The book is nearly closed on the first half of 2014, and for stocks in the S&P 500, so far it’s been a very good year.
The broad-based measure of the domestic market has seen a gain of nearly 6% through June 25, and though not nearly as strong as the gains we witnessed in the first half of 2013 (the S&P 500 was up more than 10%), we still have a very respectable bull market in place.
Now the question on so many investors’ minds is, “What will Q3 bring?”
Will we see more of the current slog to new highs (there have been 22 new all-time highs in the S&P so far this year)? Or, will we see the bull trip and fall on the many potholes lining Wall Street, Main Street and even halfway around the world?
Here are five of the biggest stories to watch in Q3, stories that will likely determine if the July-September quarter is a winner for the markets, or whether the red tide of selling is about to wash ashore.
Risk #1: Will Investors Remain Fearless?
Ironically, the success of the markets in 2014 could actually turn out to be one of the biggest risk factors facing a continued market uptrend. The aforementioned spate of new all-time highs in stocks now has many technicians arguing that the market is far too overbought here to continue moving higher. Moreover, there is a lack of fear in stocks right now, which is reflected in the ultra-low levels of the CBOE Volatility Index, or VIX. The VIX now indicates that there is virtually zero fear in the market… and when things get this carefree, that’s usually the time when reality comes back to bite the careless smack dab in the wallet.
Risk #2: Will GDP Growth Shed the Bad Weather?
The GDP growth story in Q1 — or more specifically, the lack of any GDP growth — was explained away due to the horrific weather. January and February saw unusually harsh winter conditions that put much of the country in a deep freeze. Conditions were so bad, in fact, that GDP was revised downward yet again this week, with the new revision showing that the US economy contracted by 2.9% in Q1 for the worst quarterly performance in five years. If there isn’t significant improvement in the Q2 GDP numbers that shows economic growth is back, the reaction could be a definitive decline in the equity markets.
Risk #3: Will Rates Remain Low, Low, Low?
The Fed has spoken, and the path of the central bank now is a known quantity. In its most-recent FOMC meeting, the Fed reduced its bond-buying program by another $10 billion a month. The Fed’s taper decision was accompanied by a confirmation from Chair Janet Yellen that the Fed wouldn’t likely be raising interest rates until well into 2015. Given the sluggish economic growth data, as well as the Fed committed to not raising rates until mid-2015, long-term bond yields (i.e. interest rates) are likely to remain low, low, low in Q3. If this circumstance changes, and if rates spike higher, it could roil traders counting on the continuation of a low-rate tailwind.
Risk #4: Geopolitical Risk and the Iraq Mess
In Q2, the biggest geopolitical risk to markets was the tensions between Russia and the Ukraine. While that situation is far from settled, the headlines have died down significantly. However, what many traders are concerned with right now, particularly those in the oil pits, is the ugly situation in Iraq. Muslim extremists have taken control of many of the biggest cities in the oil-rich country, and if militants can gain control of the oil-production fields in Southern Iraq, it could cause disruption in the approximately 3.3 million barrels of oil that country produces each day. That could result in a big spike in oil prices, and it also could cause a big decline in stocks.
Risk #5: Inflation
When you fill your gas tank or eat just about any food lately, you pay more than you did a few months ago. Forget what the official government line of inflation says, we all know that energy and food prices are much higher now that they have been at any time in recent years. In fact, consumer prices in May witnessed their biggest increase in more than 15 months, with even the Consumer Price Index rising 0.4%, or double the expected 0.2% increase. Over the past 12 months, the CPI has risen 2.1%. If the cost of the things we buy everyday continues to rise, that could take an even bigger bite out of American’s wallets—and that will have bearish ramifications for economic growth, for company bottom lines, and for equity prices.