Synchronicity out the Window
The first four months of the year were typified by all global markets moving higher in unison. That market action began to change in May as rates started to rise and markets around the world moved toward disconnecting. This was evident Wednesday when the Nikkei dropped 6.5 percent. In a world where all equity asset classes seemingly move together, we would have expected the U.S. markets to rollover on Wednesday as well – but the S&P 500 was only down .8 percent on the day.
This has been the case with several equity asset classes in recent months. While the U.S., Europe and the UK have held up relatively well, Japan, emerging markets and REITs have all sold off rather sharply … for many different reasons. We are not surprised by the pullback in Japan after a 70 percent run up in six months. While we continue to believe in the long-term growth story of emerging markets, they have not been as aggressive on the policy front as their developed brethren. Until we see some accelerating growth in these countries, we would expect them to lag their more developed peers. For REITs, fundamentals remain positive, but they are susceptible to higher interest rates.
Bump and Grind
It is clear that the stock market and interest rates are struggling for direction. The best analogy that we have heard is that “we are riding in a car with a manual transmission driven by a 16-year-old.” Much like trying to find the next gear in an old VW Bug, the U.S. economy is trying to “find its next gear” in the expansion. If we do indeed accomplish finding this next gear and “breakaway speed” for the economy, the Fed will be able to begin to withdraw QE3. This is known as tapering.
This withdrawal of liquidity will have a dampening effect on the markets in the near term. Earnings and economic fundamentals will have to drive the market higher from current levels.
Our Takeaways from the Week
- Stocks around the world continue to disconnect, with the U.S. showing some of the best strength
- Until the U.S. economy shows that it is clearly on its feet, fears of Fed tapering too early will continue to dominate the headlines