Of Kilts, Ballots, Bankers and Dots

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Are we getting to a place where both good news and bad news are pressuring stocks? It sure seems that way. 

Stocks slid and Treasury yields rose as a spate of encouraging economic data fueled fear that the Federal Reserve will raise interest rates sooner. Adding to the anxiety was fear of an historic vote in Scotland and what it might mean for the European Union. 

Last week, I attended our firm’s global Investment Forum in Frankfurt. The Investment Forum is an event held twice year that brings our investment professionals and outside experts together to discuss pressing themes and topics that have implications for investors. Frankfurt, the home of the European Central Bank, proved to be a fitting venue given recent rate cuts and market tumult in the euro zone. 

Without question, the ECB is facing a difficult scenario: it has finally started to increase its accommodation but the euro zone faces stiff headwinds. Looking west from Frankfurt, you can see the potential for Scotland’s secession to derail the United Kingdom’s economic recovery and its support for the EU. Looking east, you can see continued conflict in Ukraine and increased sanctions that threaten to further hurt sentiment in Germany and other European nations. 

Stubborn But Shortsighted

While in Frankfurt, a European colleague explained that the old Scottish word “thrawn” means a stubbornness that can sometimes cause people to act in spite of their own best interests. This feeling of “thrawniness” may be alive and well today, as Scotland prepares to vote on independence later this week. Conventional wisdom suggests that independence would be bad for Scotland, the United Kingdom and the EU. Consider that an independent Scotland risks the loss of companies and jobs. And the United Kingdom is likely to further distance itself from the euro zone because Scotland was arguably the most EU-friendly part. 

Like the conflict in Ukraine, a vote for Scotland’s independence could weigh down sentiment and, ultimately, impact spending. It also could inspire more separatist fervor (think Spain and Catalonia, possibly creating a European version of the Arab Spring.) In other words, a “yes” vote would likely deepen the geopolitical instability in the region, which, in turn, could spark higher volatility in US markets in the coming months. 

But much of the drama last week was actually closer to home, as investors began to grow uneasy ahead of this week’s FOMC meeting. The prevailing buzz is that the FOMC will revise its language and begin communicating the details of future rate hikes. Adding to that concern was fear that the positive consumer data released last week might “alter the dots” and cause Fed rate hikes to begin sooner. In particular, stocks were rattled by strong retail sales in August, and upward revisions to July sales, which suggest we’re finally seeing improvement in consumer spending. File this under “good news is bad news.” 

Comeback in Credit

Meanwhile, July consumer credit rose $26 billion. In addition, June consumer credit numbers were revised up to an $18.8 billion increase. More importantly, the rise in consumer credit was driven by a surprising surge in revolving credit—largely credit-card debt. Keep in mind that growth in revolving credit has been mulishly low throughout the recovery, but an increase in credit-card debt to fund spending is what many market observers believe is a necessary element of an economic recovery. This development could suggest that improving consumer sentiment is finally translating into action. 

In addition, within the non-revolving component, the increase came from auto loans as opposed to student loans. The figures are typically skewed toward the student loan category because many of the numbers can be attributed to government loan purchases from private lenders.) Essentially, even the non-revolving category suggests a rise in consumer credit. 

But it’s not just credit that’s making a comeback. Consumer sentiment is also on an upswing, presumably helped by an improving employment situation, lower gas prices and a rising stock market. However, it’s important to note that this stronger consumer data is unlikely to alter the Fed’s views on when it should begin raising rates. We can’t stress enough that the Fed is looking at a mosaic of economic data as it decides when and how to tighten—and these reports only offer a few data points in this broad picture. 

By focusing on improving consumer data and what it might mean for the Fed’s communication plan and timeline, many investors overlooked the bigger Fed news last week: the creation of a board-level financial stability committee at the Fed. The new committee, which is aimed at monitoring systemic risk, may have a sizable impact on markets in the years to come.

Looking ahead, we must follow the FOMC meeting and Scotland’s vote closely. We worry about what Scotland’s secession might mean for stability in the euro zone. Also, we would welcome a gradual stepping up of hawkish Fed language rather than an abrupt shift to more hawkish language later on, as the latter is more likely to lead to market disruptions. 

Still, we have to stay focused on the bigger picture, which is that the US economy is improving and that Fed policy is likely to involve more regulation going forward. In the short run, however, connecting the dots and counting the ballots should wield significant influence over the stock market.

Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities. 

A Word About Risk: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

Allianz Global Investors Distributors LLC, 1633 Broadway, New York NY, 10019-7585, 1-800-926-4456.


© Allianz Global Investors

© Allianz Global Investors

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