Fundamentals Rock, Market Stumbles

US Equity Strategy

There’s truly nothing that puts a crimp in a 70%, 10-month market rally like a whopping 7% correction (from the January peak). One day, Massachusetts voters deliver a seemingly fatal blow to an unpopular healthcare proposal. The next thing you know, volatility rises precipitously as
the leader of the free world takes another swipe at Wall Street “Fat Cats” (as if an excuse is actually necessary), and China taps on the brakes to prevent an overheated economy.

With the VIX jumping from 17 to 28, up over 60% (trough to peak), investors should take some solace in the fact that the market held up as well as it did. Over the past couple of years, the S&P has moved roughly 1% for every 4% change in the VIX (in the opposite direction, of course). It’s this jump in skittishness that made the selloff feel even worse than it actually was.



Longer-Term Concerns Took Center Stage

Earlier this month, we penned In the Shadows of the Great Recession, our longterm market outlook. The piece forecasts a bleak trajectory for equities once the current cyclical recovery is behind us. More than anything else, Shadows makes the point that the world remains far from normal, with risks at every turn. And while we might follow the same stocks, and track the same numbers that we did before the economy’s near death experience, it just ain’t the same.

Shadows doesn’t highlight recent news headlines such as Bernanke’s conformation. However, it does point out the challenges facing the Fed going forward, including the potential politicization of interest rate decisions. Imagine for a moment that the House was required to vote to raise or lower rates.

The President’s efforts to cap spending will likely be as effective as holding the ketchup on your double-cheeseburger

The piece also doesn’t specifically highlight recent troubles in Greece. However, it does point out the risks associated with budgetary and fiscal problems on a much larger scale — Uncle Sam’s need for debt counseling. While we applaud the President’s stated efforts to place a cap on some costs (while also recommending another stimulus package), at best we think the impact will be like trying to lose weight by holding the ketchup on your double-cheeseburger.
As the chart below highlights, interest on the national debt plus entitlements will surpass 62% of federal spending before the Golub kids ever enter college.

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