If economists, business executives and investors have been sure of one thing this year, it is that uncertainty — over economic policies, political leadership and central-bank actions — is largely to blame for the shambling global economic pace, spotty job growth and serial bouts of anxiety in financial markets.
Like most overplayed market themes, there's a set of plausible facts and resonant conditions at the core of the uncertainty obsession:
- A close and contentious presidential race, with economic philosophies at its core, is about to culminate.
- The "fiscal cliff," in which spending cuts and tax increases of up to $600 billion could be triggered, is just ahead in January.
- China is undertaking a once-a-decade leadership succession as it strains to re-energize economic growth.
- Europe's debt crisis has eased under European Central Bank promises and prescriptions but meets no one's definition of being solved.
But the run of ugly corporate earnings outlooks is almost entirely explainable as a mature profit cycle in a slow-growth, post-crisis world. And it appears the markets themselves have, in general, made a halting peace with the hard-to-predict impending economic-cum-political events that, after all, have been universally anticipated for months.
- Yields on Treasury bonds, which typically drop in tough-to-figure-out periods, have risen substantially since late summer, surrendering some of the "safe harbor" premium built up in the past several months.
- The Bloomberg Euro-Area Financial Conditions Index is near a post-crisis high, as is the domestic Chicago Fed's National Financial Conditions Index.
- U.S. stock-market volatility has been remarkably low in recent months, even including the past week's turbulence and Tuesday's swoon, which has the VIX (VIX) up near 20.
- The S&P 500 Index is riding its longest stretch without at least a 5% weekly dip since 2002 (this could change depending on how the rest of this week plays out).
Economists at Stanford have designed the Economic Policy Uncertainty Index, which draws from media mentions of economic uncertainty, the number of tax provisions set to expire in coming years and the variation in economic-growth forecasts among professional economists.
The index has been elevated all year -- no surprise given the abundance of tax statutes scheduled to sunset in January. Yet the spike in the uncertainty index to 2012 highs in July was mostly driven by its news-coverage component, a circular effect of uncertainty chatter feeding into measured uncertainty. The index has since receded a bit, in sync with the stock market's steady if not quite convincing grind to recent five-year highs.
Ajay Kapur, Asia-markets strategist at Deutsche Bank, ventures we've likely seen the worst of the uncertainty theme, in part because the measured political polarization of the main U.S. governing parties has hit a 130-year peak, based on how infrequently Democrats and Republicans in Congress break with their party in voting. In other words, it's hard to see how it can get worse than a 130-year extreme, and is more likely to give way to at least slightly less polarization in coming Congresses.
Assuming a clear presidential winner Nov. 6, one can at least take a stab at analyzing which fiscal cliff elements will go away and which might be extended. In nearly every scenario, the incentives to forestall an outright gallop over the cliff should be pretty strong. Unlike the 2011 debt-ceiling standoff, which blindsided the markets, the cliff is not so much an either/or choice between cataclysm invited or averted. It likely will involve not a market-seizing shock but a mix of negative yet measurable outcomes that would act as a bigger or smaller economic drag over time.
Europe's Lehman Moment May Have Already Happened
Similarly, investors await the return of palpable financial danger from Europe. Henry McVey, head of the global macro and asset allocation team at Kohlberg Kravis Roberts & Co., remarks he is "constantly struck by the fact that investors keep waiting for a Lehman-type moment in Europe." He ventures the notion that "maybe it has already occurred" in the less-dramatic form of the wealthy EU members forcing investors to take a "haircut" on Greek government debt holdings. The tentative truce in European debt markets among debtors, creditors and investors is only as good as European Central Bank Chairman Mario Draghi's professed resolve to do "whatever it takes" to support stability — but it's at least that good, which is an improvement over a year ago.
One final thought on the policy equation: For most of the past three years, there was a constant debate raging about whether the Fed would follow one asset-purchase, money-conjuring program with another. And if so, when and how big?
Since September, with the Fed's announcement of an indefinite asset-buying campaign totaling $40 billion a month until unemployment is notably lower, this policy argument officially is over. The plan may not work job-creation magic, but it frees investors from having to handicap the Fed's next move for the foreseeable future. Even Tuesday's chatter about Chairman Ben Bernanke not standing for a third term beginning January 2014 underscores the emerging stability in Fed policy: When in recent history has a potential shift in central-banking philosophy 14 months away constituted a daunting level of uncertainty?
Even if it's true the uncertainty bubble is starting to deflate, it doesn't mean stocks are necessarily poised to quickly shake off their earnings-driven woes, or that companies are about to binge on new equipment and staff.
It does mean investors could soon return to the old-fashioned task of determining how this business cycle will play out from here for corporate profits and risk appetites on a company-by-company basis, without the all-consuming focus on a lack of certainty which, like the weather, everyone discusses but no one can do anything about.