I am constantly asked why global equity markets are experiencing so much volatility right now.
I think there are a variety of significant factors working together to create uncertainty in the markets. Each on their own impacts market volatility (or risk), together they are a nightmare for investors.
Today a quick summary of the major variables affecting global markets.
I believe that the three main drivers in today’s uncertain markets are: the U.S. deficits and accumulated debt; the economic difficulties of multiple Euro-zone countries; the potential weakening of economies in other countries, particularly China.
Fortunately for me, The Wall Street Journal does a pretty good job discussing these variables. The linked article is well worth a read.
The Obama administration is out of control.
I do not write that as a political partisan. Especially as the Republicans are almost as based as the Democrats on spending.
My view of economic policies runs completely counter to that followed by the current U.S. federal administration. The government’s proposals for increased spending and higher tax rates will not help stimulate economic growth. Instead, I would prefer to see lower taxes and real spending cuts. Not the proposed spending reductions that will not kick in for 5 to 10 years.
As an aside, the 2011 Nobel prize winner for economics is also skeptical of these spending proposals to stimulate the U.S. economy.
I disagree with the linked article where it states that “U.S. politicians are on a war path to reduce government spending.” That is not true. There are minimal short term (i.e., real) cuts proposed. Instead, the Obama administration is seeking another USD 500 billion to finance its jobs bill. This is in addition to the USD 1.3 trillion deficit for the fiscal year ended September 30, 2011.
I would love to fight the army that believes this is waging “war”.
As far as the U.S. is concerned, I see continued volatility in their domestic markets and currency until the November 2012 (both President and Congress) results seem clear. The current spending levels and low interest rates indicate to me that interest rates will likely have to rise over the short to mid-term. This bodes poorly for fixed income investments. And, if there is inflation, real return fixed income products may do well.
The Euro was always an idea with inherent problems.
In the U.S., people are Americans first, then Texans, Californians, etc. In Europe, it is the opposite. Greeks are Greeks, Germans are Germans. Until there is strong central control over all the countries, it will be difficult to get individual countries to work together for what the Eurocrats see as their common good.
I would also argue that the bailout of Greece (and any other countries in distress) is more about bailing out the banks than saving the Greeks. I think Europe can survive Greece going bankrupt and leaving the union. It may be more problematic for all the banks should Greece fail. And I write this less about wanting to save the European banks. If the banks crash, there will be a huge impact on the economies of the stable countries.
Sadly, I do not see a Greek bailout actually solving the problem. It is kind of like giving an alcoholic another shot of ouzo. He will be happy for a while, then the effect will wear off and he will be a grumpy guy again. Already we are seeing that Greece will not meet its current deficit targets. Unless the Germans take over Greece’s finances, I do not see Greece getting the act together even with assistance this year. As I see it today, Greece will be looking for another bailout in 12-18 months.
So what does that mean for investments? Without certainty regarding Greece and the other problem Euro countries, there will be further volatility in the markets and currency.
I think there will be a continued flight from the Euro to the USD, which is seen as a safer haven for cash. How much will the USD appreciate against the Euro is hard for me to estimate. The main problem is that U.S. economic policies are hurting the USD on a stand-alone basis.
It is difficult to determine the true economic story in China due to its structure. The flow of information is less than transparent and often appears contradictory to other measures. And I speak as someone who is in close contact to people living and working in Asia.
Some believe China’s economy is fine. Others, myself included, think China is cooling down. And there may be the possibility of economic difficulties arising soon.
To the extent that China, and other countries, do slow down economically, that means s ripple effect to other countries and industries.
For example, China is a prime purchaser of U.S. debt. If they cease buying new debt issues, that raises additional problems for the U.S.
If China cools, there will be less acquisitions of raw materials to fuel the Chinese economy. We have already seen a decrease in copper prices that, in part, reflect this. Obviously, the same holds true for other countries. As other countries slow or do not recover, that saps demand for consumer products, services, and raw materials.
Markets like certainty.
Given the uncertainty with so many key factors that drive equity and fixed income markets, as well as currencies, it makes sense that there should be so much volatility.
I expect this volatility to continue until at least the second quarter of 2012. By that time, there should be some idea as to where the U.S. elections are headed and what steps have been taken in Europe to safeguard the Euro. As to whether the markets will then rise or fall will depend on the outcomes.
Unless events change in the short term and certainty prevails, expect a wild ride over the next few months.