The events of the past few trading days confirm our contention that equity markets around the world remain overly dependent on the policy whims of central bankers. There is growing concern that extraordinarily accommodative monetary policy has reached the limit of its effectiveness. Last week, stocks hovered near record-highs before falling sharply on Friday amid concerns about less accommodative central bank policy. A major catalyst for the Friday downturn came from Boston Fed President Eric Rosengarten’s comments that waiting too long to increase rates threatens to overheat the U.S. economy and poses risks to financial stability.
In addition to hawkish comments from a Fed President, European Central Bank President Mario Draghi decided to leave the ECB’s current stimulus plan unchanged, disappointing many investors. Defensive stocks, the darlings of the first half of 2016, saw share prices fall further than the S&P 500 on higher rate concerns thanks to the high dividend yields found in these defensive names. In addition, defensive stock valuations appear stretched compared to the broader market and flows are starting to reverse away from some of the most popular dividend-oriented funds.
Just as investors began to settle in for a period of extended volatility, Fed Governor Lael Brainard came to the rescue this morning. Brainard, a voting member of the central bank's policymaking committee, said in a speech that, while economic progress continues, it would be wise for the Fed to keep monetary policy loose. Naturally, markets have rallied sharply on this news and have recouped over half of Friday’s losses at the present moment.
Challenging news flow from around the globe continues to cause investors and traders to seek the comfort of central bank support. In Germany, Chancellor Angela Merkel’s Christian Democratic Union (CDU) went down to defeat in local elections in her home state of Mecklenburg-Vorpommern last Sunday. Merkel’s management of the refugee crisis is blamed for the poor showing. The CDU came in third, trailing the center-left Social Democrats and the anti-immigration Alternative for Deutschland party. Merkel is expected to stand for a fourth term as chancellor in national elections next year, and the poor result in her home state raises questions about her electoral chances.
In South Korea, markets fell on Friday after North Korea conducted its fifth nuclear test. The Kospi benchmark fell 1.1%. The South Korean won dropped 0.9% after the first reports of a test but recovered to close 0.3% lower versus the US dollar, at 1092.6.
Finally, last week’s bankruptcy filing by South Korea’s Hanjin Shipping has left some 500,000 containers of cargo worth approximately $14 billion stranded outside of ports. Hanjin is concerned that its ships could be seized by creditors if they dock. It is feared that crews are running out of food and water. The bankruptcy comes at a delicate time for the global supply chain as retailers gear up for holidays at year-end.