October 8, 2018
Markets began the month with a bit of a scare and it should be expected. Really there were many scary events that most investors wouldn’t know about, but amount to some of the scariest events in the last few years, at least in the opinion of this market watcher.
To put a framework around them, they are scary because they represent significant structural shifts in the political and economic landscape and often those shifts take years, perhaps decades, to play out. Now to be sure these ‘canaries in the coalmine’ haven’t died from asphyxiation yet, but the toxicity is rising rapidly. Investors should be very cautious about how they proceed. Here are the key issues of concern.
- Politician’s used their power to put Brett Kavanagh on the Supreme Court, which is a lifetime appointment. It is not necessary to comment on his guilt or innocence in the charges leveled against him. It is not necessary to guide whether his actions to defend himself were partisan. The point is that politicians have put a highly divisive figure on the Supreme Court, through a highly, highly politicized campaign which included a managed ‘investigation’ which was controlled by politicians and whose findings were essentially kept secret. There are many concerns here, but the key result is that the Supreme Court is a non-political pillar of the American system, and is intended to be the branch of government that works to mollify the people when emotions and rationale are failing society. To politicize the court and make it the source of such uncertainty is truly alarming.
- Meanwhile in Europe, a long standing problem may be preparing to impact world finance. The EU has been fighting for over a decade to control the spending by some of its members. Greece was the first to country to fall completely outside the EU’s financial comfort zones and the economy was decimated. Meanwhile Italy, a much larger economy, with a significantly higher debt (in Euros, not as a percentage) continued its profligate ways. Their recent budget suggests that they will continue further still, and in doing so, they may risk the entire EU. That may sound very dark, but the risk is real. Making it worse is the continuing debt fueled binges in the United States, China and other, smaller economies, which make the repayment of debt seem silly. All of this debt was not a problem with 0% interest rates, but interest rates are now rising.
- Interest Rates are likely the real ‘canary in the coal mine’. After years of managing the balance sheet of nations, the largest central banks are trying to normalize rates. In the US, rates are being raised slowly by the central bank. Years of bond buying by the central bank is being curtailed (in the EU) or reversed (in the US) reducing liquidity; debt everywhere will begin to impact spending. It is possible that central banks lose control of interest rates while they move rapidly higher to reflect the real risks in the economy. This is a thesis better left for a future post.
- All of this uncertainty leads to the impact that most investors saw last week, the one that will hurt their pocketbooks and confidence immediately. Stock markets went down. Not exactly crashing, but a move down, with more volatility than has been seen in a while. In reality, markets are up very strongly and moves like this should be expected, however the action in the stock market reflects the acknowledgement of one (interest rates) or more (political uncertainty) of these risks to asset prices. That noise is likely to continue for some time.
What does all of that mean? Well, for this week, there is likely to be some moderation in the market moves, although at times of such uncertainty, the moves can be volatile and unpredictable. Interest rates are likely to be the important factor to watch.
Earnings will begin next week and there will be much jockeying for position on that front. One news report suggested that companies are reducing earnings expectations, and if that turns out to fairly represent results, there is a good chance that equity prices will need to fall further to accommodate a reality where the economy isn’t perfect, there is risk in investment, and people, companies and governments have to pay interest on the money they borrow.
Here is a monthly chart showing how some of the rate moving and management events have played out over the last decade. Note that before the crisis started in 2008, ‘normal’ ten year rates were about 3.9% Today, they sit at about 3.23% with about twice the debt load in the US government (10T in Sept. 2008 vs. 21.6T in Sept. 2018) and corporate debt almost as bad (3.5T in 2008 vs. 6.3T in Sept. 2018).
Happy Thanksgiving to Canada and I will find an interesting single stock chart in a future post.