I am not exactly going out on a limb, but let me say this about the circumstances in Syria: Missile strikes will not be the stock market’s downfall. Granted, the short-term trend toward higher oil prices is a thorn in the paw of consumption; consumer-oriented stocks may struggle a bit. However, the recent momentum in “black gold” is more likely to wane. For that matter, the White House can always counter with the use of U.S. “strategic reserves.”
The real trouble for stock assets? Housing. The move from a 30-year fixed circa 3.4% to 4.8% is responsible for 2 consecutive months of pending home sales declines as well as significant decreases in refinancing and new mortgage origination. Worse yet, home prices are likely to stall, adversely affecting the “wealth effect” that has been the primary driver behind consumer spending habits.
Does it have to go this way? Not at all. The Fed may recognize that it can afford to wait until after the markets absorb a transition to a new chairperson. After all, with the 10-year yield at 2.75%, way beyond what May’s “taper talk” had intended, why rush to make a substantive change?
That said, if investors continue selling income-oriented holdings in anticipation that the Fed will exit (or eventually taper) its bond purchases, there is very little chance that corporate shares will be able to withstand the increased selling pressure. Flat revenue, flat earnings, uneven economic news, debt ceiling debate in Congress — stock prices will have a much more difficult time climbing the proverbial “Wall of Worry” if real estate is stuck in neutral.
It has been nearly 2 years since the broader S&P 500 SPDR Trust (SPY) pulled back more than 10%. SPDR Homebuilders (XHB) can be used to gauge the probability of whether the 23-month rally in stocks will continue or, conversely, whether we will witness a genuine health-restoring correction. If XHB cannot climb above and stay above its 200-day moving average — if it suffers a larger fall from grace — this would likely indicate trouble for the ultra-low interest rate fueled bull. If XHB fails, I would expect SPY to retreat to its 200-day trendline as well. (Yes… that’d take SPY down to the 155 level.)
Perhaps ironically, investors may need to look for their central bank-infused gains elsewhere. Consumer confidence in the Euro-Zone recently hit a 2-year high. Business confidence across manufacturing and service segments in Belgium reached its highest levels since February of 2012. What’s more, the European Central Bank (ECB) is maintaining an ultra-accommodating low rate stance; nobody at the ECB is thinking about tapering rates in the Euro-Zone.
The Euro-Zone is hardly out of the woods. Each of the economies for the PIGS (i.e., Portugal, Italy, Greece and Spain) is still shrinking. And record levels of unemployment rarely translate into increased spending. Moreover, if the U.S. Fed does travel the tapering path of slowing down its purchases of U.S. bonds, we may see Spanish and Italian yields climb back to unsustainable levels. Once more, the sovereign debt crisis abroad could come back to haunt.
Nevertheless, there’s evidence to suggest that the performance of foreign developed markets (e.g., United Kingdom, Europe, etc.) relative to the U.S. have bottomed. Both the iShares United Kingdom (EWU):SPDR S&P 500 Trust (SPY) price ratio as well as the WisdomTree Hedged Europe Equity (HEDJ):SPDR S&P 500 Trust (SPY) price ratio favor the increasing relative strength of EWU and HEDJ.
Keep in mind, the key will still be U.S. housing. If XHB cannot climb back above and stay above its long-term moving average (200-day), stock assets clear across developed and undeveloped markets are likely to suffer. Make sure that you have stop-limit loss orders on existing risk assets. If you’re looking to put cash to work, consider increments where you might make a purchase when the S&P 500 is 5%, 7.5%, 10% and/or 12.5% off an all-time record.
Gary Gordon is president of Pacific Park Financial, Inc.