After June’s solid payroll report, it’s more likely that the Fed will begin to taper its asset purchases sometime this fall. However, investors shouldn’t assume that this will derail the 2013 rally.
Why? As I write in my latest weekly commentary, there’s still little evidence that the US economy is taking off. Recent numbers, including June employment figures, suggest that the US economy will merely continue to slowly improve this year. This means that though yields may overshoot in the near term, they are likely to finish the year around current levels.
But while stocks can sometimes withstand moderate rate increases, as we saw last Friday when they rallied despite a sell-off in bonds, they may not withstand other scenarios.
Here are the three big market risks that I’m most worried about now:
1.) A prolonged and substantial move over 3% in the 10-year yield. While I expect rates to finish the year around current levels, there is the chance that yields will increase more severely then I expect. Higher rates would represent a risk to equities because they would hurt corporate margins, slow the housing recovery and make Treasuries more attractive to yield hungry investors.
2.) Europe. The region still remains a major risk to markets. It’s still mired in a recession, its banking system is fragmented and we’re starting to see more frugality fatigue, especially in Portugal and Greece. In addition, there’s also the chance that we could see a market-unfriendly result in the German elections this fall.
3.) Rising tensions throughout the Middle East. With the recent collapse of the Egyptian government and Syria still mired in a civil war, there is the potential for more unrest in the region and more oil production disruption. As oil prices are already creeping higher, any further disruption in production would likely send them higher still. Increasing gasoline prices would represent a painful headwind for US consumers and the US economy.
To be sure, there are obviously an unlimited number of issues that could derail global and US equity markets. Other market watchers might cite, for instance, the risks of more cracks in the Chinese financial system, escalating tensions with North Korea, a fall budget battle in the United States and an exogenous shock impossible to foresee today.
But at this moment, I’m most worried about the three scenarios I cite above because I feel they are not completely reflected in asset prices. Do you agree that these are the major risks to stocks now? In the comments section below, let me know what market risks worry you most and why.