10/21/2013 7:15 PM ET|
Welcome to the 'Dirty Harry' market
The Fed is no more out of ammo than Clint Eastwood in his prime. And with the economy looking shaky, don't bet that it will pull back on stimulus anytime soon.
As I look at the U.S. and global financial markets right now, I keep thinking of that iconic scene in “Dirty Harry.”
Clint Eastwood is facing a piece of urban pond scum whose own gun is on the ground but within reach. Eastwood has got him dead in his sights, but after a running gun battle, he could be out of ammunition.
“I know what you're thinking,” says Eastwood’s detective Harry Callahan. "‘Did he fire six shots or only five?’ Well, to tell you the truth, in all this excitement I kind of lost track myself. But being as this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you've got to ask yourself one question: ‘Do I feel lucky?’ Well, do ya, punk?”
Investors face a similar situation now as we try to decide if the Fed is out of the ammunition it has used to prop up the economy.
You recall the scene. The punk decides Harry’s gun is empty, reaches for his own and winds up floating face down in the midst of a spreading patch of bloody water.
While not wanting to suggest that either you or I are equivalent to Dirty Harry’s punk, I do think Eastwood’s question is appropriate for us now.
The Federal Reserve, the People’s Bank, the European Central Bank, the Bank of Japan and other of the world’s central banks have fired a lot of ammunition -- first, to head off banking system meltdowns, and second, to try to stimulate their economies into sustainable growth. Global financial markets rallied on that action with some stock markets -- the U.S. and German markets, for example -- moving up to all-time highs and already low bond yields falling even lower as bond prices moved up.
Now, with global growth rates nothing to write Sister Sara about, with politicians in Washington D.C. about to begin another round of budget negotiations that may make “Riot in Cell Block 11” look like a shining beacon of good faith, and with some economies showing all the emotional bounce of the pod people in “Invasion of the Body Snatchers” (to continue and conclude this post’s Don Siegel homage), financial markets are rallying again on hope that the central banks have more bullets left in their gun.
Well, do you feel lucky? And if you do, for how long?
It's a gambler's market
Let’s be clear, I hate investing when it resembles gambling. I like markets with clear macro trends behind them, such as the falling yields that characterized the bond markets since the early 1980s. (That trend is over now.) And I like markets without trends and where the fundamentals drive individual stocks.
But I really dislike markets where the direction of macro trends is up for grabs; where traders and investors are trying to bet that that they can guess the results of an essentially binary decision; and where the results of that binary decision -- in the latest case, a taper/no taper decision by the Federal Reserve -- will drive most drive stock prices in one direction or another, overwhelming the fundamentals of the vast majority of individual stocks.
That’s exactly where we are right now.
Which is almost certainly good news through November and into December. After that, though, I’ve got to wonder how lucky we’ll be and for how long.
The economy may be tapering
The consensus opinion on Wall Street at the moment is that the Federal Reserve’s Open Market Committee, the group that will decide when the central bank will start to cut back on its current $85 billion in monthly purchases of Treasurys and mortgage-backed securities, won’t start the taper at its Oct. 30 meeting. The thinking is that the Fed won’t have enough data on the economy to decide if U.S. growth is strong enough to stand up to a withdrawal of some of those purchases. It’s not the direct effect on the economy of cutting purchases to $70 billion or $75 billion a month that concerns the Fed, but the effect of any follow-on increase in interest rates and the potential that higher rates might slow sales in sectors of the economy, such as housing and autos, that rely on financing.
Since there is no Fed meeting in November, the earliest that the Open Market Committee could begin a taper of the Fed’s purchases would then be the Dec. 18 meeting. But the Wall Street consensus is that the Fed won’t act at that meeting, either. That consensus is based on the belief that the government shutdown and the debt-ceiling crisis whacked something like 0.6 percentage points out of annualized GDP growth for 2013. That translates into a drop in annualized growth in the fourth quarter from a projected 3%, according to estimates by Standard & Poor’s, to 2%.
Supporting that belief are scattered, so far at least, warnings of a weak holiday season for retailers and early reports of weakness in the housing market. For instance, eBay (EBAY) recently warned that fourth-quarter sales would be a weaker-than-expected $4.5 billion to $4.6 billion. (Analysts were projecting $4.64 billion.) “We are not expecting any improvement in the fourth quarter from what we experienced over the last eight to 10 weeks,” eBay chief financial officer Bob Swan said in the company’s recent third-quarter conference call. “We have a cautious outlook for the holiday season.”
