Hollywood has a long history of making films based on either a fictional or a factual story of one individual’s triumph of will over adversity. You know the kind. Boy in accident, boy paralyzed, boy struggles to walk again, boy plays football again, boy goes to college and wins Heisman Trophy, boy joins NFL side and wins Superbowl. You know the kind. Who makes a film of boy in accident, boy paralyzed, boy struggles to walk, boy gives up and spends the rest of his life achieving nothing?
Well, by the reaction of equity markets in the US yesterday, one would have thought that the latter version is up for the Oscars. The US economy has been in the accident and has been paralysed. Its consultant physician, Dr Ben Bernanke, put it in a wheelchair called Quantitative Easing and with the help of Dr Bernanke and his assistant, the good Dr Yellen, it is now being encouraged to learn how to first walk and then run on its own again. However, it appears as though the audience doesn’t have the patience to watch the struggle and would prefer the two doctors to simply jet down the road and buy a new, easy to use electric wheelchair for the patient.
But stepping back and asking where the cash which is being withdrawn from emerging markets is going to be reinvested, the obvious target must be primarily US and secondarily European equities.
I am the first to acknowledge that if the flood of nearly free money is withdrawn and as it, that’s money, subsequently reacquires a discernible time-value and when positive discount factors can again be applied to the future dividend cash-flows, then equity pricing needs to be reassessed. However, I have seen too many bull and bear markets in my time to believe that discounted cash flows, the holy cow of the equity market, really do have a consistent and meaningful influence on stock prices. Trading stocks is sadly, in many cases, more like playing fantasy football for money. Either that or equity markets were caught asleep when it came to the second round of stimulus withdrawal, announced by the Federal Reserve yesterday.
It’s not about you
A blind man could have seen this one coming – it was as inevitable as night follows day – and at US$10 bln was exactly where it was expected to be. Anybody who believed that the FOMC would hold back on its monetary policy strategy simply because emerging markets are suffering a bout of the collywobbles should either be demoted back to the graduate training programme or summarily fired. The political shenanigans in Buenos Aires, in Caracas, Kiev, Ankara and Bangkok have absolutely nothing to do with US monetary policy and therefore an alteration in its direction would have absolutely no influence on events at all. I even still question whether Alan Greenspan should have tinkered with it in the after math of 9/11 and whether his slashing of rates at the time might not have been the starting gun to the financial crisis and the mire of both public and private debt we still find ourselves in today.
There are seven more FOMC meetings in this calendar year, so even if the decision was to taper US$10 bln at each meeting and the final US$5 bln in at the December 17th caucus, QE will be in place in one form or the other until the end of 2014. However, having established that it is not shy of withdrawing stimulus in general and in back-to-back meetings, if needed, it now has the option to move or not to move going forward. That still leaves the Fed Funds rate at 0.25% and the discount rate at 0.75%. We went into the crisis on late 2007 with Funds at 5.25% and the discount rate at 6.25%.
The Fed cut the discount rate in August 2007 to 5.75% and the Funds rate to 4.75% on 18th September of that year. On the day, the Dow closed at 13,739 points and the S&P at 1,519.78. Although I don’t have the figures in front of me, I’d wager that, inflation adjusted, we must be very close to the same level right now. at 15,738.79 and at 1,774.20 points respectively.
But stepping back and asking where the cash which is being withdrawn from emerging markets is going to be reinvested, the obvious target must be primarily US and secondarily European equities. Sure, some will buy back into the emergers but the net decline will remain and core markets will have to be the beneficiaries. All the while, bonds are very well bit and with 10 year treasuries now at 2.70%, I’d be tempted to fade the rally.
The case in favour of core markets was underlined this morning with the HSBC Manufacturing PMI for China reporting in at 49.5. It had been expected to be below 50.0 – that means in contraction – and whether it’s 49.5 or 49.7 is immaterial, although it does underscore the sense that not all is unquestionably rosy in the Middle Kingdom.
A serious consolidation in the Chinese economy is not something most people want to contemplate and as I tend to repeat, the best way not to get an answer one does not want to hear is not to ask the question in the first place. However, as in all matters pertaining to 2014, I don’t think this is the year for major ructions. Although there are some quite serious cracks beginning to show in the never ending growth scenario for China, I can’t see the vehicle hitting the wall just yet.
Across the board, emerging markets excepted, I remain a better buyer of risk on dips with a short bias in duration.