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What could be next for the American stock market?

The January FOMC minutes, Toll Brothers earnings miss, the WalMart memo, awful Europe PMIs, US payroll taxes, China’s housing curbs and Chicken Little’s sky is falling narrative of tight money/quatitative easing exit. The result was the entirely predictable first global synchronised risk aversion hit of 2013.

The grind higher last month was precipitous and replete with performance anxiety/index huggers/don’t fight the Fed nervous long beta chasers. Bull markets are supposed to climb and not pole vault over a wall of money, as happened since November. This means a five per cent correction in the S&P 500 index is not unrealistic at all, as Europe and China indices wilted last week. The index can well trade down to 1,460-1,470.

This does not negate the fundamental foundations of the bull market. Economic growth, the housing recovery, solid earnings, stellar merger/buyout deal flow. Is the stock market cheap now that index earnings estimates are $110? Not really. Yet a market priced at 13.64 current earnings is not expensive and nowhere near comparable to past bull market peaks in 2000 (tech bubble at 28 times) or 2007 (credit bubble at 17 times). As long as the macro and the politics remains benign, the stock market can continue to move higher without flashing a valuation SOS.

So are the January FOMC minutes a game changer for Fed policy? No, though it is now painfully obvious that full-scale QE is not unconditional and Dr Bernanke faces dissent in his own conclave. A ECB central banker’s magic wand triggered a 20 per cent bull run in global equities since July. However, it is no longer credible to assume benign macro in Europe or benign politics in Washington.

One, the US economy could stall due to fiscal austerity. Two, the ECB has removed tail risk but is now de facto tightening monetary policy due to the shrinkage in its balance sheet on LTRO repayments. Three, $117 Brent is a burden on the global economy. Four, US and Chinese politics make economic policy making sub-optimal on occasion. Five, European PMI and gasoline/payrolls make a growth scare possible on both sides of the pond. Five, the credit market leveraging unwind has now begun.

Sure, the Fed could scale back QE but only in response to improved economic growth data. Are there monetary hawks on the FOMC? Yes. Will Ben Bernanke remain Fed Chairman for life? No. Will monetary policy remain easy even if the $85 billion debt purchase is scaled back? Yes. But any scale back in QE3 means the monthly payroll number is well above 250,000.

Gold telegraphed the uglier mood on Wall Street a week ago since a $80 fall meant Fed QE policy was at an inflection point. Yet the Bank of Japan and the Bank of England have scaled up money printing, the reason for the severe decline in the yen and sterling. Yet the fall in gold also demonstrates that higher US dollar interest rates and falling inflation expectations are new realities. Is the Great Rotation as dead and gone as Nineveh and Thebes? No. It has barely begun. The risk is in overleveraged, overcrowded, ridiculously expensive credit markets all over the world, including Middle East debt capital markets.