After a strong 2013, the U.S. stock market was certainly due a breather, and whether the recent 4 percent decline in the S&P 500 is the start of a bona fide correction or simply just a breather remains to be seen.
I have to admit, it’s often easy to justify any market trend while it is occurring. When the market in 2013 marches higher with barely an interruption to the downside (there were a few sub 5 percent reversals), it’s easy to be convinced our economy’s recovery is finally cast in stone. And every time the market corrects, we can always convince ourselves the end is near. This being said, the nature of this decline has me a bit apprehensive.
The uninterrupted climb the market experienced in the fall was doing a great job creating investor complacency, but there’s nothing like a few 200-300 point down days on the Dow to create a collective wake up call. So now we’re awake; the problem is when we pull back the rug, it turns out the world is a bit more of a mess than our late December Santa Claus rally would have had us believe.
The most concerning bit of mess is the ongoing turmoil in a number of emerging market nations. In basic terms, much of the new money supply created by the easy money policies propagated by the central banks in developed nations resulted in massive capital inflows from mature economies to large emerging economies such as India, Brazil and Turkey. Investors took the newly created money supply and explored the world looking for yield and opportunity.
With all these investment dollars flowing in, these economies experienced booms in their financial markets, the value of their currencies and their national prosperity. The problem is capital that flows in quickly and can also flow out quickly.
As the U.S. economy improves and the Fed scales back its quantitative easing program as anticipated, the fast money in these economies is being pulled out causing stock market, real estate market and currency value declines. The result is a perfect storm of crashing asset values, spiking interest rates and inflation. As would can expected, social uproar has been following.
This phenomena is clearly the “cake” in the recent pull back in the U.S. market, the icing if you will is a lackluster earnings season and some serious economic red flags coming out of China (we’ll talk about this later).
All signs point to a strengthening U.S. economy, and earnings while lackluster aren’t dismal by any means. Let’s hope these emerging market nations are not serving as a leading indicator of what could happen elsewhere as easy money programs wind down here. Caution and awareness are prudent right now, because remember, it’s typically the dog you don’t know that ends up being the one that bites.