Trim Your Portfolio; Danger Ahead!

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As the global economy progresses from the interest-depressing, liquidity-injecting actions of the European Central Bank and Federal Open Market Committee, there will be a pullback in the US equity market for a bulk of the third quarter, if not throughout the remainder of 2012.  At the close of the market on Sept. 28, the S&P 500 had rallied over 12% since June.  However, there are several reasons to doubt the elongation of such a magnificent bull market.

To begin, allow me to address America’s domestic economic adversity.  Despite Bernanke’s best efforts to combat unemployment via quantitative easing, the underlying economy remains weak. At the beginning of September, the ISM reported that manufacturing activity fell for a third consecutive month in August.  The data could have been overcome by the increasing expansion of the service sector if it weren’t for the BLS’ abysmal created-jobs figure of roughly 96,000 (forecasts had been revised down to 141,000 in July).  Consumer spending declined as well, as one might expect. 

Despite the spark of hope the FOMC has provided to the market through its decisions to keep interest rates near 0 through mid-2015 and to purchase $40 billion in mortgage-backed securities per month, it is unlikely that its actions will be sufficient to catalyze a full-blown economic recovery.  Quantitative easing has already, for lack of a better term, failed—twice.  Uncertainty, due largely to the upcoming presidential election and nearing fiscal cliff, is the true source of our economic paralysis.  Families and businesses are hesitant to spend their capital without some level of confidence in our government and economy at large.

At the beginning of 2012, many analysts were lauding companies such as Nike (NYSE: NKE) and Starbucks (NASDAQ: SBUX) that had captured significant market share in Asia.  While that remains a harbinger of long-term growth—due to Asia’s immense populations and increasing consumerism—due to significant macroeconomic tensions, Asian markets cannot be viewed as rectifying the American economy in the short term. 

China’s increasing consumerism has been well reported and speculated.  However, it should not be taken for granted.  After years of promoting manufacturing via depreciative currency manipulation, China’s purchasing power is dramatically short of where it should be.  Accordingly, there will be some growing pains accompanying the transition. 

Nike evidenced this fact with its earnings report earlier this week, reporting that Chinese orders dropped 6% in its fiscal first quarter.  Japan’s government, on the other hand, might “run out of money before the end of October,” according to japantoday.com.  The legislature is split on a bill regarding the sale of 38.3 trillion yen in bonds—more than 40% of this year’s budget.  It goes without saying that this kind of uncertainty reflects negatively on the business environment.

Then, of course, there is Europe; a crisis that stands far from resolution.  As I am sure you are aware, Mario Draghi announced a new program earlier this month in which the ECB would purchase the short-term (up to 3 years) debt of governments with unsustainable borrowing costs.  The program, however, is contingent upon “progress in a certain direction,” according to Italian central bank chief Ignazio Visco.  That direction is fiscal austerity, elements of which become more socio-politically contentious as the debt crisis lingers onward. 

Europe’s periphery—specifically Greece, Italy, and Spain—will inevitably erupt in turmoil once again, as their domestic electorate challenge the culture-clashing austerity measures handed down from the technocrats of the ECB.  Such measures affect more than just policy; they conflict with the “welfare” culture of southern Europe.  The gap in mentality between northern Europe (i.e. Germany) and southern Europe’s is tremendous, and raises continental tensions. 

The bottom line is that the south is economically uncompetitive, forcing capital to flee.  By controlling their borrowing costs, Draghi augments their efforts to be business conducive, but in no way provides an instantaneous repair.  There will be political hiccups that follow, inciting depreciations in the US equity market along the way.  At year’s end, I would predict the S&P 500 to be in near 1,350.


FatNDSquirrels owns shares of Nike. The Motley Fool owns shares of Nike and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Nike and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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