Macro fears grab stock market spotlight

For the rest of 2012, big picture problems -- and particularly the fiscal cliff -- will dominate how financial markets behave, trumping company-specific news.

By The Fiscal Times Nov 9, 2012 11:28AM
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Digital Vision Ltd SuperStockBy Suzanne McGee

The election is done. Now comes the hard part: governing. Little wonder, therefore, that the mood within the financial markets suddenly shifted from nervously uncertain to downright bearish. Those on Wall Street who were hoping for a Romney rally instead got a Washington wipeout as major stock market indexes suffered a 2% tailspin. The dive was the worst of the year and dropped the Dow Jones Industrial Average ($INDU) below 13,000 for the first time in three months.

For the rest of 2012, macro issues -- and particularly the fiscal cliff and our odds of toppling into a Greek-style morass -- will dominate not only the headlines but also how financial markets behave, trumping company-specific news. Unless a pharmaceutical company triumphantly announces a cure for cancer, or the discovery of a fountain of youth, we're in for a prolonged period in which mid-cap companies can announce new contracts, large-cap companies can put forth bullish forecasts -- and all will be ignored as investors rivet their gaze on Washington.

Here are some thoughts on what lies ahead for markets, based on a handful of early post-election commentaries, or those published in the days leading up to the election focused on the market environment in coming months:

"The hard-fought election will likely be followed by more fighting in Congress, resulting in higher volatility and a potential pullback for the stock markets … Markets may provide attractive buying opportunities" in the final weeks of the year. -- Jeff Kleintop LPL Financial

We're already seeing the first part of Kleintop's prediction come true, as the specter of a divided Congress -- a Democratic-dominated Senate and a Republican House of Representatives -- makes investors worry that avoiding the fiscal cliff will be all that more difficult. The sentiment is understandable given the gridlock and increasingly vituperative political rhetoric of the last two years.

But Kleintop's second point -- that there is the prospect of bargains being created by the dramatic selloff -- is equally valid. Look for them in so-called "Republican" industries, such as some of the energy companies entering a new era of large-scale domestic shale oil and gas discoveries.

There also are likely to be bargains among the companies that continue to spend on research and innovation. Studies of what drives corporate spending and hiring decisions have shown that only rarely do tax policies on their own shape that spending. True, if a punitive tax is directed at a particular industry -- coal mining, say -- or regulations viewed as burdensome are directed at, say, the pharmaceutical industry, that may well constrain spending. But if companies believe that failing to spend will cause them to miss a chance to generate profits, they'll spend. People don't stop coming up with smart business ideas based on who occupies the White House or Congress.

"Monetary policy will have to remain very loose and, along with a renewed escalation of the crisis in the euro-zone, this should anchor 10-year Treasury yields at around 1.5%." -- Julian Jessop, Capital Economics

In light of the uncertainty surrounding the fiscal cliff, one of the biggest sources of investor anxiety remains what will happen to corporate dividends. That has kept the pressure on stocks with high dividend yields in recent weeks, and may continue to do so, given the market belief that President Obama will lobby for a return to treating dividend income as ordinary income for those earning $200,000 or more a year. But against the backdrop of loose monetary policy and rock bottom Treasury yields, dividend stocks are likely to remain attractive investments. A stock that offers a 3.5% yield, even if that yield is taxed at the top marginal rate, will still look more appealing than a 10-year Treasury bond paying 1.5 percent, except for the most risk-averse investors. Municipal bonds -- which have attracted steady inflows from investors for most of 2012 -- are also likely to emerge as attractive.

"To a significant extent, foreigners finance the deficit by buying U.S. bonds. Should the bond market impose reform on policy makers in the U.S. by selling off bonds, the implications for the U.S. dollar might be far more sever than they have been for the euro." -- Axel Merk, Merk Investments

Merk's point is an interesting one -- and indeed, we're already seeing the dollar take a beating in the immediate aftermath of Obama's victory. If, as Merk argues, the hefty current account deficit in the United States is a source of risk, investors can address that by diversifying their portfolios more broadly outside the dollar. It's worth remembering that if the dollar falls, returns generated from non-dollar investments automatically do better.

True, it is getting harder to find a corner of the world that isn't suffering to some extent from the global economic slowdown, and no one in their right mind is going to put 5% to 10% of their portfolios in those pockets that are going gangbusters -- Indonesia and South Africa spring to mind. But for those anxious about the dollar's fate in the short and medium term, it makes sense to check out the growing array of funds that specialize is higher-yielding bonds from governments that have only recently made the leap into investment grade territory.

