Stocks Here Take a Downside Beating on Emerging Market Woes

After meandering around aimlessly for the first half of January, the various stock market indicators took a huge downside tumble starting last Thursday, January 16. The downside that has resulted from this selloff has been so severe in such a short period of time that it qualifies as one of the most vicious and sudden declines in years.

We can read the statistics on this decline and weep, as the Dow Jones Industrial Average has now fallen on 12 of the 17 trading sessions in 2014 (not a very auspicious way to start the month of January!) and was lower by 4.5 percent as of Monday. The S&P has now lost 3.6 percent from last year’s record high close; last week was the worst one for the Dow since November 2011 and its worst two days in three and a half months; the S&P put in its worst weekly performance since June 2012. The Dow Jones Transportation Average had its largest one-day decline on Friday since September 2011 and the S&P fell below its 50-day moving average for the first time since last October 9, which just happened to coincide with the end of that particular market correction, and we should be so lucky this time as well.

In addition to these sharp declines by the major averages, the Russell 2000 Index of small stocks and the Dow Jones Transportation Averages, both of which were star performers in 2013 and had set all-time record highs as recently as last Wednesday, have now undergone setbacks of 4.6 percent and 4.9 percent respectively in the three trading days following those achievements.

What makes these declines more difficult to take is the fact that they have come about just as readings for the U.S. economy are improving as the I.M.F. last week raised its forecast for growth in this country to a rate of 2.8 percent, up from the 1.9 percent pace in 2013. In addition, it is now expected that the E.U. will see their economies expand by 1 percent after two prior years of contraction.

So what happened to cause the recent misery here? It all began on Wednesday night when it was reported that China’s economy, the second largest in the world, is starting to cool off, as the preliminary estimate of their January Purchasing Managers’ Index for manufacturing fell below 50, which is the number that separates expansion from contraction. This was the first such reading below this dividing line in six months and was further evidence that their economy grew by “only” 7.7 percent in the final quarter of 2013, lower than the previous quarter’s 7.8 percent rate. Instead of gaining steadily as it had for the past several years, their G.D.P. has now returned to its 2012 level and the slowest rate of growth since 1999.

This report sent shock waves throughout some of the emerging markets, which had been in their own downside worlds in any event, as they have declined by 10 percent in the past year, the worst such performance since their 15 percent tumble in the historically awful year of 2008. The reason for this spillover effect is that many of these countries supply raw materials such as oil, iron ore and copper to China and any slowdown in the second-largest economy is bound to take its toll on the ones who have such a close connection to it.

As a result, the currencies of some of these countries have suffered tremendously, with the Argentine peso getting devalued against the dollar, the Turkish lira declined to an all-time low against the greenback, the South African rand reached a five-year low versus the dollar and the Ukrainian currency declined sharply as well on the political turmoil taking place in that country.

There has also been the specter of the start of the tapering process by the Federal Reserve, which has reduced the amount of monthly bond buying stimulus by $10 billion, from $85 billion down to $75 billion. At today’s F.O.M.C. meeting it is expected that the central bank will reduce the monthly purchases once again, down to $65 billion a month until the entire program is done away with later in the year. This drawing down of the stimulus programs is the result of the fact that the U.S. economy has exhibited signs of strength on its own and might not be in need of this amount of force-feeding any longer.

Ironically, this is also hurting the emerging market currencies and economies because when rates were moving lower in this country, investors rushed into these other countries seeking higher rates of return than could be obtained here. Now that ostensibly higher interest rates are on the horizon here as the Fed pulls back the stimulus, money flows are returning to the U.S., which has weakened the currencies in those emerging markets. On the other hand, there is some irony to this line of reasoning because yields on the all-important 10-year U.S. Treasury note have fallen to their lowest level in eight weeks, reaching 2.72 percent during last Friday’s stock market plunge on the old “flight to safety” syndrome, and are now actually lower than where they were when the Fed made its tapering announcement in December.

All of this turmoil comes against the backdrop of the fourth-quarter earnings reporting period, which has produced the following results so far: of the 125 S&P companies that have released their numbers, 70 percent have bested profit estimates versus the historical average of 63 percent and 66 percent have come in better on top-line revenue growth as opposed to the 61 percent that traditionally do better. At the present time, it is estimated that profits for the last three months of 2013 will have risen by 6.6 percent while revenues are expected to gain 2.6 percent.

The reason that these earnings have failed to motivate the upside is that forward guidance for the first quarter of 2014 has been skewed to the downside at a negative ratio of 8 to 1, and as a result we have seen important companies such as AAPL, IBM, INTC, JNJ and LMT, among others, get sold off after they beat their earnings projections for the quarter just ended but give weaker than expected guidance for the current quarter. This selling in major stocks has only added to the market’s recent woes.


 

Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media. 

If you have any questions, contact dselkin@nationalsecurities.com.