Behind the market tumble

A confluence of developments had the markets trade lower this week.

With the passage of earnings season, we have an overall scenario of modest revenue and earnings growth. In my opinion, the current valuation based on price-to-earnings ratios of the market is neither cheap nor expensive. Outside of market fundamentals, there are several things going on:

  • August is vacation time and market trading volumes are quite low. This tends to create exaggerated market moves.

  • September 18th is the next meeting date of the Federal Reserve where the topic of tapering (a reduction in the $85 billion monthly bond buying program) will be considered. Since May, the Fed has set the table that it will likely do something in September but any move would be dependent on strength in economic data.  As of late, such data has not been robust and odds of a taper appear to be less with today’s decline in long-term rates.  My best guess is that we will still see reduction in bond buying but it will be modest.

  • The unresolved question of who will replace Chairman Bernanke has people concerned for what may happen to Fed policies after he leaves. This is a legitimate concern but I doubt that a new person will want to rock the boat right away.

  • Debt ceiling and government funding will be coming up for debate and decision by our government. This should get resolved but brinksmanship may be part of the scenario again.

  • Lastly and perhaps most important is Syria and a likely military action. Most expect a response focused on specific targets. Despite this, reactions and consequences are the unknowns that the market appears to be concerned with.

The outlook of optimism has changed to an outlook of worry.  Though things are probably going to be choppy over the next couple of months, the fundamental outlook of modest economic growth has not changed in my mind.

Outside of Syria, the list of worries listed above are likely to be addressed over the course of the next couple of months.  I cannot make a call on how Syria will work out but it looks like the markets are starting to assume the worst.  With all this, I think the current combination of fundamentals and expectations looks favorable from a long-term perspective.