February 1, 2014
The February 2014 issue of The Credit Strategist is now available – “Submerging Markets.” If you are not already a subscriber, be sure to subscribe today!
“Nature hates monopolies and exceptions. The waves of the sea do not more speedily seek a level from their loftiest tossing than the varieties of condition tend to equalize themselves. There is always some levelling circumstance that puts down the overbearing, the strong, the rich, the fortunate, substantially on the same ground with all others.” Ralph Waldo Emerson
As of the close of trading on February 3, stocks were well on their way to a correction despite the fact that the monetary backdrop remains supportive of stocks and other risk assets. For the moment, however, the emerging markets have reared their ugly heads and sent stocks to their worst losses in seven months. Last summer’s sell-off occurred when Ben Bernanke warned that quantitative easing would soon be coming to an end. That end came in mid-December although the markets delayed their reaction for some year-end window dressing. Once the calendar turned, however, it didn’t take long for investors to repeat their reaction to earlier terminations of quantitative easing when the S&P 500 sold off by 16% (2010) and 19% (2011). The current sell-off combines concerns about problems in emerging markets with worries about economic headwinds in the U.S. against the backdrop of Fed tapering. The question is whether this combination will turn out to be something more than a run-of-the-mill correction in a highly leveraged and therefore fragile global financial system.
Markets have surprised a lot of people (myself including) with how they opened the year. After rising by 30% in 2013, the S&P 500 quickly shed 3.5% in January and lost another 2.3% on February 3 (when my publishing deadline mercifully intervened). In sharp contrast, Treasuries have generated strong gains after suffering losses last year. It is extremely difficult to distinguish among the myriad factors that move markets in today’s complex world. As David Rosenberg recently explained, while stocks sold off sharply when the Federal Reserve ended QE1 and QE2, other factors were also influencing equity investors during those periods. When the Federal Reserve threatened to end QE1 in 2010, the S&P 500 dropped by 16% and didn’t start to recover until QE2 was announced. But the economy was very weak at the time – much weaker than it is today – with GDP growth running at a tepid 1.6%, non-farm payrolls shrinking at -40,000/month, and the ECRI economic index reading a recession-threatening -10.9. The economy was just barely out of recession and was threatening to double-dip. In 2011, the S&P 500 shed 19% as QE2 was about to end, but the world was dealing with the depths of a European debt crisis that posed genuine systemic risk. Non-farm payroll growth had improved to a tepid 90,000/month rate and the ECRI index was still stuck at -10.9. The economy had still not found its post-crisis legs.
Michael E. Lewitt
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