So you know those geopolitical events that investors have been trying to avoid — kind of like whistling past a graveyard? Well, it was kind of easy when sentiment was buoyant, but now there are some actual reasons for concern.
There are some real effects of slowdown in emerging markets and the euro zone, especially now that Russia and Brazil have fallen into legit recessions and the euro zone is not far behind. The stronger dollar moreover is a headwind for U.S. multinationals, and particularly the commodity producers like ExxonMobil (XOM) and Chevron (CVX).
The heads up in this regard came from Ford (F), which appropriately got an F from investors when it reduced its profit estimate last week by $2 billion, citing sales slowdowns in Russia, Brazil, Argentina and the euro-zone countries, plus recalls. Instead of breaking even in Europe next year, Ford now expects to lose $250 million, according to reports.
The message, in case it’s not clear: The worsening conditions in emerging markets and Europe are a clear and present risk for MNCs, or multinational corporations.
Russia is now not only in recession but also a bear market, in part due to sanctions, and the ruble is in free fall. These are similar conditions to the turmoil that led to the summer 1998 wipeout in stocks. As for Brazil, you may recall that there is a lot of concern about slowing growth and the business elite does not like the prospect of a reelection victory of President Dilma Rousseff.
Hate to say this but a lot of the structural issues that were uncovered in the financial crisis of 2007-09 are still in place in the euro zone and Russia. Now consumer confidence is fading, unemployment is rising and banks are reeling. Note in the chart below how much the Russell 2000 fell during the last ruble crisis, in 1998.
Here in the U.S., consumer confidence has risen a bit after taking a hit following the start of military action in Iraq and Syria. More pluses: Unemployment claims’ 13-week average made a new cycle low, and falling gasoline prices are a big tailwind — and could fuel economic growth of as much as 4 percent in the third quarter annualized, according to Cornerstone Macro estimates.
Still, looking back over our shoulder, it is now clear that a lot of things peaked in July and world markets have been running on fumes since then. The only pieces of the puzzle that have remained firm are U.S. large-cap stocks and the overall U.S. economy.
It’s nice to be exceptional, but the disparity has resulted in a lot of talk of “decoupling,” which sounds like the fallout of a Divorce Court decision but it’s actually more serious. It’s the idea that U.S. large-cap stocks and the U.S. economy can continue to separate themselves from what’s happening in the rest of the world and even amongst the smaller stocks in the U.S market.
It’s not the craziest idea in the world. For one, the job gains reported Friday speak for themselves as the unemployment rate has fallen to a level not seen since May 2008. There’s anecdotal evidence as well.
Macy’s (M) is seeing enough strength in the consumer to justify its seasonal hiring intentions by 3.6 percent this year to 86,000. Kohl’s (KSS) plans on boosting seasonal hiring to 67,000 from 50,000. No wonder, with consumer spending on durable goods up an 11.4 percent annual rate in the three months to August.
Overall, U.S. GDP growth has clocked in at a 3.5 percent annualized rate or more in three of the last four quarters. Two of the four were results of 4.5% or more.
Compare that to what’s happening elsewhere. Japanese output has disappointed, U.K. home prices dropped 0.2 percent in September for the first setback in 17 months, manufacturing activity in China is dangerously close to stalling, German unemployment rose for the second month in a row as factory activity declined on a month-over-month basis, and deflation continues to threaten the euro zone.
According to the latest global factory activity data, of the 25 countries with the largest economies, 60 percent are seeing growth in factory activity slow. Nine are actually seeing factory activity decline on a month-over-month basis.
Paul Ashworth and Paul Dales, analysts at Capital Economics, have observed that the U.S. is not just beating the euro zone and China but pulling away. They note that the U.S. economy is fairly closed and benefits from strong domestic demand (i.e. that enthusiasm at Macy’s). If demand holds at current levels, they see evidence of U.S. exports to Europe growing by around 5 percent this year while exports to China grow 6-10 percent.
As for small caps, my sense is that much depends on how the market digests the fact that the unemployment rate has already tagged the Fed’s year-end target two months early. Think about what that means for the pace of monetary policy tightening. The Fed will be back in the headlines this week when the minutes of the September policy meeting are released on Wednesday.
While earlier rate hikes are a risk, ace bond fund manager Jeffrey Gundlach of DoubleLine Capital has told reporters that predictions of a rise in U.S. interest rates are “almost comical” because Fed chair Janet Yellen still sees issues in the labor market outside the unemployment rate, such as the lack of wage growth and the still significant cadre of long-term unemployed.
It’s an exciting situation for investors, with lots of moving parts as big, long-term trends — the stock market rally since 2012, the Fed’s QE3 program since 2012, the 0 percent interest-rate policy since 2008, the global economic recovery since 2009, and maybe even the bull market in bonds since the early 1980s — are all coming under pressure.
These pressures create opportunities. Be sure to stay in sync with me as we charge out of an oversold condition into the final quarter of 2014 and look ahead to the opportunities that lie ahead in 2015.
Stocks have a great shot at rebounding back toward September highs later this month as Q3 earnings reports — to be released over the next four weeks — may not be as soft as feared. Corporate managers have been amazingly resilient in recent years, and it’s unlikely that they have suddenly lost their touch.
You do have my permission to worry about one thing, however: Very few investors or analysts expected the recent surge in the U.S. dollar, and thus the potential for American companies’ goods to be more expensive overseas is not in many analytical matrixes.
Companies might throw investors a curve ball in coming weeks during Q3 reporting season by warning that the stronger dollar will negatively impact Q4 earnings. If the market wavers because of a surprise in this regard, it’s more likely to be a much more real and lasting concern than any of the more obvious, and thus superficial, geopolitical bugaboos such as the conflicts in the Middle East, Ukraine and Hong Kong.