There are a lot of potential hurdles for the markets in the coming weeks. A potential strike on Syria is foremost on the market’s mind as evidenced by the rapid selloff Friday in the wake of hawkish comments by Russian President Putin. Russia and China both appear to be backing the Syrian regime while the US and France – yes, France – represent the sum total of the coalition of countries reluctantly willing to punish the Assad regime. An old market saying attributed to Nathan Rothschild is that one should buy on the sound of cannons and sell on the sound of trumpets but I’m not sure that applies to a market that is already near all time highs. And a lot can go wrong between the hopeful cacophony of the cannons and the triumphant blare of the trumpets.
Certainly, everyone is aware that President Obama believes we have a responsibility to respond to the use of chemical weapons by the Assad regime so in that sense, maybe the strike is already factored into current prices. On the other hand, we have no idea what form such a strike might take except the President insists it will not involve ground troops. We also don’t know whether Congress will approve such a strike or how it might seek to shape the response although passage at this point looks highly unlikely. Will the president go ahead with a strike without Congressional approval and public support (polls show a majority of both Democrats and Republicans opposed)? I have no idea and neither does anyone in this market. There is still plenty of opportunity for surprise out of the Middle East – as always I might add.
Personally, I would not want to be in the President’s shoes right now. The evidence against the Assad regime is not a slam dunk and neither side of the conflict appears to be playing by the international rules of war. What would a strike accomplish if it didn’t remove Assad? More importantly, maybe, what would it accomplish if it did? There is every possibility that whoever replaced Assad would be worse for Syrians and potentially our strategic interests as well (whatever those might be; I’m not sure there are any). I am also very wary of what havoc we might sow by interjecting a bunch of cruise missiles into an already dangerous situation. I can think of all kinds of scenarios that end up making a bad situation much worse. Is there any doubt that wherever our missiles land that someone will be showing us pictures of collateral damage in the form of dead women and children? What if one of our missiles goes off target and hits a Russian ship? I abhor the idea that Assad could get away with using chemical weapons but I also abhor the idea that we might start a much wider conflict by trying to defend a principle to which regimes such as Assad’s will never adhere. The markets may follow Rothschild’s script if things go as designed but war making is a messy business and mistakes are the rule not the exception.
Even if Syria is resolved in a manner that is agreeable to the markets, there are plenty of other issues that could upset a bull market that may have already passed its expiration date anyway. Another old saying on Wall Street is that tops are a process while bottoms are an event. It usually takes time to form a top – crashes are not the norm and hope springs eternal – and we may already have started the process. The market has struggled since making its high at the beginning of August and the internals of the market do not indicate health. The Advance-Decline ratio was falling even as the market made its high indicating a smaller cohort of stocks was pushing the index higher. The New High-New Low ratio is making similar noises. Sectors that were leading the market previously – homebuilders, financials and retail – are now lagging, another worrying sign. Technically, the S&P 500 is trading below its 50 day moving average but is still above the all important 200 day. In other words, the short term trend appears to be turning lower while the longer term trend is still higher.
On the economic front, the signals are still, at best, mixed. The jobs report Friday was only marginally less than expected but the details were pretty bad. The headline showed an add of a respectable 169,000 jobs but the last two months were revised down by 74,000. The unemployment rate fell to 7.3% but that was entirely due to a drop in the workforce, a trend that has several explanations none of which point to better growth. The labor force participation rate is now at levels last seen during the Carter administration and I don’t care what your political affiliation, that is not good news.
There was some positive economic news last week to offset the bad. Both the ISM surveys were quite positive although these are quite volatile and a month does not a trend make. Auto sales hit a post crisis high over 16 million annual units. Construction spending was up a bit although the rate of change continues to fall. Factory orders ex-transportation were up but capital goods orders were down. Global trade rebounded somewhat but is still not robust and with several of the emerging markets in trouble seems unlikely to improve in the short term. The global economy may – and I emphasize may – be stabilizing at lower levels as China and Europe appear to have stopped getting worse. I’ll put this in the we’ll see column for now as the US is still the 800 pound gorilla of the global economy and I don’t sense much improvement here yet.
Along with the war and economic concerns, this month we’ll get to see our elected leaders go toe to toe again on the budget. We’ve already hit the debt limit and Treasury is apparently kiting checks or something to keep the government open for business but Secretary Lew has warned that his bag of fiscal tricks will run out early next month. The last time we had one of these battle royales over the budget the market did not like it one bit and my guess is that this one, coming as the parties position for the mid-term elections, will be worse. Neither side appears amenable to a compromise.
Lastly, we have the Federal Reserve. The FOMC meets next week to consider reducing its purchases of Treasuries and MBS. Whether one believes that QE has been effective is irrelevant as the majority of market participants certainly seems to think it has. If you believe that QE has been good then less of it isn’t what you want to see with an economy still growing below the long term trend. The prospect of the Fed reducing purchases has been widely cited as a factor – the factor some would say – in the bond market sell off of the last few months. Higher interest rates, ceteris paribus, mean a lower valuation for stocks so if rates keep rising, as everyone seems to expect now, stocks are probably not going to react favorably. However, I’m not sure the idea of tapering is all that is going on in the bond market and would not be surprised in the least to see tapering and a bond rally happen at the same time. But if that bond rally comes due to continued weakness in the economy it is hard to see how that would be good for stocks either. And oh, by the way, since we’re talking about the Fed, we should also find out soon who will be leading the Fed in the near future. All indications are that Larry Summers has the job, but I’m still holding out for someone who has a clue. If Summers gets the job, I don’t think the market will react positively.
Since I’ve already used two Wall Street cliches, let’s end with another one. It is said that bull markets “climb a wall of worry” and so I guess that must also mean that bear markets start when the wall gets too high to scale. Is the current wall of worries too high? Syria could be nothing. The economy could keep chugging along just north of stall speed or it could finally accelerate as every economist on the planet has been insisting it will for the last 4 years. P/Es could just keep expanding despite a worrying lack of revenue and profit growth. QE might end with a whimper rather than a bang. Yes, all that could happen, but will it? It seems like a lot to ask of a bull that is getting rather long in the tooth.
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