Policy Driven Markets are Treacherous
Volatility in the stock market is rising, intraday swings more violent, and high-to-low ranges increasing. The lurching action of the market is not driven by fundamentals, it’s difficult to profit from, and disconcerting. There isn’t a single item to pinpoint with respect to market angst, rather, a combination of factors, leading to manic sentiment changes. The sweeping issue of late-2015 is the extent to which global financial markets remain policy driven. During the financial crisis and subsequent few years, the degree of governmental and regulatory involvement in the economy and markets was prudent. Letting a crisis flare served no one. However, it’s worrisome that markets are still sooooo policy dependent 7-years into a recovery. One shudders to think what will happen if the economy really slows.
China markets sit at the policy driven extreme, with outright governmental buying (only) of securities, restrictions on the IPO market, restrictions on insider selling, regulation of margin trading, effective elimination of futures trading (because this facilitates shorting) and severe control over the extent of global investor participation. With all this intervention, the domestic Chinese markets are deemed “uninvestible” by most institutional investors. The rest of the world doesn’t want markets to mirror China’s. Unfortunately, monetary policy is driving global markets to an increased degree in late 2015, at a time when policy is supposed to be normalizing. Some observations:
- All year, the Federal Reserve dropped hints on the start of a rate hike cycle. Expectations for a rate hike were premature all year. Shifting of expectations on rate hikes causes investor anxiety.
- Europe’s economy is weak, and not easily achieving escape velocity from its sovereign debt crisis. ECB quantitative easing, and expectations for additional easing, is driving the market.
- The Bank of Japan is openly intervening to purchase/support the stock market.
- China is openly purchasing and supporting its stock market and managing its state run oriented economy.
- Above policy actions influence global currency markets, impacting capital flows and the economic outlook for emerging economies around the world.
The above items are all driving markets. It’s futile to pretend otherwise, but investors do need to accept that policy forces can outweigh fundamentals for an extended period. Fundamentals and valuation will ultimately drive stock returns in the long-run, but heading into 2016, it’s crucial to acknowledge the likelihood for severe moves based on policy, policy expectations, sentiment, and positioning. All these factors will determine the extent of a “year-end rally” (if we get one) and the direction of the market at the start of the new year.
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