And on Oct. 21, the National Association of Realtors reported that purchases of previously owned homes fell in September for the first time in three months. The sales rate fell 1.9% from an almost four-year high to an annual rate of 5.29 million homes. Economists surveyed by Bloomberg had forecast an annualized sales rate of 5.3 million. Prices climbed 11.7%, pushing affordability to an almost five-year low. That’s not good news for future sales.
Betting on a long Fed wait
Part of the reason for that weakness may be what happened, or didn’t happen, in the government shutdown/debt ceiling crisis just before the Treasury’s Oct. 17 deadline for a potential default. The “solution” -- a continuing resolution that extended government spending authority until Jan. 15 and raised the debt ceiling until Feb. 7 -- didn’t really end the problem. We could go through the drama, uncertainty, and worry of October all over again in early 2014. The guessing on Wall Street and among economists is that these conditions aren’t exactly going to have consumers reaching into their pockets to spend.
The bet on Wall Street, then, is that not only won’t the Fed begin to taper off its asset purchases in December, but also that the central bank will sit without acting until at least March. That’s the consensus among economists surveyed by Bloomberg.
Does that make you feel lucky? The U.S. market look ready to continue a rally that has pushed the S&P 500 to record territory on that basis. Money is flowing back into risk on currencies, weakening the dollar and the safe-haven yen. Money that fled emerging markets when the world seemed a risky place is headed back into those markets.
Cash flows in and out of ETFs, exchange traded funds, give us a good sense of what has been happening. About $725 million flowed into ETFs on Oct. 16, the day of the deal in Washington. $6.9 billion flowed in on Oct. 17 and another $2.5 billion joined the flood on Oct. 18, according to Bloomberg. Much of that money has flowed into U.S. stocks, with ETFs that specialize in U.S. stocks getting $12 billion in October. But overseas markets have joined the trend, too.
But before you get too comfortable with that trend, notice how incredibly volatile the market has become lately. Those big inflows were balanced by huge outflows in August. In that month, $14 billion came out of the SPDR S&P 500 ETF (SPY), the largest ETF. And that followed on inflows of $13.8 billion in July.
To me, even with the possibility of data surprises such as an unexpectedly strong September jobs report on Oct. 22, this adds up to a strong macro trend that’s likely to rule the direction of the market through November and into December. In that period, I think betting on global central banks is a good and not terribly risky bet.
After that, the likelihood of the Fed staying out of the taper business depends on the data, as well as how the economy and markets react to any replay of the government shutdown/debt ceiling crisis in January and February.
I think the likelihood is that the market will be even more blasé about this next round in the crisis than it was about the last one. U.S. financial markets hardly budged (well, OK, short-term Treasurys budged.) But I think the markets do need to see relatively weak holiday sales numbers, continued softness in housing sales, and solid but not rapidly accelerating economic growth from China for the Fed-stays-away-from-the-taper consensus to remain in charge of the market until March.
So what should you do?
Time to get your money in play
First, to take advantage of the likely November continuation of the no-Fed-action/financial market rally trend, I think you need to move now. Put money to work now and over the next week -- rather than at the end of November, when it will be time to re-evaluate this trend.
Like me, you might have moved into cash at the beginning of October for protection and to have cash available to take advantage of any bargains on a pullback. We never got the pullback I anticipated, but this isn’t the time to mourn missed opportunities. They’re gone. What you do now counts, and I don't think you should be even 25% in cash over the next 6 weeks. Put some money to work.
Second, put that money to work in the U.S. market, in Japan (still my favorite) and in select emerging markets such as Mexico. I think U.S. stocks will move upon on the Fed consensus, but that the move won't be equally strong across the market. I’d avoid financials, retail, and consumer durables. Expectations for no increase in rates should work to the benefit of dividend stocks --take a look at my Dividend Income portfolio at JubakPicks.com for suggestions.
Japanese stocks should get a boost, again, from a weaker yen as traders sell their safe-haven positions. (For example, the Nikkei 225 index in Tokyo climbed 0.91% on Oct. 21 on a weaker yen.) You can find some Japanese recommendations in my Jubak Picks portfolio at JubakPicks.com.
