Stocks and other risky assets experienced particularly violent moves last week, and given uneven global growth and the impending tightening of U.S. monetary conditions, I think we are likely to see more turbulence ahead. As I discuss in my weekly commentary, there are two forces driving the volatility.
Uneven Global Growth, Despite U.S. Resilience. As we saw last week, countervailing forces are pulling stocks in opposite directions. Next to more evidence that the U.S. economy is improving, we are seeing several signs of slowing growth outside the United States: weak import/export data from China, multiple downgrades of global oil demand accompanied by a further plunge in prices, more stringent collateral requirements in China and renewed angst over European politics.
This dichotomy between the U.S. and the rest of the world was stark, but economic resilience at home does not mean U.S. assets are immune to the global slowdown. The S&P 500 Index traded down to a five-week low, with energy and technology leading the way down on concerns over global growth. Volatility spiked and reached its highest level since June 2013, consistent with a further widening of credit spreads. The sell-off in high yield has been largely driven by growing concerns over energy issuers.
But the biggest losses were once again in the commodity sector. U.S. benchmark WTI crude slipped below $60/barrel, the lowest level since July 2009. With risky assets selling-off, investors are fleeing to safe havens such as German bunds and U.S Treasuries.
Global politics. Unlike the rest of the world, a fairly quiet year in politics seems to be in store for the United States, with midterm elections over and the presidential election still two years away. Indeed, the U.S. Congress just barely managed to squeeze a funding bill through and avert another government shutdown. However, the political dynamics for many parts of the world are very different. We are seeing global politics reemerge as a key investment driver, be it a risk or potential opportunity.
The risk comes from Europe. Last Monday, Greek Prime Minister Antonis Samaras surprised everyone by moving up the date for a Greek parliamentary vote for a new president. (The first vote will take place on Dec. 17, but the final round does not occur until late in the month.) It is not clear the government can reach the necessary majority to maintain power.
Anxiety over the election and the potential for a new government in Greece less committed to reform is already being felt in asset prices. Not only did Greek assets sink on the news last week, but broader European equities suffered one of their worst weeks in months, reflecting investor concerns that the ramifications would be felt throughout the eurozone.
While European politics represent a risk, Japan's may offer an opportunity. Results from Sunday's election indicate that the ruling LDP party maintained its super-majority in Japan's lower house (The Diet). The strong showing by the LDP party will-in theory give Prime Minister Shinzo Abe the political clout to push through more pro-growth policies, including trimming the corporate tax to 20%, enacting labor market reform, and deregulating the energy and farming sectors. All of these, in our assessment, would further strengthen the case for Japanese stocks.