A Change of Tenor

by Shawn Narancich, CFA Senior Vice President of Research

Dog Days of Summer

Change at the margin is key to the direction of stock prices, so with the month of August producing its fair share of downside catalysts, investors are left to ponder whether or not a 4 to 5 percent pullback in blue chip stocks has run its course. Weak earnings reports from benchmark retailers Target, Macy’s, and Wal-Mart, heightened geo-political risks in the Middle East, rising U.S. interest rates, and discouraging economic developments in key emerging market countries serve to remind equity owners that a good bull market is never far from a correction. With the Fed now on the cusp of paring back its program of Quantitative Easing (QE) in a month of September that historically hasn’t been so kind to investors, stock prices could experience some additional downside.


It’s an ugly word for investors, and one that is suddenly being used to describe the economies of several key emerging market countries where inflation is rising and economic growth is slowing. In a world of cause and effect, we see an anticipated slowing of U.S. QE producing weaker emerging market currencies (i.e. Indian rupee down 20 percent since May), which in turn threaten higher levels of inflation, as resource dependent countries like India, South Africa, and Indonesia pay more for oil and other U.S. dollar-denominated imports. Compared to developed market economies like the U.S. and Japan, commodity costs are a bigger portion of consumer spending, and thus put the onus on emerging market central banks to raise rates in an effort to quell inflation.

Investors witnessed this phenomenon again this week, when both Brazil and Indonesia raised their benchmark interest rates by half a percentage point, in continuation of a trend toward tighter monetary policy in emerging markets. The objective here is to contract the money supply and produce higher currency values, while at the same time attracting additional investor capital seeking higher interest rates. While higher interest rates tend to reduce economic activity in the short-term, depressed currency values provide a built-in shock absorber for economies because their exports become more attractive to foreign buyers. In a challenging environment for emerging market economies, the stocks have been notable underperformers year-to-date. That said, we continue to favor emerging market equity exposure for these countries’ faster long-term rates of growth that stem from faster population growth and an ascendant middle class consumer.

Taper Light

Anecdotal evidence of weaker retail sales, slower order rates for interest-sensitive capital goods, and below-target levels of inflation serve as the backdrop for next week’s payroll report, the last one before the Fed’s next meeting on September 17th. Consensus believes the Fed will announce a $10 to 20 billion per month reduction in its $85 billion per month QE program, but with housing activity starting to slow because of higher mortgage rates and consumer spending threatened by the tax of higher oil prices, we believe the Fed’s error of action is to taper less rather than more.

Our Takeaways from the Week

  • The near-term tenor of equity markets has deteriorated amid higher interest rates, Middle East turmoil, and emerging market turbulence; nevertheless, we continue to favor equities for their longer-term growth potential
  • Ahead of Labor Day, we wish our clients and friends a safe and enjoyable holiday