2. Economic fragility.
The recent data indicate that the domestic economy is growing moderately but steadily, but job growth is weak in quality, retail sales seem to be stalling, automobile sales have essentially flatlined since November 2012, and
housing appears to be pausing
(as measured by lower purchase applications, slowing traffic, reduced order books and rising cancelations).
I challenge anyone (excluding the economic perma-bulls) to say (with confidence) that the U.S. economy is at escape velocity. I don't believe it is self-sustaining without the benefit of continued quantitative easing. As expressed earlier, any further increase in interest rates will be a headwind to growth.
3. The economic prospects for China, the straw that stirs the drink of global growth, are uncertain.
I am not only suspect of publicly stated China growth rates but I am increasingly concerned with the rapid pace of credit growth, which has been increasingly sourced from the more risky and less transparent Chinese shadow banking sector.
China's credit growth relative to its GDP growth has been too rapid, so the country's leadership is committed to slowing credit. This raises the risk of a banking crisis and subpar (5% or less) real economic growth.
This downturn in growth will likely have a systemic financial impact on China's banking industry (which could feed into non-Chinese banks), global economic growth and on the pricing of risk assets. (Note: I would recommend both
recent "Top of Mind" and
in this week's
for lengthier discussions of this issue.)
4. An expected 2013 tapering is likely a policy mistake.
I anticipate a September tapering despite the economy still growing at less than its potential. In listening to the Fed fiesta over the past month, it appears that most Fed members want out of quantitative easing for two basic reasons: 1. It is increasingly clear that QE is having a reduced or more marginal impact on growth; and 2. it is also clear that some feel exiting a $4 trillion balance sheet will be a challenge.
This could be a policy error, especially if consensus and Fed economic projections are wrong-footed, as I think they are. If I am right, investors will begin to see tapering as premature relative to economic activity. Though tapering has been well-telegraphed and should start moderately -- let's say a $15-billion-per-month reduction from $85 billion -- if I have to quantify, I would guess that the S&P falls maybe up to 50 points in anticipation of it.
I recognize that though tapering lies ahead, tightening does not. That said, corrections can occur anytime, despite quantitative easing and despite zero interest rates as far as the eyes can see. Look at the weakness in the
. The hedge fund community's favorite regional stock market is almost 10% off its high despite even more expansive quantitative easing than in the U.S.