In the aftermath of the Fed's September fiasco, in which Yellen single-handedly cost the Fed years if not decades of carefully scripted "credibility", and more than unleashing a selloff has gotten us to the point where even Tier 1 banks admit that "market participants have started to question the effectiveness of monetary policy, with good reason", we were shocked to learn that at least according to Socgen, the Fed is no longer a major factor driving the market in the fourth quarter.
Here is SocGen's explanation of how the Fed lost credibility.
Monetary policy: central banks take a back seat
Last month, neither the ECB’s threat to expand its QE programme nor the delay in the Fed’s rate hike succeeded in stopping the equity sell-off. Market participants have started to question the effectiveness of monetary policy, with good reason. With still a large debt overhang in many developed economies, further easing is unlikely to boost credit demand significantly from current levels. Moreover, easy financial conditions have led to a growing divergence between modest global growth and frothy valuations. This divergence culminated earlier this year in an S&P 500 P/B ratio at 2.9x (a level last seen on the eve of the Great Recession): a correction was overdue. Although growth is expected to remain solid in developed economies, corporates are now facing external headwinds, against which central banks have limited tools.
We can only hope that SocGen is right and that the Fed will no longer be a driving force for the market, but as everyone knows this is merely a pipe dream. If anything, the Fed - which will not hike rates in 2015 - is merely taking a sabbatical until next year, when it will be forced to decide between either delivering on its promise, or losing all credibility and going straight to NIRP/QE4+.
So if not the Fed then what, according to SocGen, will be the two major drivers behind the stock market in the last quarter of 2015? The answer:
1) China: to remain a headwind into 2016, but...
EM and, especially, commodity-dependent economies have been severely impacted by China’s slowdown this year. With globalisation, developed and emerging economies have become more integrated, thereby raising concerns of spillover effects spreading from EM to DM economies. But, DM economies seem to have been left relatively unscathed so far. This is because DM growth is mainly driven by stronger domestic spending, notably owing to lower commodity prices and better employment prospects. China should continue to weigh on global growth into 2016. But, we expect Chinese activity to stabilise somewhat near term, mostly due to a greater focus on infrastructure investment. Any sign of growth stabilisation in China could alleviate fears of a global recession: watch China’s leading indicators closely in Q4.
And:
2) Earnings: strong divergence between sectors
US EPS growth has been very disappointing this year, with Q3 earnings likely to decline (yoy) for the second quarter in a row. Our Equity Quant team notes that profits growth has never been this weak outside of a recession. Consequently, risk aversion has increased, reinforced by fears of contagion across asset classes and notably the return of idiosyncratic risk in credit. The external headwinds of a strong USD, lower commodity prices and slower global demand should continue to weigh on sectors such as industrials, materials and energy. But, lower oil prices and a healthier job market (with the current soft patch likely to be transitory) are positive for US consumers, as reflected by strong spending data over the past months (+0.4% mom on average). As a result, sectors exposed to US consumption could still report solid EPS growth going forward. The eurozone recovery should also support earnings, allowing the Euro Stoxx to benefit from less demanding valuation levels.
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If SocGen is right then enjoy the last day before Chinese stocks reopen after its week-long holiday. As for earnings season, if today's atrocious announcements by Yum Brands and Adobe are any indication, then not even a "recovering" China, one paradropping billions in debt rescue packages on top of insolvent banks, will be able to offset the acute earnings recession about to unfold.
