Monday, October 8, 2012

November speed bumps

Last week, I wrote that I was willing to give the bull case the benefit of the doubt (see The bull case is still intact) and the equity market's strength late in the week vindicated my view. The market action on Friday was somewhat disappointing for the bulls, as the minor beat on the NFP failed to fully energize stocks for the day. I am becoming more wary of the outlook for stocks as we head into November as there are a couple of important hidden speed bumps for the bulls.

J.C. Parets over at All Star Charts said that investors should beware of the post-election hangover. He quoted Jeff Hirsch of the Stock Traders Almanac, who warned of poor post-election quarterly returns based on historical patterns:

A GOP civil war?
While this is not my base case, I can envisage a scenario where a civil war erupts within the Republican Party that could endanger the fiscal cliff.

Let me explain. Right now, the consensus outlook is that the November election will result in the status quo. Obama retains the White House (as per, the Democrats control the Senate and the Republicans control the House of Representatives.

Before you start writing me about how Romney destroyed Obama in last week's debate, I would point out that Business Insider reported that while the overwhelming opinion was Romney won the debate, he didn't win their hearts. Analysis of Twitter shows people still favored Obama over Romney despite the debate result.
Assuming that we get a status quo electoral result, I believe that the market hasn't considered the possibility that the Republican Party could turn on itself. The GOP has been divided between two wings, the Establishment wing, as exemplified by the likes of George H. W. Bush, the classic East Coast Establishment patrician, and the social conservatives, as exemplified by Sarah Palin and the Tea Party.

You could see the tension develop as the presidential nomination battle developed. The social conservatives lost the nomination, but closed ranks with other Republicans and for the sake of the Party. The implicit message was, "You get your chance to make your mark this time."

What happens if Mitt Romney implodes? Could the social conservatives start to point fingers and try to blame the Establishment wing for the loss and split the GOP? If that happens, the Tea Party and their social conservative allies would make an ideological stand in order to differentiate themselves from the Establishment Republicans and send the country over the fiscal cliff like an innocent bystander.
Mr. Market wouldn't like that at all.

Changing of the guard in China
In addition, there is another important event that occurs two days after the US election - the start of the Party Congress in China that marks the change in leadership. Since China's affairs are so opaque, this is another wildcard as important questions remain unanswered.
  • What is the philosophy of the new leadership?
  • How will they react to the economic slowdown in China?
There are reasons to be cautiously optimistic, but the level of uncertainty is high. Also Sprach Analyst believes that China's economic cycle is divorced from the political cycle:
In terms of economic growth, the notion that the political cycles have something to do with that appears to be just as superstitious. The chart below from Barclays Capital shows the GDP growth and growth in fixed asset investment and the timing of Party Congress.

In terms of GDP growth, there is no evidence at all that growth will pick up in the following year after the Party Congress. In terms of fixed asset investment, growth picked up in the years following the Party Congresses. Because of the pick-up of investments, some believe that the same will happen again next year.
I also wrote last week that the latest data shows a nascent turnaround in Chinese growth (see China dodges a bullet?) which should be of some comfort for the bulls.

To put these risks into perspective, all these musings are highly speculative and I am not one to second guess my models, which is still flashing bullish and forms the basis for my vote in the Ticker Sense blogger survey. Nevertheless, given the sort event risk surrounding in November, I have to allow for the possibility of significant speed bumps in that time period and my inner trader is watching carefully and very concerned.

Be careful and keep your stop losses tight.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

1 comment:

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