On optimism and cliffs

Well, that’s Q3 out of the way and the we’re on the home straight. And what a shambles the last day of the quarter turned out to be with Rome and Washington in self-inflicted turmoil and investors of all hues struggling to work out what to do next – other than to go to the gym and to turn up the volume on the iPod in order to drown out much of the self-indulgent nonsense which is being spouted by politicians, the media and, not to be forgotten, sundry market strategists.

By and large, Q3 wasn’t quite as bad as it felt. The Dow might only have made 1.03% over the quarter but the S&P rose by 4.12% and the NASDAQ 9.81%. The FTSE was like the Dow in terms of looking modest with a gain of 2.45% but the DAX was up 7.65%, the CAC 9.98% and the key indices for the two limping economies of Spain and Italy were up by 16.18% and 12.78% respectively. Does that look as though things were critical?

Admitted, the “June drop” which largely left Q2 in negative territory has helped to make the past quarter look better than it really was but in general equity investors have not had too bad a year so far.

Should they now, as some of the stresses which have been plaguing us for several years begin to resurface, be panicking or should they be taking heart that as we made it through all the previous storms and that we will again? Is this the time to follow the optimists, to look back and to say “so far, so good” or do the pessimists finally have their day were they are proven right that whatever recovery we have seen has been built on nothing other than the piling on of more debt and that this time we really are going to find ourselves hit by a storm in a vessel fatally holed below the water-line?

Yin and Yang

Overnight we were treated to the latest quarterly Tankan Survey, the barometer of Japanese business sentiment. It is, while basking in the glow of Abenomics, glowing with optimism. Consensus for the key Large Manufacturers confidence number swept past the consensus of 7 with a reading of 12. The Medium Manufacturers improved to 0, the first non-negative reading in a very long time and the Small Manufacturers rose to -9, still negative but a lot better than the -19 they were sporting at the beginning of the year.

Forecasts for Q4 are largely at or around the current levels. In general, this is all a deal better than analysts had expected but sceptics will wonder whether the huge boost to QE has kick-started the economy or just created a bubble which will deflate as soon as the authorities dare to take their foot off the gas again. The mention of tax increases has already worried some, not least of all because the last time the government tried to do the same at the first sign of an economic recovery, it pushed the whole shooting match straight back into recession.

Thus, after a period during which governments have liberally sponsored the free distribution of rose-tinted spectacles, questions are clearly being asked. There is decidedly a sense of unease amongst investors and I would not be surprised to see some of them begin to take a few bets in the risk asset department off the table as they look to protect gains and opt not to put them at risk in the last quarter.

Thelma and Louise

Although the term “Fiscal Cliff” was seemingly put to bed in the Spring, what is occurring in D.C. is nothing less than what one US commentator referred to as Congress’s Thelma and Louise moment in which they put their foot down and, whooping and cheering, go sailing over the edge in their ‘66 T-bird. (You must agree that that is one wonderful analogy, musn’t you?)

During the election campaign, Mutti Merkel kept on repeating that deficit spending was not a long term strategy and in his speech to the Conservative Party conference, UK Chancellor of the Exchequer George Osborne made it clear that his long tern aim – yeah, yeah, sure – is to continue to squeeze spending until the country is back to running a structural surplus.

Knowing what needs doing is one thing, knowing how to do it is another and actually getting it done is yet again something entirely different. Despite the sniping from the Tea Party, nobody in Washington seems to have seriously addressed any one of the previous three steps to fiscal rectitude and as soon as anyone does, they are immediately attacked as heartless destroyers of the fabric of a caring society.

Alas, will Q4 bring back the worries which took so much out of us during the same period in 2012? In November last year, 11 months ago, the S&P bottomed close to 1.350 points. Conversely, just two weeks back in mid September it was at 1,725 points, a bottom to top rally of over 27%. Can it go back to plumbing those November lows? It looks unlikely but if there are signs that the economy is stalling and even that the growth trajectory is flattening, the market must look rich and the temptation to play closer to home will become compelling.

Has 2013 to date perhaps been nothing more than a long and slow dead cat bounce?

Irrespective of which side of the argument you may be on, Q4 is most probably going to anything other than an easy ride through to year end. Bon voyage.