We recently reached that undefinable, (in advance), crunch point at which the sum of all fears just becomes too much to bear. Each of the clouds hanging over the markets might not have been, and indeed haven't been, by themselves enough-IMF world growth fears, deflation fears, Germany growth fears, French downgrade, Greek exit, Ukraine, China slowdown, Schauble clash with Draghi, and Ebola, but suddenly, together, they just became too much to ignore-especially with the crutch of US QE about to be taken away......and the ECB apparently reluctant or unable to step up to the plate with 'proper' QE.
So where now for US stock markets? Is this the time to bank profits made on the long climb from March 2009 lows; are we really embarking on a meaningful, >10% retracement? It's certainly the case that the two previous occasions in recent history on which the Fed allowed tiny shrinkage of its balance sheet, in 2010 and 2011/12, coincided with distinct pauses, if not setbacks, in the otherwise inexorable equity market rally of the last 5 and a half years. (I've chosen to ignore the post-QE1 balance sheet reduction, although the market did indeed tank then, as markets were still in shock after the Lehman bankruptcy).
Let's focus on the US economy and markets. The declines in stocks which we witnessed over the past few weeks seem to massively exaggerate any real or potential downturn in the US economy, which is still producing new jobs at a rate of roughly 200,000 per month, jobless claims keep plummeting, the JOLTS job openings report looks good, as do PMI's, the housing market seems relatively healthy, as does industrial production, and the daily Rasmussen consumer confidence index remains relatively robust, despite air strikes and Ebola. It's true that retail sales for September were a tad disappointing, but this is a noisy series, with 3m averages looking fine and lower oil, and hence petrol prices, should help there.
The only indicators one might choose to fret about are the continued low levels of average earnings growth and inflation, but we know the Fed is also worried about these, as evidenced by the extraordinarily dovish minutes of the September FOMC meeting. Consider last week's comments from non-voting Fed hawk Bullard, who said, 'Inflation expectations are declining in the U.S.,' and, 'That's an important consideration for a central bank. And for that reason I think that a logical policy response at this juncture may be to delay the end of the QE.' And he's a hawk! The dovish Minneapolis Fed President Kocherlakota suggested that rate hikes should not come before 2016, as the Fed could do more to help with regard to employment and inflation.
What about the decline in oil prices? Isn't that a bearish leading indicator of global demand? Well it can be, and we all know the European economy's demand for oil is hardly likely to be spiking higher anytime soon, but supply is also growing-Libya and Iraq continue to increase production, as does the US, with the latter possibly tempting Saudi Arabia to desist from increase in output, so as to force the oil price below the cost of US shale production.
Admittedly, falling commodity prices may mean that CPI inflation fails to rebound, especially as the Eurozone, Japan and Switzerland all continue to endeavour to export deflation via weaker currencies, but we know from the Fed minutes that the FOMC is all over this, having identified an excessively strong dollar as a risk in this regard.
What about Europe? Sure, the Eurozone economy will continue to flatline at best, with 1% now an optimistic 2015 growth forecast, and inflation will flirt with deflation, but with Germany sharing the pain this time therein lie the seeds of success for Draghi in his mission to persuade Schauble and the German public that full-blown QE will be the only way to revive their economy. Hence also achieving his avowed aim of a Euro 1 trillion expansion of the ECB's balance sheet to avoid deflation and weaken the Euro. The ECB staff's preliminary 2017 inflation forecast, to be released on 4th December, and the second TLTRO allocation on 11th December will be key milestones. The endgame will be a further addition to global liquidity, ultimately finding its way into stock markets.
Chinese growth may be moderating as the economy rebalances from investment and exports to consumption and the housing market may appear wobbly, but the authorities have enormous resources at their disposal to address any acceleration in these downturns; we have already seen piecemeal easing measures and we will see more. Take property; down payment requirements could be relaxed, mortgages could be excluded from banks' loan to deposit ratios, supply could be controlled by disincentivising land sales by local governments-instead, central government could forbid this and force local authorities to issue municipal bonds, say.
Finally, Ebola. We're all amateur virologists now, but hopefully President Obama was correct when he said that "the dangers of a serious outbreak, (in the US), are extraordinarily low."
Could we retest the recent lows in US stocks, or even the year's low at 1742 in the S. & P.? Sure, but I believe central bankers will once again ride to the rescue.