Emerging markets will get a bigger bounce in any rally, just as they've taken a bigger fall recently. So far it looks like traders are avoiding “risky” markets such as Brazil and Indonesia on fears that current account deficits pose too much risk if the consensus on the Fed turns out to be wrong. I disagree with that view of Brazil, but the economy there is growing slowly and traders are likely to maintain a show-me attitude. (In other words, in the short run my opinion gets trumped by trader sentiment.) Mexico gets a thumbs -up among traders on better finances and more work on economic reforms. It is my favorite emerging market at the moment. An ETF such as the iShares MSCI Mexico ETF (EWW) will work, although it holds more financials than I’d like. If you’re looking for individual stocks, you might look at Industrias Bachoco (IBA) or Grupo Televisa (TV), both of which trade as ADRs in New York.
And after early December? Time to re-assess.
If the consensus that the Fed won’t taper until March remains intact and if the market looks inclined to shrug off the next round of the drama in Washington, I’d leave the recommendations that I made above intact -- and possibly extend them by adding more exposure to emerging markets such as Brazil and China.
But going into December, I sure want to make sure I know how much ammunition remains in the central banks’ guns. Don’t forget to count.
December and into 2014 won’t be a time to hope that we get lucky.
At the time of publication, Jim Jubak did not own shares of any of the companies mentioned in this column in his personal portfolio. When in 2010 he started the mutual fund he manages, Jubak Global Equity Fund, Jubak liquidated all his individual stock holdings and put the money into the fund. The fund did not own shares of any stock mentioned in this column as of the end of June. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.
The last Jubak’s Picks column will run on MSN Money on Nov. 13. His my free web site JubakPicks.com will continue to offer the same mix (frequently with more daily content than MSN Money ran) of big-picture posts, stock picks and portfolios. You can also find his columns at MoneyShow.com. If that doesn’t fill your Jubak needs, you can get a free seven-day trial and $100 off a yearly subscription to my premium investment letter JAM (by clicking here).
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My favorite Dirty Harry quote, "A man's got to know his limitations" would exactly apply to all of those money printers who preside over this broken, bizarre economy.
QE 3 is like a toll booth. They tell you it’s going to be temporary, then everyone gets hooked on the revenue and it becomes impossible to remove. So it stays in place year after year, decade after decade and instead of funding the critical project it was intended to fund, it becomes a slush fund for passion projects and greed.
I understand the free market is an uncontrolable beast.
I understand that good accounting and solid business principles lead to WONDERFUL economy.
I look at the world with sceptical eyes. The Russian (mob), the Chinese (well, you know), middle east (unstable oil money pit), africa (diamonds, human exploitation), south america (drugs/oil), and on and on. We too have some funny business going on at the top. The books are cooked and we freely trade with a world whos books are cooked too.
Did I mention we're printing funny money?
The problem I have with the fed, is the same problem I have with wall street, the same problem I have with congress, and the same problem I have with the president. There is no end game.
Sustainable growth? Can we talk about sustainable, period. Infrastructure that isn't rated terrible. A society where our childrens futures aren't being spent to finance today. Look at our environment. Why isn't it clean?! Look at our labor. Why aren't there tariffs, that equalize goods so that American's can earn the paychecks to continue buying those goods. What good is China making cheap electronics if the only people who can buy them are cheaply paid retail workers. Return to American made. Make this country whole again and get the money out of the damn politics.
printing money to buy our own debt, so silly.
The House and Senate so useless.
Someone had better take a stand while we still have ground to stand on, an earthquake is coming.
The fed should have only three jobs.
1. Maintain an accurate and honest CPI.
2. Keep the real inflation rate between a deflationary 1% and 0% inflation (no more inflation). This will increase the purchasing power of the consumer. Also, this will bring real earnings to saving. If, savers can earn real income on savings, interest rates will stay low. Also, it will increase the value of the dollar. This would move money to America (an estimate 5 trillion dollars).
3. Replace the fed with a computer program ASAP.
"It's a hell of a thing, killing a man. Take away all he's got, and all he's ever gonna have." - Unforgiven
That's my favorite Clint Eastwood quote and pretty much what I have a feeling this market is going to do to a lot of speculators. Good luck my friends.
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