U.S. stocks just suffered through their worst month since May 2012, as the S&P 500 fell 3.13 percent and the Dow Jones Industrial Average lost nearly 4.5 percent in August.So now, as tensions mount over Syria, renewed budget battles loom in Washington and the market heads toward the fifth anniversary of the collapse of Lehman Brothers, are we in for another dire September to remember?
The good news: There’s no massive financial crisis threatening to destabilize or destroy the world’s largest banking institutions and the markets they sustain. The bad news? What is happening is almost as nerve-rattling: a series of events that have reminded investors just how inter-linked global markets have become. The worst news of all is that the cumulative impact of all those trends and events may end up leaving investors with few places to take shelter as major markets become more and more correlated – on the downside.
Let’s be clear: It’s not time to panic. What’s happening is that “risk assets” –investments not guaranteed in some manner, most typically by a sovereign state with a high and solid credit rating – are volatile and under siege. One after another, like cannonballs hurled against the walls of a medieval castle, markets are suffering a series of shocks. And just as castle walls are gradually weakened when too many projectiles hit the same spot over time, so each successive shock can have a more serious impact on the market’s overall resilience, even if it seems as if it should be a relatively minor one.
These factors will be critical in determining how stocks perform in September and, quite possibly, for months to come:
1. Geopolitical Turmoil: As Congress returns from its August recess to deliberate and vote on taking military action in Syria, geopolitical uncertainties are bound to keep the world – and perhaps the market – feeling like a more dangerous place. The civil war in Syria and the military coup and rioting in Egypt may be happening half a world away, so the direct consequences are minimal. But it’s hard to gauge the long-term consequences of recent developments, let alone another U.S. military strike.
From an investor’s perspective, wars like Vietnam, Iraq and Afghanistan have had consequences for the United States’ fiscal position and thus the competitive environment it can create for business. Geopolitical conflict can turn friends and trading partners into hostile forces; it can drive up or depress the prices of commodities; it can make trade more difficult. At the very least, it contributes to tremendous unease among investors, leaving them reluctant to buy risk assets and ready to seize on any reason to sell and stick their gains under their mattresses.
2. The Great Taper: The Fed has been the market’s focus since May, when Ben Bernanke first signaled that the bond-buying of QE3 could start winding down before very long. Even if we haven’t all become addicted to the cheap money (in the form of ultra-low interest rates) the Fed has pumped into the system, any reversal of direction will be dramatic. So mark September 18, when the Fed’s next two-day meeting ends, on your calendars.
After decades in which interest rates have tended to decline over the long term, we’re not sure what might happen when rates rise over the long haul. That nervousness is one reason for the market’s wariness, but there are segments that will feel a real impact from higher rates. These include traditionally rate-sensitive parts of the market (telecom and utility stocks, for instance) as well as bonds, whose prices fall as yields rise. Along with demolishing the idea that bonds can be a safe haven for investors, this blow makes it clear that two investment ideas that have generated a lot of profits in recent years – bonds and housing-related stocks – likely won’t be as helpful in future.
It’s quite possible that if housing sales decline, profits at banks and retailers like Home Depot (NYSE: HD) will falter. Nor will the impact be confined to the United States. There is the economic fallout to consider – the old saying that when the U.S. sneezes the rest of the world catches a cold still contains an element of truth. The new environment has put an end to the arbitrage trades of hedge funds and other big global macro investors, who used cheap U.S. money and redeployed it in the higher-yielding emerging markets.
3. Emerging Unease: Speaking of emerging markets…. The Indian rupee keeps sliding as worries grow about the country’s economy. And India isn’t alone among emerging markets causing investors anxiety. It hasn’t been that long since everyone was gushing about “Abenomics,” the package of policies and promised reforms that Japanese Prime Minister Shinzo Abe introduced in order to revive the country’s stagnating economy. The most visible change, however, has been a big decline in the country’s currency, making it cheaper for the country’s well-developed exporters (Toyota, Sony) to sell their goods in Europe, North America and elsewhere. But at some point, the yen simply can’t keep falling. And an export-led rally is a perilous undertaking at a time when economic growth in the United States is weak and that in the Eurozone has only just edged back into positive post-recession territory.
The outlook for China as an engine of economic growth and source of future investment profits isn’t that much more appealing at present. The country’s government is wrestling with making sure Chinese banks curtail credit, and the Shanghai Stock Exchange was recently described by , head of China equity research for Nomura, as “a very muddy pool of water” that investors feel reluctant to wade into.
The reason? While in the United States all eyes were focused on the Nasdaq’s “Flash Freeze,” a series of erroneous trades totaling $3.82 billion by China Everbright Securities has revealed how unprepared Chinese markets and their regulators are to deal with trading problems. The China Everbright issues sparked a “flash crash,” in which some $100 billion of value may have been wiped out off a key Chinese index in the course of a day. On top of the fundamental issues like slower economic growth, this could end up being a final reason for nervous investors to turn away from China.
4. More of the Usual: Lurking in the wings are the usual kind of risks, including earnings reports and economic data (a new unemployment report will hit on Friday). Then there’s the continuing battle over the federal budget and another fight about the debt ceiling, which Congress must raise by the middle of October. We’ve been through this before, and if there’s anything certain about the outcomes it may be that they won’t be determined until well after investors’ anxieties have spiked. Add to that the political uncertainty elsewhere – German elections are looming – and other long-standing factors like Europe’s fiscal crisis and it’s hard to see when or why the worries might stop.
Given how significant the U.S. stock market’s gains were in the first seven months of the year, it’s hard to look beyond those near-term uncertainties and spot factors that will propel stock indices to fresh highs. September has been the weakest month for the markets, historically. So now that summer is unofficially over, are you ready for the fall?
