August is usually considered a bad month for implementing major changes to investment strategies. With so many traders on holiday and with volumes at seasonally subdued levels, liquidity can be quite patchy. Yet, this time around, there are good reasons why investors may wish to reconsider the conventional wisdom of waiting for the autumn to reposition their portfolios.
The next few months promise to be particularly tricky and volatile for markets, with uncertainty coming from the US, Europe, Japan and the Middle East.
On this topic
- Emerging markets feel the heat
- Editorial Taper tantrums
- Lex Central banks and asset prices
- The Short View BoE guidance fails to convince markets
In the US, the Federal Reserve is expected to signal at its September policy meeting its appetite for tapering its exceptional support for markets and the economy. In deciding whether and by how much to alter its $85bn of monthly purchases of market securities, and in placing greater relative emphasis on forward policy guidance in the policy mix, central bankers may also provide us with greater details on the why. In particular, on the balance between positive reasons (because the economy is improving on a sustainable basis) and negative ones (because of worries about the collateral damage and unintended consequences of prolonged reliance on this experimental monetary policy).
The market implications of the two are quite different, particularly for emerging markets. Having been on the receiving end of significant private capital flows prompted by the Fed’s quantitative easing, these markets require credible signals of solid growth prospects. Otherwise, both the prospect and reality of destabilising capital outflows increase the risks of internal policy slippages and an unbalanced policy mix, a phenomenon that is already evident in some countries.
September may also bring news of the next chairman of the Federal Reserve. With Ben Bernanke expected to step down in January at the end of his second term, markets will carefully assess the scope for policy continuity at the central bank – particularly at a time when investors have repeatedly relied on the “Fed put” to disconnect high asset prices from sluggish fundamentals.
Then there is America’s highly polarised Congress. When they return from their summer recess, lawmakers will be unable to avoid for long two important pieces of legislation: the immediate one required for the continued functioning of the government; and that needed to avoid a technical sovereign default a few months down the road. In both cases, there are already noisy political trade-offs in play; and they have less to do with merit and more with the manoeuvrings of an unusually polarised Congress.
The situation across the Atlantic is also quite uncertain. With German elections in September, and with few wishing to undermine Chancellor Angela Merkel’s likely victory, several national and regional initiatives have been placed on hold. This summer pause has reduced policy disagreements; but at the cost of heavily burdening the autumn policy agenda facing officials who have repeatedly proven reluctant to take prompt decisions absent crisis-like conditions.
This European uncertainty relates to more than discussions on the four legs of a robust eurozone – namely, supplementing monetary union with closer fiscal, banking and political integration. Officials also face politically-complex decisions on three particularly tricky programme reviews (Cyprus, Greece and Portugal). In each case, they need to find ways to increase funding and reduce the burden of debt.
In Japan, delays in unveiling the “third policy arrow” are undermining the policy pivot implemented by the Bank of Japan at the behest of Prime Minister Shinzo Abe. Judging from the recent sell-off in Japanese equities and the behaviour of the currency, markets are already signalling that Japan’s policy experiment will falter if exceptional monetary and fiscal stimulus is not accompanied quickly by structural reforms.
Given also the disproportionate damage to emerging markets, we should expect all this to reignite some tensions at the multilateral level ahead of the September G20 Summit in Russia and the early-October IMF/World Bank annual meetings in Washington.
Then there is the Middle East. The regional effects of the tragic civil war in Syria are now being amplified by developments in Egypt. And while the Egyptian situation is not as dire as Syria’s, it too lacks the institutional and political anchors needed to restore stability quickly.
Wherever you look at it, a long list of uncertainties is building up as the summer comes to an end. And it consists of factors that are not easily resolved by the tepid endogenous healing of the global economy – all of which points to quite a bit of autumn market volatility.
Mohamed El-Erian is chief executive and co-chief investment officer of Pimco