Published January 30, 2014
With the Dow officially in a pullback – sliding more than 5% from its record high – and turmoil rocking emerging markets, many analysts on Wall Street wonder whether this is the beginning of a steep slide for U.S. equities.
Goldman Sachs' senior investment strategist Abby Joseph Cohen isn’t nervous.
“We think this is the correction,” she said in an interview with FOX Business.
Cohen said the market’s recent skid is attributable to concerns in emerging markets, the continued reduction in the Federal Reserve’s monthly bond buying, and other central banks around the world.
But Cohen said that while the selloff has been substantial, it’s not a sign of more to come.
“When we take a look longer term, later in the year, for example, we see a U.S. economy that’s likely to grow 3% this year, corporate profits which we think will be okay, and the valuation of the U.S. markets is also okay,” she said.
She notes U.S. equities aren’t as attractive to investors as they once were at cheaper levels, but she doesn’t believe the markets are overvalued at their current levels.
To that point, the S&P 500 surged 30% to record highs last year, while corporate profits only climbed 11% on aggregate.
Don’t Fear the Emerging-Market Rout
Emerging markets widely underperformed U.S. equities over the last year as U.S. Treasury rates rose and Wall Street rallied. In the last 12 months, the MSCI emerging markets index fell 5% while the S&P 500 jumped almost 18%.
Issues in the emerging markets have been bubbling to the surface with countries like Argentina, Turkey, and South Africa battling to defend their currencies amid capital outflow.
It’s those issues that have resulted in the selloff spanning the last several sessions in U.S. equity markets. Still, Cohen isn’t too concerned.
“Really several months ago, many investors were recognizing the strongest economic growth was coming from the developed world, and some of the developing economies were facing problems, in large part because the liquidity that they were so dependent on was beginning to change,” she said.
She also noted those effects reached developed markets as well, recalling the “taper tantrum” in the markets before the Fed began trimming its bond-buying program. At that point, investors’ tastes in the kinds of stocks they preferred began to change.
“Not that long ago, many investors just put money into emerging markets without thinking about the specific country or market, and now they’re trying to differentiate. We think this is going to stabilize. We think investors ultimately calm themselves in part because the valuations on these markets and these currencies are reaching more attractive levels,” she said.
When that stabilization does happen she believes money will begin to flow back into the countries with the better growth prospects and ones not facing structural impediments to economic activity and growth.
Easing Off the Fed’s Economic Accelerator
In a rush to save the U.S. economy from collapse after the 2008 crisis, the Federal Reserve began an unprecedented bond-purchase program.
Last month, the central bank announced it would begin scaling back QE3, its third round of long-term asset purchases. On Tuesday, the central bank chopped the rate at which it buys long-term bonds to $65 billion from $75 billion.
Cohen notes a portion of the market's uneasiness over the last month is due in part to the concern the U.S. is in uncharted territory when it comes to exiting this type of easing program.
“There’s not really a mapped course,” she said. “What the Fed has been talking about thus far, and has been implementing thus far, hasn’t really been a tightening, it’s just been providing more liquidity but at a slower pace…(The economy is) still growing, but it’s growing more slowly.”
Cohen believes the Fed, as it made clear in its most recent FOMC statement Wednesday, will be paying attention to facts that are data-dependent, and not making decisions based solely on recent market moves.
“If the U.S. economy is growing well, then it doesn’t need as much liquidity growth. But if the economy isn’t growing so well, for example if the labor market begins to slow again, I think the Fed can be very flexible and can decide to adjust their process on Fed tapering,” she said.
When Government Gets in the Way
Emerging markets and central bank tapering aren’t the only things able to throw a wrench in the market’s seemingly endless climb higher. The U.S. government is also partly to blame.
Last year, investors and the American people saw a very public fight between the nation’s two parties about whether to raise government borrowing authority, or risk default. In the end, after a days-long partial shutdown of the federal government, lawmakers came to the negotiating table and opted to raise the debt ceiling.
But the resolution is short-lived.
The nation is again nearing its maximum borrowing limit, and, according to the U.S. Treasury, will exceed it if the debt ceiling isn’t once again lifted by February 7.
“I think the government, particularly fiscal policy, has been an enormous obstacle to this economic recovery,” Cohen said. “One of the good things about 2014 versus 2013 is it’ll be less of a problem and so it’s the absence of a negative that becomes more of a positive, if you will.”
Cohen noted last year it was fiscal drag – policy that held back economic growth – that tended to weigh on the markets. And it was that uncertainty about the debt ceiling, rising taxes, and the partial shutdown, that caused investors to pay closer attention to decisions made on Capitol Hill.
“These were bad things. Fiscal policy run amuck. Congress, in my view, has not performed as we’d like and we think it’ll be somewhat better,” she said. “There’s a little bit of leeway in terms of the Treasury moving money from one pocket to the other. But the debt ceiling will need to be raised again and I would hope the congress would act in a more responsible fashion this year than last.”