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Monday, February 4, 2013

What might derail the market’s rise?

R Sivanithy

ONE question that stock market players must be asking themselves is: When will the party end? Or rather, perhaps, what might cause the party to end?

The most obvious answer, of course, is that all the money printing fails to work, leading to rampant inflation and forcing interest rates upwards. This was what happened in early 1994 when an inflation-wary US Federal Reserve unexpectedly raised its federal funds rate, derailing what was then a happily charging bull market that had, at that point, run non-stop for about five months.

The Fed of today, however, is a different beast altogether. Having contributed to the Great Financial Crisis of 2008 by falling asleep at the regulatory wheel for most of the 10 years leading up to Lehman Brothers' collapse, the US central bank is now bending over backwards to try and redeem itself. So investors needn't worry - interest rates aren't going to rise anytime soon and if anything, the Fed probably isn't done with its money printing yet.

Still, as last week's news of a surprising 2012 fourth-quarter GDP contraction of the US economy shows, things are by no means rosy. Investment firm Neuberger Berman, in a report last week titled "What's Ahead for US Growth", said that the GDP drop appears to validate the opinions expressed in a recent Wall Street Journal poll which found that about 60 per cent of the public continues to think that the country is headed down the wrong track.

However, the firm cited three reasons to be less bearish - the US private sector is in the final stages of deleveraging, and unlike Japan which dragged its feet and therefore suffered from deflation, the US government acted swiftly with its unconventional bond-buying measures, and not least, unlike Japan, US banks cleaned up their balance sheets faster.

US newspaper Barron's, however, asked a pertinent question in its Jan 31 Up And Down Wall Street titled "As Stocks Near Records, Why Does the Fed Act as if Times Are Bad?"

In a nutshell, writer Randall W Forsyth's view is that monetary policy pumps up asset prices more than jobs, obscuring reality about the economy. We tend to agree.

"It might be argued that the disparity between the real economy and the Dow's seemingly inevitable march to 14,000 and beyond its record close of 14,164.53 on Oct 9, 2007 ... can largely be explained by the Fed's monetary policy," wrote Mr Forsyth.

"Money for nothing, and lots of it, provides the wherewithal to bid up asset prices - for those who can take advantage of it. For everybody else, it means higher costs for necessities but not income gains; in other words, a lower standard of living."

Incidentally, the Dow on Friday closed above 14,000, a whisker away (just over one per cent away) from an all-time high. Perhaps not surprisingly, the advance has been led mainly by the banks, the recipients of most of the Fed's "money for nothing".

If US growth really is 50-50, then what about China? In its Feb 1 China Macro Watch, Bank of America-Merrill Lynch (BoA-ML) said that feedback from its global marketing in the past two months suggests that even the die-hard perpetual China bears are believing in a soft landing now.

"Investors are no longer interested in verifying China's green shoots. Instead, they are asking how sustainable the current recovery is and when macro indicators will once again turn negative on the markets as they are considering when to take profit," said the bank.

"In this regard, we have a concise answer. In 2012, macro environment was anemic to asset prices in the first half but turned increasingly supportive in the second half. In 2013, we expect exactly the opposite. Macro environment could remain supportive of asset prices in H1, but will likely turn less supportive or even negative in H2 as GDP/IP/earnings growth slows and inflation rises.''

So if BoA-ML's guess is correct, play the market for the next couple of months but get out before June because China's economic data for the second half will likely be poor.

Sound advice - unless, of course, it all unravels earlier and the US economic numbers start a sustained downturn that even more frantic money printing can't reverse.

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