Bears go into hibernation
by Raul Elizalde - 2014-11-21
The rollercoaster market of the last few months has left investors on edge and deeply divided on where assets may be headed. A series of lower lows and higher highs suggests that investors have no idea of what the price for stocks should be. Some insist that this confusion means that things will end up badly, with a sharp drop in stocks that could erase the year’s gains. To others, the volatility is mere noise and represents an opportunity to pick up bargains.
We explored this point in our last newsletter, when we noted that the market stood at a precarious balance between new highs and a return to weakness. In the medium term, this is still the case as the opposing trends of a global outlook that continues to deteriorate and a US economy that is at its best shape in years remain firmly in place.
More bad news from Europe comes from the usual suspect: Germany. As soon as the European Central Bank announced efforts to revive the eurozone’s economy through bond purchases, the powerful head of the Bundesbank – the German counterpart to the US Federal Reserve – stated his opposition to the plan. This was as predictable as it is regrettable, since there are few avenues for Europe to avoid deflation and economic contraction other than by massive policy stimulus. And China, thousands of miles away, also struggles with the threat of deflation as October inflation figures dropped close to a five-year low.
Meanwhile, 80% of US companies reporting Q3 results have exceeded earnings estimates, and 60% topped revenue estimates. The number of employed persons is at a record high and fuel prices are declining, suggesting that the holiday shopping season may bring even more good news for retail sales.
It also just happens that this time of the year is good for stocks. Looking at 100 years of history of the Dow Jones Industrial Average reveals that November, December and January are usually calm. December is also the month with the highest median return for DJIA, and the month when it is most likely to go up (January is second).
As if on cue, perceptions about the global outlook have improved in the last few days. The head of the ECB, Mario Draghi, gave a dramatic speech where he warned about the “excessively low” inflation that is plaguing the eurozone and promised to “do what we must” to confront it – a statement reminiscent of his famous “whatever it takes” speech. Remarkably, Jens Weidmann, the head of the Bundesbank, declined to reiterate his opposition to Draghi’s plans and told the press that he didn’t want to be “constantly commenting on one another.” China also surprised everyone with a cut to its benchmark lending rates in response to stalling factory growth, slowing retail sales, a weak property market, and a pile-up of corporate debt.
While both the ECB and China actions highlight that the two economic areas face urgent and worsening problems, the market chose to spin the news in a positive way (“it shows central bank resolve to tackle the crises”). In the historical context of how the market responds to news at this time of the year, this reaction makes sense.
Investors, therefore, may enjoy a moment of peace that may well extend into the new year. Whether it lasts through or beyond January is anyone’s guess. But, for the time being, chances of a market dislocation seem to have receded.
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