Part 1 of 4: Introduction, Overview of the following 3 Parts: The Must-Know Forces Driving Markets Into 2014, The Biggest Questions Facing Investors
The following is a partial summary of the conclusions from the fxempire.com weekly analysts' meeting. We stepped back from our normal weekly focus to form our outlook for the end of 2013 - start of 2014, as part of our preparation for our full forecast for all of 2014. The US government shutdown's data delay set us back about 3 weeks. Here is Part 1 of our 4 part series covering how the bullish and bearish forces align as we finish 2013 and transition into 2014.
To view other parts click on the following links: Part 2, Part 3, Part 4. If your pressed for time, Part 1 and Part 4 are what you need to see now. They provide the overview, summary and conclusions. Then you'll know if you need to read the rest. Part 2 provides details on what's needed to keep markets trending higher, and Part 3 reveals what will send markets plunging.
Although this four part series covers the macro-view outlook for global markets, our focus on US stock indexes here, for a few reasons:
The big 3 US indexes, the S&P 500, Nasdaq, and DJIA together are a good shorthand representation of the rest of the leading global indexes, albeit a bit more bullish than most.
They (and the fundamental themes and events that move them) remain the most influential of all global markets. For example, changes in US stimulus tend to move markets more than those in the EU or Japan due to the sheer size of the figures involved, even if the ECB or Japan make proportionally bigger changes.
Leading global stock indexes are good overall barometers for risk assets in general, such as commodities and the risk currencies. The inverse correlation between risk and safe haven assets means that usually, the indexes work equally well as (reverse) barometers for safe haven assets too, although there are definite exceptions to that rule. Those unfamiliar with the terms risk and safe haven assets (they are not to be taken literally) see here and here for an explanation.
As discussed in depth here, US and European indexes, as well as the indexes of the more developed Asian exchanges such as the Nikkei, Hang Seng, and MSCI Taiwan, all tend to move in the same direction. With the US there are only 3 major indexes, whereas in Europe and Asia there are many more. So it's simpler to use the US equities indexes as a general, albeit imperfect, representative the major global stock indexes.
Although some claim, based on price-to-book measures, international stocks are 30% to 40% cheaper than U.S. stocks, that valuation gap doesn't consider that the European, Japanese, and other equity markets come with additional risks due to deep fundamental flaws in their economies that may or may not be curable without a major crisis or two. The US just has to have a Congress that can make some decisions about who bears the costs of reducing government spending relative to revenues. In other words, it just needs enough Congresspersons willing to risk their careers and disappoint their supporters for the sake of the common good. The rest of the world has deeper challenges that make their markets potentially less indicative of how most global assets are doing (in terms of the total value of assets traded).
- The EU doesn't yet even have the basics features of a durable currency union, like centralized banking supervision or a mechanism for transferring wealth to weaker regions that lack the option of having a separate currency to devalue as a means to spur growth. It still has multiple sovereigns and banking systems with more debt than they can afford to repay. They are being kept liquid, but are insolvent. It has yet to decide whether individual nations are willing to give up essential sovereign powers like supervision over national banks and budgets. Funding nations have yet to accept that they will need to transfer wealth to debtor nations, and debtor nations have yet to accept that such funding will come with conditions by which they must abide. We don't know how much longer that situation can continue. As we wrote in depth here, they'll likely be forced to confront issues they've avoided in the coming months as they prepare for the ECB's bank stress tests and takeover of EU banking supervision.
- Japan's debt/GDP is the highest in the developed world (somewhere well above 200% and the supposed cure is to make it worse in hopes of ultimately raising GDP faster than debt. It has to somehow devalue its currency without causing its sovereign bond rates to spike. Its benchmark 10 year bonds yield about 1%, yet debt service consumes well over a quarter of its budget. So even a doubling of yields to a still modest 2% would bring debt service to over half of its total budget, and so on.
- China is growing robustly, but its financial markets are not yet ready for prime time due to issues with liquidity, regulation and transparency. If that wasn't clear to you, China admitted it by its sweeping reforms recently announced at its November 2012 Third Plenum meeting.
- The other emerging markets are still emerging and taken individually probably too small to present enough contagion threat to be market moving.
Overview Global Market Drivers - For The Coming 3 Years Or More
For the rest of 2013 and into 2014, global markets will continue to be dominated by the following big investment themes:
Overall, slow recovery, restrained and at times reversed, by fear originating from:
- How the US, EU, Japan, and China cope with their ongoing deleveraging: how they distribute the costs and how that influences other economies. For example, as we saw in the summer of 2013, rising US rates from taper fears hurt emerging market asset prices, and the knock-on effects on global bond rates threatened to complicate recovery plans in Japan and the EU.
Expect no resolutions of these issues as policymakers continue to do just enough to avert crisis and continue "kicking the can down the road," while avoiding politically difficult (or impossible) decisions about who pays for reforms and how.
- For example, in the US:
- spending cuts vs. tax increases
- money printing vs. austerity or default
- In the EU: Within each nation, the same issues as the US, but also:
- Funding nations' continuing to bear part of the debtor nations' burdens, and if so, at what price?
- Further integration of EU banking and budgeting needed to both prevent further crisis and fix the current one, and the implied loss of national sovereignty, yes or no?
- China as it continues to grow relatively strongly yet cope with transition from state to market economy.
Global Market Drivers - Near Term, 2013-14
In the nearer term, the key market drivers include:
From the US:
- How to begin a QE taper without causing an interest rate spike that damages both the US and global economy
- Resolving the debt ceiling and budget fight without causing further damage to America's growth, creditworthiness, or Washington's credibility as a government that can make hard decisions in a timely fashion
From the EU:
- The coming ECB bank stress tests, which will likely force the EU to either make some hard decisions about these issues, and if they fail to do so, could risk a new chapter in the EU crisis. See here for details.
- The conflict over how much additional monetary easing to provide and if so, how. Debtor nations will risk inflation and a debased EUR in order to stimulate their economies and fend off deflation risks. Risks of debasing the EUR are not a major concern for funding nations like Germany want to preserve the EUR's value and thus minimize additional stimulus.
From Japan: Disappointment over Abenomics' third arrow and doubts that the BOJ's inflation target will goals can be reached without additional easing.
From China: How it balances between the need to tighten monetary policy in order to fight inflation that is causing increasing social unrest, and the need to keep enough liquidity to keep growth around 7.5%.
The following three parts cover:
Part 2: The Bullish
- Mother Of All Liquidity Rallies, Or, Don't Fight The Fed
- Growth And Earnings: Good Enough To Defuse Bubble Fears
- Stocks Considered Expensive But Not A Bubble, Especially While #1 And #2 Persist
- Year End Data Positive But Doesn't Raise Early Taper Fears, Holiday Shopping Results In Focus
- Technical Picture: Entrenched Long Term Uptrends Keep Bullish Momentum While Above Fundamentals Hold
Part 3 The Bearish
- Taper: Interest Rate Shock, Fears or Actual, Undermine Rally, Recovery
- Stock Valuations: Bubble Fears Rise If Growth, Earnings Data Doesn't
- Higher Risks Exacerbate Valuation Concerns
- Tail Risks From The US, EU, Japan, China, and Emerging Markets
Part 4 Summary And Conclusions
- Summary of the balance of bullish and bearish powers
- The must-watch developments that will shape the year's end for global markets
- Concluding Thoughts: The Biggest Questions
- The Big Common Denominator
- Be Wise - Learn From A Fool: Easy Ways To Avoid A Common Fatal Investor Mistake
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Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.