While you and I were enjoying the last rays of summer sunshine, the pundits, gurus, and Twitter addicts have sounded the warning bell for a rocky fall. The S&P 500 index fell 4.5% from its August peak, the Dow Jones Industrial Average lost 5.4%, and emerging markets have been pummeled. But the pundits say several big events -- mostly political -- could make things even worse during the historically weakest month for stocks.
How big of an impact could these items have? Let's review them one by one.
1. Syrian crisis. President Obama has asked Congress to approve limited military action against Syria in retaliation for the alleged use of chemical weapons against civilians by President Bashar al-Assad. After much hemming and hawing, I think he'll get Congressional approval and will then launch cruise missiles against selected targets. (On Wednesday, the Senate Foreign Relations Committee authorized military action by a 10-7 vote.) It will go on for a couple of days, the rhetoric will be heated, there may be some limited retaliation against U.S. or Israeli targets, but it won't lead to a regional war. Or, if he doesn't get the votes, there may be no fighting at all. So, on a scale of 1 to 10, I'd peg the short-term impact at 4 and the longer-term impact at 1.
2. German elections. Germans go to the polls Sept. 22, and most pundits expect Chancellor Angela Merkel to be re-elected. But Social Democratic opponent Peer Steinbrueck's strong debate performance may narrow her wide lead in the polls. Steinbrueck could make this election a referendum on Merkel's European austerity policies. Late last month, her own finance minister pulled a Joe Biden and said Greece may need another bailout.
Still, in an email, Klaus Deutsch of Deutsche Bank wrote me: "European policy will hardly change, no matter what the election outcome might look like. Only a true change in government to a SPD/Green government would open up a different position on eurozone debt issues."
My best guess: Even an upset SPD victory would have a short-term impact of 4, but a long-term effect of only 2.
3. New Fed chairman. The president punted on appointing a new Federal Reserve chairman to replace Ben Bernanke after Democrats pushed back on reports former Treasury Secretary Larry Summers was his choice over current Fed Vice Chair Janet Yellen. Still, well-connected reporters like Ben White of Politico, John Harwood, and Ezra Klein say it's in the bag for Summers. Some liberal Democrats on the Senate Finance Committee may vote no, but I expect the Senate to hold its nose and confirm him.
Nonetheless, Summers' notorious abrasive style will take its toll. Six current Fed presidents and top officials -- including Yellen and Bernanke -- may step down by next year, and more could follow. So, I give the short-term impact a 3 and the long-term impact a 5.
4. Fed tapering. Maybe the best-advertised retreat from easy money policies in history could start with the Federal Open Market Committee's Sept. 17-18 meeting, followed by Bernanke press conference. It's the ideal venue for the lame-duck chairman to begin unwinding quantitative easing before he walks out the door next January.
Primary dealers of Treasuries expect the central bank to reduce its $85 billion of monthly purchases by $15 billion a month starting at this meeting, but who really knows? And whether it happens in September, or October, or December, or whether the Fed tapers, then stops, and then tapers again, the die is cast: Barring an outright recession, the Fed will phase out QE over the next couple of years, then gradually raise short-term interest rates.
Bond investors already have concluded that tapering is tightening, as they face their worst year since the notorious 1994. Ten-year Treasury rates may top 3% and then gradually move higher. So far, stocks haven't been hurt that much, but that could change. This really is a big deal, but much of the uncertainty already is in the market. Short-term impact: 5. Long-term impact: 9 or 10.
5. Debt limit and government shutdown. Besides dealing with Syria, our hard-working Congress will return from its grueling summer vacation to face another budget crisis centered on, yes, the debt limit. Republicans once again insist that every increase in the debt limit (which covers already allocated expenditures) be paid for dollar for dollar with spending cuts. A new initiative by conservative senators Mike Lee and Ted Cruz would cut off funds for Obamacare.
Late last month, Treasury Secretary Jack Lew wrote House Speaker John Boehner that the U.S. will reach the limit of its borrowing authority in mid-October, and Congress must raise the debt ceiling by then. He also said that was non-negotiable. We'll see, but the tone of the current debate is markedly different than it was two years ago, when political fractiousness caused the U.S. to lose its AAA-rating from Standard & Poor's.
Several top GOP leaders, including Speaker Boehner and House Majority Leader Eric Cantor, have downplayed talk of default and government shutdowns. And Cruz himself acknowledged "we do not have the votes right now” to defund Obamacare. Let me go way out on a limb and predict that a deal will be done by the deadline, even if it just kicks the can down the road a little further. Isn't that what Congress does best?
So, short-term impact 4, long-term impact 1 or 2.
Of all these challenges, the Fed's tapering policy is the only one, I think, that could have a real lasting impact on financial markets. The rest is just noise, which is why long-term investors can safely ignore much of it. Traders, however, will have to earn their money the hard way.