"The American Society of Civil Engineers gave the nation's infrastructure an overall rating of D.… The investment need is particularly great in the transportation sector and water systems.… At near-zero interest rates and a high unemployment rate, a massive infrastructure program would therefore make a lot of sense -- from all angles." -- Harm Bandholz, UniCredit Research

President Obama now doesn't need to worry about re-election, but undoubtedly he'll be concerned about his legacy. A major part of that is the jobs outlook. Investment in infrastructure is a necessary and logical move -- and in contrast to monetary stimulus, it would lead directly to job creation. As a medium-term issue, it's worth keeping an eye open for comments from the President that indicate this is becoming a priority, and then seeking out some of the heavy industrial stocks most likely to benefit, ranging from engineering companies to makers of heavy equipment like Caterpillar (CAT).

"Our base case remains a high possibility of a market-unfriendly resolution to the fiscal cliff resulting in dampened risk appetite." --Bank of America Global Economics team.

In the eyes of these Bank of America economists, this prospect argues in favor of a higher dollar. But it's also a recipe for investors taking shelter in safe assets, including gold. Indeed, it's hard to envisage a scenario under which gold falls suddenly out of favor, however irrational owning it at relatively high prices has become in recent months. Hoping to profit from the movement in gold prices is little more than speculation, and there may be better assets to own if you are investing for the long-term gains. But in the nervous, uneasy and risk-averse climate that is likely to prevail over the next few months, safe assets are likely to appreciate.

"Of the past 15 elections, the 4th quarter of the election year was up 13 times . . One-third of the time the 4th quarter of an election year was up (more than) 8%. That would translate to a one-third chance of a 9% gain from current levels… The only two negative [market returns] were in the recessions of 2000 and 2008, so unless you believe we are in a recession with money availability shut down, it stands to history the SPX should see a meaningful advance through year end." -- Tony Dwyer, Canaccord Genuity market strategist

It's nice to know that optimism isn't dead.

Suzanne McGee is a columnist at The Fiscal Times. Subscribe to The Fiscal Times' FREE newsletter.

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Nov 9, 2012 3:59PM

Ok, enough already. Thirty years ago have a derelict congress in Washington was the only thing that kept the country from being taken over by party-spefic special interest legislation--nothing got passed so the power was not used for evil or good. Sure they were incompetent, but inaction meant status quo was maintained. But that was fine because America was greatest nation on earth and our economy was singing, and the average american lived well, with the chance for so much more. If you worked hard you could start a business and the sky was the limit.

Inaction isn't so cute any more so enough already, The frustration of watching our leaders on Capital Hill refuse to act in the best interest of my country year after year, while they foolishly play the childish game of political tic-tac-toe, has gotten unbearable. The ship is off course and the Captain is screaming for action, but the Officers are wearing coats of Red or Blue and refuse agree on whether to to move the rudder seven degrees starboard lest ye be seen as a traitor within your split ranks and thrown overboard, never to be re-elected again.

Enough already. Move the expletive emphasized rudder! No leadership would be so much better than bad leadership. A star would rise to the top and words of one man would guide the actions of many and colors of the coats would fade in importance towards purple and common sense would overtake petty squabbling as the chief affiliation of those who have the duty to kep us off the rocks.

The way I see it, the impetus for action is once again with the people, with two viable options available: Self governance through the referendum process or a voter lead revolt that replaces the incumbent until we have a New Congress that has two years to get this country's act together or walk the plank. Arrrrrg!

Enough already.

Nov 9, 2012 3:21PM
So tell me, Suzanne, what's the answer? President Obama and Congress are like a dogs chasing their tails; over the past four years they have accomplished absolutely nothing!  Do you really think the next four years will be any different?  First, we need to put this egregious behavior of Obama v. Congress in perspective.  I believe its mainly just a power struggle -- "personal power" -- both for President Obama and Congress, especially Mitch McDonnell, the senior senator from Kentucky, my home state.   On National TV, several months before the election, McConnell bragged that his and the Republican Party's main focus  was to make sure that President Obama was "a one term President" (a direct quote).  Wow, now that's really looking out for the welfare of our country.  Suzanne, I'm neither Democrat nor Republican, but in my opinion, anyone in McConnell's position, no matter what their political party affiliation, should be censured by his colleagues for making such a stupid statement (truthfully, if there is away, he should be kicked out of the Senate)!  It just dawned on me, this is a perfect example of Forrest Gump's famous line, "STUPID IS WHAT STUPID DOES."  WAKE-UP, President Obama and Congress, this GREAT NATION, OUR BELOVED REPUBLIC is teetering on a "slippery slope!"  Are these morons oblivious to our country's problems; most of the time, it seems as if they are comatose or even brain-dead!.     

If you take a more pragmatic approach to these problems, however, it all makes perfectly good sense. All parties involved are financially set for life; they get paid the same whether they do something (the duties and responsibilities for which they were elected) or do nothing (what they seem to do best). They have legislated themselves the very best:  huge salaries, free healthcare, lengthy vacations/personal time/sick leave, etc., liberal and exorbitant pensions, and the list goes on and on. 

Whoa, I'm beginning to feel dizzy and nauseous, something has made me deathly sick!  Sorry, but I have to go before I vomit on my keyboard.

Best Wishes and Happy Hoidays to Everyone,
Don Moore
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