Wednesday, June 26

Market turmoil has not yet reached.

Market turmoil has not yet reached.
| By Jim Jubak

It may be tempting to try to get out front of the rally that would surely come when recent turmoil simmers down. Problem is, trouble is often followed by more trouble.

Do you buy amid the selling or hang on until the worst is over? Let’s look for advice from warriors of the past.

"Buy on the sound of cannons; sell on the sound of trumpets" is attributed to Nathan Rothschild, who, the story goes, made a fortune on early knowledge of the result of the Battle of Waterloo.

Rothschild supposedly bought when everyone in England thought the battle was lost and prices were deeply depressed, and then sold in the euphoria that followed the Duke of Wellington's victory over the armies of the emperor.

Good advice -- even if the quotation and speaker are in historical dispute. (Rothschild is also credited with the advice to "Buy when there's blood in the streets.")

If you can buy at the moment of maximum doubt or turmoil and when prices have been depressed by the certainty of further chaos, and then sell at the moment of maximum joy, when disaster has been averted and all everyone wants to see is victory, then, yes, without a doubt, you can make a lot of money.

The problem is that the sound of cannons can be followed by the sound of even more cannons. And blood in the streets by even more blood in the streets. It's hard to pick the climax of doubt and turmoil.

In the same way, it's hard to pick the moment when the trumpets are to be trusted. Many the flourish has turned out to be maddeningly premature.

I bring this up because I think we're at one of those moments when we can hear the sound of cannons and when blood (and tear gas) is indeed running in the streets, but when it's hard to tell if we've reached the climax of the barrage.

Jim Jubak

In my opinion, it's still early in the turmoil in global financial markets. The cannons are indeed still increasing their rate of fire.

If your goal is to buy when prices are near their lows because chaos and turmoil have reached a peak, I think it's still early. The trend in many of the world's markets -- yes, probably even in emerging markets, though they have clearly broken downward -- is toward more turmoil.

Let me try to run quickly through the arguments for increasing turmoil in several significant markets. You can decide what the picture is for the global market as a whole.

The United States: I think Ben Bernanke's performance on Wednesday, June 19, has left the markets deeply worried. The Federal Reserve chairman said that the Fed would begin to taper off its $85 billion in monthly purchases of Treasurys and mortgage-backed securities later in 2013. And that it would then gradually reduce its monthly purchases month by month until the Fed ended the buying program completely by mid-2014.

IF, and this is the crucial IF, the strength of the U.S. economy is consistent with projections by the Federal Reserve that put GDP growth at 3% to 3.5% in 2014 and forecast unemployment to drop to as low as 6.5% to 7%.

The market, if I can judge by the selling pressure on June 19 and 20, has taken this as a clear statement that the Fed will begin to taper on that schedule. The problem with that belief -- and with the Fed's policy statement -- is that very few economists working outside the Fed believe in anything like that rate of growth for the economy and jobs in 2014.

The median estimate among economists surveyed by Bloomberg calls for 1.9% growth in 2013 and 2.7% growth in 2014. The U.S. economy hasn't grown by an annual rate above 3% since the four quarters that ended in June 2006. Either the Fed has got this right and just about everyone else has got this wrong, or the Fed is deluded in its optimism.

But anybody who thinks the Fed's June 19 statement puts to rest the debate over when the central bank will taper and by how much is mistaken.

The Fed has left traders and investors in the U.S. wondering whether the Fed's optimistic economic projections are a reflection of the Fed's desire to end quantitative easing as soon as possible or represent an honest appraisal of the U.S. economy.

The Chicago Board of Options Exchange Volatility Index (VIX) has spiked in the last two days, and is now up 53% since May 17. And the market has been set up for further turmoil if economic data in the next quarter or two don't back up the Fed's optimism.

Forecast: More cannon fire likely as the market tries to figure out the data and Fed policy. Hopes that the Fed will be right about growth make U.S. growth stocks a better bet than income stocks and interest-rate-sensitive stocks in the financial and housing sectors.

I'd particularly look for growth stories that aren't dependent on an increase in the rate of growth in the U.S. economy. Companies positioned to benefit from the boom in U.S. energy production come to mind. I'll have some picks on that theme next week in a post on best stocks for the second half.

Brazil: It's tempting to think of the mass protests now rocking Brazil as the sound of cannons -- and therefore a signal to buy -- and the end of the protests as the blare of trumpets -- and a signal to sell.

I think that's a misreading of the extent of troubles in the Brazilian economy. The mass protests in the streets of Brazil's cities were initially touched off by demonstrations against an increase in bus fares in Sao Paulo. But they've now grown into a protest against inflation -- officially 6.5% but far more punishing in crucial categories as food and healthcare -- against bad schools, economic inequality and government corruption.

There would be less anger to fuel these protests if Brazil's economy were growing at the 7.5% rate of 2010, but growth fell to 2.7% in 2011 and then to 0.7% in 2012. The forecast for 2013 has been falling this year and is now down to 2.77% among private economists -- and no one believes the Banco Central do Brasil's official forecast of 3.1% growth.

At the same time as growth has lagged, inflation has kicked up to an annual rate of 6.5% in May. That's at the top of the central bank's inflation range of 4.5% plus or minus two percentage points. Raising interest rates to fight inflation would reduce economic growth, but the central bank doesn't seem to have a choice.

Forecast: The cannon fire gets louder as we move deeper into 2013 and I don't anticipate a drop in volume until we've seen a couple of further interest rate increase from the central bank. I'd look to Brazil's domestic consumer sector after those rate cuts. As tempting as the price of shares of Brazil's banks and exporters are at current levels, I'd still look for further drops in those sectors.

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