September 3, 2013
The only thing nice about August, 2013 was the weather. It was another month, like June, where both stocks and bonds were down. Everyone lost money. The worries from August can be boiled down to one reason: September. September promises to be eventful for four reasons: the Federal Reserve, the political theater we call the U.S. budget, the Syrian conflict, and the German elections. Though these concerns may slow the markets down, they hardly represent an existential threat; here's why.
The potential for the Federal Reserve to reduce its monthly purchases has been the sine qua non for all the market turbulence this summer. Since rising bond and equity prices have correlated closely with Fed purchases over the past several years, it's intuitive to fear a reduction in those purchases. However, it is unlikely that the Fed will begin reducing purchases, or if they do, the amount will be de minimis for three reasons. The first is that inflation is still well below their target. Second, unemployment rates remain historically elevated. Third, GDP growth is too weak to change either of the first two conditions. The actual economic benefits of the Fed's purchases may have been limited and diminishing while the risks are increasing. Still, Fed governors are unlikely to call their own bluff and reverse course now.
The first salvos in the pending U.S. budget fight have already been fired. On the one hand, Speaker Boehner has again demanded spending cuts. On the other, President Obama has again simply refused to negotiate. Neither seems to leave any open doors for the other. But investors have seen this movie before and are unlikely to be too interested in a rerun. Look for an eleventh hour punt. Anything else would be exceptional.
The European economy, and especially the German economy, is back to the black. Germany is one place investors do not want regime change so these economic improvements couldn't happen at a better time. Angela Merkel is poised to win a third term as Chancellor, assuring a continuation of policies. Greece will likely default for a fourth time and Portugal for a second. Rescue packages will be pieced together. Like the U.S. Federal Reserve, they've gone too far to turn back now. All this is a side show from the real news, which is that stabilization in the Eurozone economy represents a big improvement in the global economic malaise.
Syria is mostly a human tragedy. The effect on global GDP if Syria were to fall off the map would be a rounding error. However, these tensions could elevate the price of oil and create an economic headwind just as it seems things are poised to improve for the first time in two years. Such a scenario is unlikely considering that just a few years ago Libya went through a similar crisis and was a much larger producer of oil and strategically located in a more important trade corridor.
True to tradition, nearsighted investors sold both bond and equity funds en masse. My advice is to do your best to be farsighted and avoid getting caught up in the moment. Trying to make investment decisions based solely on what to expect over the next month is like trying to drive your car looking out the side window; it's bound to lead to an accident. Despite all of the noise created by the Federal Reserve prognosticators, U.S. and European politicians, and the Syrian situation, it appears that the business environment is improving. There was too much money in cash before August and now there's even more. Eventually, that will go somewhere. At this point, both bonds and stocks are likely to benefit. Between the two, stocks represent the better relative value for farsighted investors.
Brennan R. Redmond, CFA Vice President Brighton Securities
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities.)