With the shutdown/debt ceiling crisis behind us, the stock market is free to worry about a slowdown in U.S. economic growth and to hope for a delay in the Federal Reserve’s taper until sometime in 2014.
That’s pushing the U.S. market away from growth sensitive stocks and toward what James Mackintosh of the Financial Times today called “bond proxies.”
That means stocks with safe dividends that won’t be cut even if the economy stumbles.
Yesterday’s market leaders were telecom stocks (up 1.7%), utilities (up 1.6%), and consumer staples (up 0.8%) on a day when the Standard & Poor’s 500 stock index climbed just 0.67%
The worry here, of course, is that a U.S. economy that wasn’t growing fast enough for the Fed to begin to withdraw any of it stimulus even before the shutdown/debt ceiling crisis will show even slower growth in the fourth quarter because of that crisis. And that the damage will extend into 2014 because we’re scheduled to revisit the shutdown and debt ceiling battles in January and February of 2014.
The hope—for bonds themselves and “bond proxy” stocks–is that uncertainty about economic growth will keep the Fed from beginning to taper off its $85 billion a month in purchases of Treasuries and mortgage-backed assets until January or maybe even March or April. That kind of delay would continue the post crisis rally in Treasuries that has sent the yield on the 10-year Treasury to 2.59% today from slightly above 3% in early September. Falling yields make the payouts from “bond proxy” stocks more valuable. For example, eight of the 12 stocks in my dividend income portfolio http://jubakpicks.com/jubak-dividend-income-portfolio/ are up today as of 2:15 p.m. New York time. Verizon (VZ), which isn’t part of that portfolio, is up 1.57% today. Read more
Was last week’s rally—you remember Wednesday and Thursday, right?—on the surprise “no taper” decision from the Federal Reserve a sign that stocks are headed even higher from here or an indication of an increasingly nervous and volatile market?
I’d vote for the latter.
Think about this indicator: A decision to put off a cut of what was probably no more than $10 billion to $15 billion a month in Fed purchases of Treasuries and mortgage backed securities was enough to drive the Standard & Poor’s 500 stock index to a new all time high.
That’s clearly an over-reaction unless global financial markets see the Fed’s decision on when to taper its purchases as a marker for the end of cheap money. I think the logic goes something like this: As long as the Fed doesn’t taper at all, the moment when the central bank decides to start to raise short-term rates is postponed. When the Fed does start to taper, even if rising short-term rates aren’t on the immediate agenda, they do go on the calendar.
In other words, the big rally last week was a relief rally and global markets are starting to make a transition from certainty that U.S. short-term interest rates will remain at 0% to 0.25% to a period of worry about exactly when interest rates will start to climb.
If this isn’t the end game for cheap money, we’ve moved closer to that end game and that means more volatility and more exaggerated market moves.
Globally, money is still cheap. Short-term benchmark rates are effectively 0% in the United States and Japan. It pays to borrow at low rates and put the money to work. It doesn’t pay to keep money on the sidelines since cash and cash alternatives pay almost nothing. Traders and investors who look down the road into 2014 or 2015 can see this environment coming to an end: The Fed has said it will keep short-term rates at their current extraordinarily low level until 2015, but doubts are starting to creep into the collective mind we call the market. There’s not an endless amount of time to waste if you want to play the cheap money game. You don’t think its coincidence, do you, that Verizon (VZ) just sold $49 billion in bonds, beating the largest previous biggest bond deal (Apple’s $17 billion offering by Apple (AAPL) by a mere $32 billion? Verizon sold $15 billion just in 30-year bonds.
This remains a global financial market driven by the availability of cheap cash. And the single biggest worry is that the world’s most influential central bank can’t be all that far away from taking away the punchbowl
If your goal is keeping money at work, it pays to look past negative data or the lack of data for as long as you can. The U.S. markets did that immediately after the Federal Reserve decided last Wednesday not to begin taper off its program of buying $85 billion a month in Treasuries and mortgage-backed securities. The S&P 500 rallied on that news to a new all-time high—even though the Fed’s decision to keep pumping the full $85 billion a month into the global economy (and global financial markets) was predicated on persistent under-performance in the real economy.
As markets get closer and closer to what they feel to be the end of the ball with its cheap cash punchbowl, you can expect to see more volatility. Read more
This morning’s U.S. inflation numbers are good news if you live in the alternative reality called the financial markets. However, if you live in the real world—you know the one where you buy things and have to make income and outgo match each month—the inflation news was remarkably bad.
The headline consumer price index climbed 0.7% in February. That’s the biggest jump in almost four years. It’s also a significant increase from January and December when headline inflation was flat. Economists had expected an increase of 0.5% for the month.
Core inflation, the number the Federal Reserve and financial markets watch, presented a much better picture. The core inflation rate, which excludes volatile food and energy costs, rose just 0.2% in February. That was actually a drop from the 0.3% increase in core inflation in January. The February core inflation number exactly matched expectations among economists surveyed by Briefing.com.
Why the big difference in the headline and core inflation rates? Two guesses—food or energy—and the first guess doesn’t count.
It sure wasn’t the result of soaring food prices. Food prices rose just 0.1% in February.
So it must have been energy, right? Yep, energy prices climbed 5.4% in February (after falling for three consecutive months) on a huge 9.1% increase in gasoline prices.
