What the hell happened last week? I don’t know.
We’ve just witnessed the worst Thanksgiving week drop since 1932 in the S&P 500 and a 4.7 percent sell-off since November 18th. Six consecutive down days for the index are extremely rare – as are down Novembers in general; the penultimate month is typically considered one of the best for stocks of the whole year with an average return of plus 1.6% over the last fifty years.
To the best of my reckoning, some combination of these five things produced the horrendous performance of the US stock market of the past week…
1. Europe – the debt crisis entered a new phase this week as a German bund auction was labeled “disastrous.” German bunds are considered to be the pillars of the entire financial system in Europe, they are viewed to be “risk-free” like US Treasurys. Seeing the problems of the peripheral countries begin to manifest themselves in the core countries is probably the proximate cause of this recent spate of selling. Hungary downgraded to junk status and the rumors of France losing triple A status certainly didn’t help either. For those of us who’ve been in the game, it all feels very 2007 at times – what with the tail risk fears and the talk of ringfencing and the hanging on every utterance from a government official – even though there are critical differences between this mess and that mess.
2. China – China has a high class problem: their economy is growing too quickly and in all the wrong places. China’s attempting to slow down its real estate development and provincial infrastructure buildout to ease inflation and put a stop to the wage slavery grumblings that could lead to civil unrest around the country. As real estate becomes both more unaffordable and too plentiful at the same time (quel paradoxe!), China’s central government knows that it’s only a matter of time before the speculative bubble lays waste to everyone, including their own banks. So the Chinese planners have decided to put pressure on real estate speculation with both government policy (limiting apartment unit ownership by bureaucrats, bank lending curbs etc) as well as monetary policy (higher interest rates and reserve requirements for lenders). The good news is, they are doing the opposite of what we do here – attempting to head off a bubble before it truly wrecks everything. The bad news is that it’s working. This week we saw a surprisingly weak Chinese PMI number (a measure of economic growth and activity) that slammed commodity prices and industrial stocks from Peru to Pennsylvania. Every economy and multinational corporation around the world – ours included – was counting on Asia and emerging markets to serve as the engine of growth in 2012 and beyond. A markedly slowing China takes that possibility off the table.
3. Emerging Markets Stocks – And it’s not only China that’s dragged our markets down these last few weeks. Economic softness is rearing it’s ugly head everywhere – nowhere quite so vividly as in the charts of emerging markets stocks. These charts, when viewed concurrently, resemble a museum exhibit about a painter who only did portraits of falling knives. Latin America is down 27% year-to-date despite being comprised of rapidly growing middle class demographics and fast-developing consumerization and industrialization. You can also look at India, with a currency (the rupee) at a multi-year low against the dollar. This is text-book repatriation and “run for the safest haven” activity. In fact, the US broad market is off about 6% this year – which is fantastic considering that the MSCI World Ex US stock index (everyone except us) is down triple that with a loss of 18% since the beginning of 2011.
4. US Economic Data – For a minute there, the one thing the bulls were able to point to was the fact that although the rest of the world was falling apart, we were still recovering, even if at a dreadfully slow pace. The double dip recession fears of August had subsided by the fall and we began referencing the fact that jobless claims were ebbing (under 400k a week) and there was even some strength where we least expected it (homebuilding, mid-level retail sales, industrial production etc). But now these pockets of strength have been turned out and there was nothing much else in them other than some lint and a Canadian penny. That inkling of strength is not quite what it was even a few weeks ago – this is one more leg pulled out from under the bull table and one more source of consternation. When you combine this with the resumption of earnings estimate and GDP estimate cuts coming from Wall Street analysts, you can see why stocks have been abandoned with so little regard at even the hint of systemic risk coming from Europe. The Q3 revision from 2.5% to 2% didn’t do us any favors either this week.
5. Seasonality – When the market is melting up into year end (as it looked like it would headed into the end of October with a 14% S&P 500 trough-to-peak rally that month), the assumption is that under-invested and underperforming managers will do what they can to catch up. This means chasing market-leading stocks higher, buying more aggressively and favoring the high-beta “movers” that will give them the most bang for their buck. But alas, this phenomenon cuts both ways. And so those who were tempted to chase the rally are now more than happy to sit back and play wait-and-see. The more unlikely it seems that the fabled “Santa Claus Rally” will materialize, the more unwilling those with dry powder on the sidelines will be. When the market is showing a year-to-date decline this far into year-end, the arms-folded-across-my-chest posture is much easier to maintain than you’d think. Especially when you have investors or a board to answer to come January.
Anyway, these are the five main issues that have contributed to what we’re fighting through, in my view. Not so easy to climb a wall of worry when there are four right behind it.