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VOL. 36 | NO. 24 | Friday, June 15, 2012

Punch and counterpunch

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With baseline sentiment pessimistic, small changes can lead to outsized market movements. To best understand this schizophrenic environment, we must understand the forces at war. I call this the punch-counterpunch dynamic. The opponents are the economic gravitational pull of deleveraging in the developed world versus the helium provided by monetary and fiscal policy makers worldwide. Uncontested news on the deleveraging gravitational pull punches markets lower, riles pessimism, cues action from monetary and fiscal policy makers, who then counterpunch markets higher with programs and proclamations.

THE PUNCHES

USA: Low confidence

Caution fed by losses, pernicious unemployment, rising regulations, uncertain tax policy and lending constraints overrides usual growth impulses. The psychology of the marketplace most closely correlates to changes in the unemployment rate. Anytime employment gains undershoot expectations, markets fall.

Europe: Recession, Euro fragmentation

Poor austerity-directed policy decisions have eviscerated Eurozone growth, decreasing tax receipts and increasing debt burdens. When sovereign credit spreads rise (due to deepening recession risks or political gaffes), the Euro falls, and the markets fall as well.

China: Slowing economy

With the globe dependent upon Chinese economic momentum for lift, any downshift in the Chinese economy is a downshift in global growth expectations. This trend, more than any other, creates investor discomfort. For without Chinese growth, where will our economic propulsion come from? When Chinese data points disappoint, markets fall.

THE COUNTERPUNCHES

U.S.: Fed stimulus, tax cut extension, Romney

Should Bernanke need more power, the Fed can initiate another QE program, set inflation targets, or surprise us. Any stimulus gesture would improve confidence. They are finished targeting the cost of money; now their counterpunches target velocity. Without intervention, the current tax law expiration will cue a recession in Q1 2013. Legislators will certainly counterpunch this “Taxmeggeon” further out. Lastly, polls suggest that the country perceives Romney a more capable steward of the economy, upticks in his election prospects may counterpunch upticks in economic confidence.

Europe: Stimulus, injections, Euro plan

The European Central Bank demonstrated its might when it counterpunched with $1 trillion in bank liquidity last year. Any further actions will provide uplift. Announcements of utilizing European rescue facilities to recapitalize fragile banks would add a haymaker. Any German concessions that result in a credible European master plan might lend a decisive blow.

China: Monetary stimulus, fiscal stimulus

The Chinese fiscal and monetary authorities actually have the capacity for traditional stimulus. The central bank has room to cut rates, and the government has oceans of dry powder to subsidize GDP growth. Stimulus from China equals stimulus for markets.

Perhaps the most recent series of punches will finally knock the S&P 500 out. It’s certainly possible. But based upon the empirical data over the last four years, it isn’t probable. Chin up, the counterpunches may appear clumsy, but they’ve also proven effective.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.

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