In financial world all this is reasonably good news. The core inflation measures the Fed watches showed no signs that core inflation might be on the upswing or that inflation expectations might be rising. Nothing in these numbers to suggest that the Federal Reserve, scheduled to meet next week, should consider ending its monthly $85 billion program of quantitative easing early. That’s especially true because the most likely explanation for the increase in gasoline prices—soaring prices for the credits that U.S. refineries buy so they don’t have to blend quite so much corn-based ethanol into their gasoline—can be passed off as a short-term technical problem.
On the other hand, in the real world, these inflation numbers are bad news. Read more
So now what?
We’ve had a December sell down on fears that the United States would go off the fiscal cliff—the Dow Jones Industrial Average was off 2.48% in the fourth quarter.
We’ve had a huge pre-New Year’s move—the Standard & Poor’s 500 Stock Index climbed 1.7% on December 31 on hopes that the crisis would get resolved and an even bigger January 2 move on an actual “solution. The total gain comes to 4.3% for the two sessions.
But where does the market go from here? I think you can guess, right? After all we did go through this pattern of sharp rallies and deep retreats in 2012.
So with the benefit of that experience, let me give you my seven steps for the first half of 2013. Read more
The topic of this post is simple: The value of cash in uncertainty.
You can guess what prompts it: the looming U.S. fiscal cliff.
And the uncertainties that accompany it.
Let’s count up those uncertainties and then take them apart a bit.
First uncertainty: Will Congress and the President strike a deal before the December 31 expiration of the Bush tax cuts, the lower Social Security withholding rate, and extended unemployment benefits and the beginning of automatic budget cuts?
Second uncertainty: How will the financial markets react if the U.S. does indeed go over the cliff?
Third uncertainty: If the U.S. does indeed go over the cliff, how quickly will Congress and the President move on a solution in January?
Fourth uncertainty: Will the financial markets be placated if it looks like a January solution is likely?
Fifth uncertainty: Is the dysfunction in Washington as great as we fear in our nightmares and could the fiscal cliff crisis morph into a debt ceiling debacle with no solution to the cliff in January?
I could go on imagining better and worse for quite a while, but let’s stop there.
Here’s how I see the odds on these five uncertainties.
First, I think there’s just about no chance of a deal before December 31. The strategy of the Republican majority in the House and House Speaker John Boehner seems to be to try to force the Democrats in the Senate to put a proposal on the table with the hope—and it’s a reasonable one—that enough conservative Democrats will compromise so that the Republicans in the House get a better deal than the one they’ve turned down from President Barack Obama plus political cover by forcing the Democrats to provide the votes to pass the compromise. I think that’s one reason why the House is, as I write this on Wednesday afternoon, not scheduled to go back into session until Friday, December 28, at the earliest. I think Democratic leadership in the Senate and the House sees this one coming and they’re unlikely to bite. So no deal by the 31st by my math. (Senate Minority Leader Mitch McConnell, who could help broker a Senate deal, is up for re-election in 2014 and is likely to keep a lower profile rather than risk a conservative challenge in a Republican primary.)
Second, the financial markets have held up surprisingly well—the S&P 500 closed down just 0.45% today, for example–under the uncertainty of the fiscal cliff. I think there’s a likelihood that markets will continue to fret but not panic if Congress and the President miss the December 31 deadline—as long as investors believe in a January bungee cord. If, however, that belief starts to fray, then the market will quickly get more worried. Do note, however, that while this is in my opinion the likely market attitude, it is by no means certain. There is a sizeable, in my estimation less than 50%, chance of a sell-off if the U.S. misses the December 31 deadline. How bad could any sell off be? Well, the 2011 drop associated with the debt-ceiling crisis amounted to 18.2% from July 21 to October 3. (And, yes, I agree that not all of that was connected to the debt-ceiling crisis.) I’d guess-timate a maximum damage of less than half that—say 7%. But that’s only my guess, I freely admit.
Third, optimists are assuming that Congress and the President will reach a quick January solution if the U.S. does indeed go over the cliff. The optimists could be right—and I think their optimism is largely responsible for stocks holding up so well in this uncertainty. That also means, however, that the pessimistic possibility—that this crisis will get rolled into a debt-ceiling crisis in January—isn’t priced in. The likely shock here is to the downside if it looks like there won’t be a relatively quick January deal.
What does all this add up to in my opinion?
It suggests raising some cash right now. That move has the advantage of giving you some downside protection to any of the uncertainties I’ve outlined above. Moving to raise cash could cost you potential gains if we do get the traditional Santa Claus rally in the sessions between Christmas and the first couple of days of the New Year but the gains in such a rally, if it occurs this year, are likely to be muted from even the 1.5% gain that the Standard & Poor’s 500 has averaged since 1950. Raising some cash also gives you the chance of being in a position to bargain hunt if we do get a market drop in January or February because of this crisis. I’d expect the financial markets to bounce back relatively quickly if the delay in negotiating an end to this crisis is limited to just a few weeks. And if that’s the extent of the delay, I think the damage to the U.S. economy will be minor and 2013 could still turn out to be a good year for U.S. stocks. If that were the case I certainly wouldn’t mind being in a position to put some money to work at lower prices.