-austerity' rhetoric, something that could unravel the seeming containment of the financial woes?
What about Asia? Has the recent spike in short-term rates in China, clear evidence of a liquidity problem among banks, raised concerns that the world's second largest economy might not be able to navigate a smooth landing of economic growth in the 7+% level, and may not be able to safely defuse the time-bomb of debt overload and real-estate bubbles that exist?
And Abenomics, for all its optimistic hope, is it possible that in fact what it's done, near term at a minimum, is to ignite the fuse of a currency war (or as some might argue, throw fuel on an already burning fire of currency wars) that will complicate the economic recoveries of other Asia nations and others in the EM world?
As one might surmise from the tone of this post, we're not quite that sanguine with regard to the post-FOMC press conference briefing centered on when and how often the term 'tapering' is used by BB. To be sure, that will be an important moment for markets. But more broadly, there are global economic and geopolitical factors that ought to weigh as heavily into the mix of strategic inputs. And when one does that, what emerges is a global economy that is growing, but struggling, and very vulnerable to shocks. Those shocks could come, as mentioned, in the form of familiar crises in the Eurozone financial arena. Or they could come from a mis-estimation of the success of Abenomics and its collateral impact. Or from a new set of geopolitical issues triggered by new leadership in Iran, or the outcome of the Syrian civil war.
In light of that, we remain defensive in our portfolio positioning. Our cash levels are historically high and our sector weightings remain heavy in defensive sectors, with a particularly heavy weighting, however, in tech and telecom with the view that growth in that space will, over time, transcend many of the headwinds that come from all of the above.
We'll be posting more commentary on specific portfolio holdings and sector selections in coming days......with seat belts and helmets on......
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