Global Market Commentary

October 24, 2013

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Government Dysfunction Was Not Effective in Putting Much Fear in the Markets. Here’s Why.

The investing world has gotten tired; it is especially tired of crisis. It is tired of financial TV’s network anchors babbling on about how bad the debt limit fight would be, about the looming disaster when the U.S. can’t pay its debt, about the inevitable endless political gridlock in Washington shutting down the government… and so on.

U.S. Stock Market Participants

The market, after seeing several years of similar political fights, decided simply to ignore them this time. The S&P 500 fell 4 to 5 percent while the debate and voting was going on, and then headed straight up to new highs this week. Doing even better than the S&P have been the mid- and smaller-sized stocks, which have risen even more rapidly.

During the political bickering of 2011, the S&P 500 fell by about 21 percent, and in the 2012 fiscal fight caused the market to fall by about 8 percent.

So this time, why didn’t we get the big pullback? The stock market ignored the circus.

What Was Different This Time?

1. The major trauma of the banking-system crisis of 2007 to 2009 in the U.S., and the banking crisis of 2010 to 2011 in Europe, are becoming more distant memories. The fear created by those traumas is gradually abating in the minds of corporate executives and investors.

2. Investing is greatly influenced by psychology. Investors are concerned with the expansion of corporate profits, banking stability, political coherence or the lack of it, etc. But they are also psychologically affected by events. They are asking themselves about each of their investments: will their company, its industry, and the overall economic performance of the nation, be better than or worse than expectations?

For market observers, the most important investing variable has always been corporate profits. Today, corporate profits are growing, and they appear poised to continue to grow in the future. Why are they growing? One major reason is that corporate boards of directors are no longer dwelling on the meltdown of 2008 that continued to shape their strategy from 2009 to 2012. They have begun to authorize spending on new capital investment.

These investments will lead to expansion of plant and equipment, more research and development spending, and the expansion of job availability. Boards are authorizing these capital expenditures so that profits will grow in the future. The visibility of rising corporate profits is the second reason for the stock market’s current resilience.

3. Thirdly, investors saw that the 2011 and 2012 pullbacks on political issues were temporary. In hindsight, they see now that in both years, market pessimism was an overreaction — the markets bounced back each time after the political battles ended. In 2013, we saw that investors were determined not to repeat that mistake.

S & P 500 Index: Jan 2012 Through Oct 2013

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Source: Bloomberg

 

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