Global CIO Commentary by Scott Minerd
The mantra now is that bad news may turn out to be good news for the markets. Over the past couple of weeks, policymakers around the world have indicated that should any kind of negative event roil the markets, central bankers are prepared to take some form of action or, in the case of the Federal Reserve, non-action. In Europe, European Central Bank President Mario Draghi hinted strongly that additional monetary policy easing is on the way as inflation remains well below the ECB’s 2 percent target and the growth outlook remains uncertain. In Japan, the central bank revised down inflation and growth forecasts, and signaled a willingness to expand its quantitative easing program further. In the United States, the Federal Reserve is keen to begin raising rates in December, but there is no assurance it will because the decision will be data dependent.
Employment report virtually assures December rate increase.
The Federal Open Market Committee’s resolution to remain on hold at its September meeting due to volatility emanating from China confirmed that global macroeconomic issues and market volatility can play a significant role in determining when policy tightening finally commences. All this goes to say that any bad news or setback in the global economy is likely to be met with a policy decision that will be supportive for credit and equity markets; therefore, at this point, I see limited downside for risk assets between now and year end. Put another way, a December Fed hike should be taken as a sign that the Fed is sufficiently comfortable with the strength of the economy and the near-term outlook, which should be good news for investors. Given the October employment report, December liftoff has become a virtual certainty unless there is some catastrophic event between now and then.
As for the fundamentals of the economy, in the United States, the data look encouraging. Underlying real GDP growth was actually stronger than the 1.5 percent preliminary estimate for the third quarter would suggest. This is because the U.S. was due for an inventory correction, and declining inventory investment shaved 1.4 percentage points off the headline growth figure. Consumer spending, which accounts for about two-thirds of U.S. demand, rose by 3.2 percent, indicating that consumer spending is strong heading into the holiday shopping season. Robust equity returns in October—the largest monthly gains in four years—also bode well for Christmas sales.
Policymakers have no tolerance for declines in risk asset prices, and seem prepared to delay tightening if necessary.
It would be premature to open the champagne just yet. Slowing emerging market growth continues to weigh upon economic growth around the world, particularly in Europe. Meanwhile, the New York Stock Exchange Accumulated Advance/Decline Line, or market breadth, has failed to make new highs, or at least return to old highs, which would confirm sustainability of the current equity market rally. This is okay for the moment, because equities have yet to quite reach their old highs either—the market remains a stone’s throw away from its peak in May—but breadth leads the market, and over the coming months investors should keep a close eye on it.
While it is always prudent to be mindful of potential headwinds, the bottom line is that policymakers have made it very clear that their tolerance for sharp declines in risk assets is virtually nonexistent. They are prepared to take action (or inaction) as necessary. Against this backdrop, I do not see significant risk to my forecast that the S&P could climb to a high of 2,175 in the next few months. Given policymaker commitment to support risk assets, it is likely that the rebound that has been underway in credit and equity prices will continue to endure over the coming months, regardless of bad news or concerns about slowing global growth.
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