Monday, April 11, 2011

Seven Headwinds Confronting the Markets

This list nicely summarizes why I see the market moving sideways for the next bit of time:

1) QE2 is ending on June 30th. The program will, by that time, have pumped $600 billion into the economy, meeting Chairman Bernanke’s stated goal of jump-starting the stock market. The end of the program means a defacto tightening of monetary policy. This has been the major factor holding up both the stock market and a fragile economy that will not be self-sustaining once the Treasury bond purchases are halted. A continuation of quantitative easing is highly unlikely as it would be politically difficult. Furthermore an increasing number of FOMC members are themselves hinting at a possible imminent tightening.

2) Fiscal policy is about to tighten as well. That is obviously what the discussion in Washington is all about. Whether the government temporarily shuts down or not is a non-issue. The fact is that, one way or another, both sides of the debate are now intent on reducing the federal deficit. So, whatever the merits, both fiscal and monetary policy will be less easy. That is a headwind against the economy and stock market

3) A broad array of commodity prices is rising. This is increasing corporate costs at a time when they will be difficult to pass on as consumers are strapped for income and are paying down debt. This is bound to squeeze profit margins in the period ahead and result in downward earnings guidance.

4) The Mid-East turmoil is continuing and showing no signs of lowing down. Although the eventual outcome is unknown, it is doubtful that it will be market-friendly.

5) The European Union (EU) is another major problem. First the authorities tried to build a firewall around Greece, second around Ireland and now around Portugal. These are relatively small economies, and the EU can probably “kick the can down the road” one more time with no real solution in sight. Now they are attempting to build a wall protecting Spain, a nation said to be “too big to fail and too big to rescue”. If Spain follows the lead of Greece, Ireland and Portugal, the results could be catastrophic to the global financial system. In the midst of these events the EU has also raised interest rates, a move they last made in the summer of 2008 just prior to the credit crisis.

6) China is battling against soaring inflation and has increased interest rates four times in the last five months in an attempt to slow down the economy. No financial bubble has ever been stopped without a recession, and we doubt that this will be the first. This would have major ramifications on the global economy including the commodities markets, emerging market suppliers, multinational corporations and the U.S bond market.

7) The Japanese earthquake is yet another headwind to the economy. Toyota is shutting down all of its American factories, and American vehicle manufactures are facing parts shortages as well. According to AutoNation, “production disruptions will significantly impact product availability from Japanese auto manufacturers in the second and third quarters.” We’re hearing about supply disruptions in a number of other industries as well. We won’t be surprised to hear numerous companies comment on this issue when they report first quarter earnings and give guidance for the rest of the year.