This has been an incredibly eventful week in the US. There’s obviously no need to rehash the election or the talk about the so-called “Fiscal Cliff” because they’ve been covered, and will continue to be covered, in nearly every possible venue.
In the background, the S&P 500 in the US and the broader global indices have experienced a mini-correction since the second week of September. Over the past two months, the S&P has declined approximately 5%; approximately one-third of the declines during the recent correction have come this week, post-election. The MSCI World is down a similar amount. In essence, markets have basically taken back the gains investors here and abroad picked up in the wake of major European and US monetary policy announcements. Technically, markets were rather overbought to begin with, at least on a short-term basis, making it somewhat unsurprising that the market is letting a little air out of the tires.
Nonetheless, it’s been interesting to watch those in the media whose jobs revolve around ascribing stories to every market move breathlessly talk about the election and the Fiscal Cliff as the primary, A1 catalysts for this week’s downward action. In reality, the election result was probably already baked into general market expectations. Prediction markets, such as Intrade, remained firmly in the camp for the President’s reelection for months. A number of statisticians had been forecasting the margin in the Electoral College and general national vote tally for weeks. In nearly all cases they were proven correct, with nearly all of the statisticians coalescing around a national vote margin of 2.5% and an electoral college count for the President of 303 to 332 votes depending on which way Florida fell. They nailed it. In the end, I’m not convinced that markets were truly “surprised” or “disappointed” by the result. Furthermore, pundits for weeks have sliced and diced the election and the implications for the Fiscal Cliff from every possible angle. Nothing we’re seeing today should surprise anybody.
On the other hand, with everything going on here, investors in the US largely ignored several overseas developments that actually may have generated a few negative surprises and contributed to market declines. Perhaps confirming the notion that US election results were anticipated, markets in the US were relatively unperturbed after the election, with futures in the US basically flat early on Wednesday relative to the prior day’s market close; European markets were up for approximately the first half of the trading session on Wednesday. Then, European Central Bank President Mario Draghi spoke and laid out the following statement at a conference in Germany: “Germany has so far been largely insulated from some of the difficulties elsewhere in the Euro area. But the latest data suggest that these developments are now starting to affect the Germany economy.” Almost immediately, futures in the US and European markets began a quick descent. The statement seems rather innocuous, and maybe a bit obvious. It was an important shift for markets, though. It was the first time the ECB head had truly acknowledged publicly or officially that Germany growth was eroding and at risk. This is important because German economic strength has been a bulwark. Furthermore, Europeans are looking to Germany and Germany President Angela Merkel to prop up and support the rest of Europe as the continent works through a difficult economic transition period. Alas, a look at German economic releases this week shows a wheezing economy. Year over year industrial production declined again in September; year over year numbers have been negative three months running and five out of the past six months. Germany’s exports went negative year over year in September, the first time this has happened since the 2008 global recession. Services and manufacturing PMIs/surveys remain in contraction territory.
Matters certainly weren’t helped by developments in Greece. While many expected the Greek Parliamentary vote on a new €13.5 billion austerity package to come down to a few votes (and expected protesters to unleash their venom), investors were surprised yesterday by a statement from an EU official stating that European finance ministers weren’t ready to sign off on the release of €31.5 billion in EU funds until the “end of November.” A positive parliamentary vote was supposed to ensure quick release of the funds. Market declines subsequently accelerated in the US. This is just further indication of the general confusion and mistrust that’s occurring at all levels between Greek lawmakers and European policymakers. While I’ll go out on a limb and say that there’s a very strong chance that European ministers eventually release the bailout tranche, the damage is done. In the face of massive electorate dissatisfaction with the austerity program in Greece, it’s been incredibly difficult to keep the current parliamentary coalition intact. Face slaps and delays after hard decisions have been made are going to make it that much more difficult. The delay once again required investors to discount the increased probability of a Greek default or exit and work through all scenarios surrounding these potential outcomes.
Finally, the US isn’t the only major power working through a leadership change. China began the process this week of transitioning the nation’s leadership at the Communist Party’s 18th Congress. With the controversy surrounding Bo Xilai and his wife earlier this year, protests in various parts of the country, and several major stories in the Western press outlining the corruption and capital accumulation of several important top officials, it hasn’t been a smooth year to say the least. Observers inside and outside of China have speculated (maybe “hoped” is a better word) that the leadership would use the Congress as an opportunity to incrementally open up the political system to accommodate more voices. Instead, President Hu Jintao delivered a 100 minute speech at the opening of the Congress that largely affirmed a status quo stance and a hard line against any major political reforms. On the surface, this doesn’t seem like a game changer. Investors, however, are worried about political unrest, corruption, and general economic imbalances continuing to derail China’s growth story. Without change, investors worry the economic situation may not improve. GDP growth this year is already forecast to decelerate to approximately 7.5% from 9.3% last year and 10.4% the year before. China’s growth has been an important crutch for global GDP growth as developed economies muddle along. A prolonged dent in growth rates would be problematic. China’s equity markets are trading near the 2009 lows and thus have discounted a significant amount of negativity. It remains to be seen whether other global markets, especially those in the US, have fully incorporated this downshift. US multiples are elevated as we’ve discussed in the past.
Again, it was easy to focus on the election and developments in the US this week and blame the election for volatile market moves this week. It’s important, though, to see the forest for the trees and recognize that several significant international developments were likely more responsible for uncertainty in US and global markets this week. Investors were reminded that there are still some thorny issues to work out abroad that could have substantial influence on US economic growth prospects in the coming year or two.
