Broker Check

7300 Wealth Connect – 10-16


The summary below is provided for educational purposes only. If you have any thoughts or would like to talk about any other matters, please feel free to contact me.

Modest Volatility, an Election, and a European Bank

The third quarter began on a very uneven footing. The U.K. had just surprised investors by voting to leave the European Union (E.U.), and markets were in the process of digesting an enormous amount of uncertainty and repricing shares in the face of that uncertainty. But hindsight has a way of offering clarity that’s difficult to grasp in the middle of the storm. While markets at home take their longer-term marching orders from profits and profit expectations, shorter term any number of variables such as the surprise vote in the U.K. can influence sentiment.

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC
*Monthly: June 30, 2016 – September 30, 2016

In reality, Brexit led to a two-day selloff in shares (St. Louis Fed Reserve). When cooler heads prevailed, the selloff was quickly followed by new highs for the S&P 500 Index (see Figure 1) and the Dow.

Let me reiterate, when negative geopolitical or global events occur, they can create short-term selling pressures, as we’ve witnessed on several occasions. But if it does not impact the U.S. economic outlook, the event is usually discounted and investors tend to regain their composure.

It’s important to point out that we saw an unusual amount of complacency starting in mid-July. That complacency came to an end in September when talk surfaced of a potential rate increase at the Federal Reserve’s September 21 meeting.

However, this is a very cautious Fed. It’s in no mood to surprise financial markets. While it signaled a rate hike this year is still very much a possibility, the Fed also paired back rate hike expectations in 2017 and 2018 (Federal Reserve Economic Projections).

In other words, those patiently waiting for the day when safe investments will offer a more palatable return may have to wait even longer.

Still, let’s look past Fed policy and review the long-term driver of stocks – profits and profit expectations.

Figure 2 illustrates the earnings recession that began Q3 2015 may extend into the Q3 2016. But it also highlights a forecast of a much better fourth quarter, which has played a significant role in supporting shares.

Too big to fail

Let’s shift gears. Too big to fail isn’t just a topic here at home. It’s something European governments are also grappling with. While U.S. banks have done a much better job of raising capital, the same can’t be said of many of their European counterparts (CNBC, various sources).

At the end of June, the International Monetary Fund called Deutsche Bank (DB $13), Germany’s largest bank by assets and the fourth largest in Europe (, the greatest risk to the global financial system (Wall Street Journal).

Without diving into the weeds, problems continue to bubble just under the surface with a bank that sports assets of just under $2 trillion.

As onerous as bank bailouts can be, Germany may find itself in the unenviable position of having to stand behind its largest bank. One thing we painfully learned from 2008: once confidence evaporates, a bank is in very big trouble.

I suspect this is not a “Lehman moment,” which is a reference to the disorderly 2008 failure of Lehman Brothers and the subsequent financial crisis. Knowing what we know today and knowing what happens when a large institution collapses, it seems hard to imagine that Germany would allow its largest bank to fold. The economic ramifications for Europe’s largest economy would be overwhelmingly negative.

Today, the European Central Bank has the tools to step in. While new E.U. rules limit taxpayer assistance, it’s not prohibited (Financial Times). That’s not to say that additional problems for Deutsche Bank won’t create short-term volatility at home. It could. But a Lehman moment that creates turmoil in Europe seems unlikely.

A barroom brawl

It’s a tongue-in-cheek way of describing the upcoming election, and I would be remiss if I didn’t address what’s going on. That said, I’ll cautiously tiptoe into a minefield of opinions.

So far, there’s been very little volatility inspired by the upcoming vote. In fact, markets reacted favorably to the first debate when a CNN poll suggested Hillary Clinton bested Donald Trump.

Yet, that remark seems to fly in the face of conventional wisdom. Wouldn’t Wall Street prefer a Republican? Aren’t Republicans the party that favors business and investors? Won’t Trump’s tax policies aid business?

Well, Wall Street also favors certainty over uncertainty, and professional investors see continuity with a Clinton win. Trump’s strong rhetoric fuels passions among his supporters, but it also sparks heightened uncertainty among professional investors. And heightened uncertainty can short-term volatility.

It’s analogous to the idiom, “Better the devil you know than the devil you don’t.”

As your financial advisor and financial confidant, it’s my job to view your investments and strategies through a financial lens, and not spout political ideals when it comes to your financial goals. That said, this is not to be viewed as an endorsement of Clinton or Trump.

Longer term, stocks will take their cues from what happens to the economy and corporate profits. Shorter term, many issues can crop up that either fuel an advance or hinder shares, including a presidential election.

In a nutshell, the long-term trajectory of the U.S. economy is positive, as has been the case for over 200 years. While either candidate may implement policies that help or hinder the economy, U.S. fundamentals remain intact.

Warmest Regards,

Christopher J. Carroll, CIMA®
Founder, Portfolio Manager, and Founding Partner


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