this week’s bounce…
The rebound in global equity markets over the past few days does qualify as a technical bounce–that is, a sharp recovery from a steep market decline.
–the S&P 500 had fallen about 10% over the prior two months. And that’s been good performance compared with other national indices
–some economically sensitive stocks had lost a third of their value
–the selloff showed almost no regard for recent earnings performance or for reasonable forward profit prospects
–the decline had been showing climaxing behavior recently, where sellers pushed prices down especially aggressively.
It’s possible that the rebound is merely technical. That is, it could be no more than a statement that markets have fallen too far, too fast, rather a sign of a change in market direction.
…might be something more
The argument that it is rests on several new pieces of macroeconomic information that have appeared over the past week. The most important two come from the EU.
1. German has been maintaining that economic assistance for heavily indebted countries in the EU should come only after they have made substantial economic sacrifices. That’s been its standard position, influenced by memories of the hyperinflation of the Weimar Republic, during economic crises for decades. The debtor countries, on the other hand, want assistance before austerity measures induce deep and long-lasting recessions.
Last last week, Germany blinked. It said it would be willing to negotiate changes to its position.
2. Spain has so far been a model for initiating voluntary reforms to cut excessive spending. Nevertheless, smaller Spanish banks are in terrible shape, because their loan books are stuffed with dud property and construction debt. Madrid has been reluctant to seek a bailout from the “troika” of the EU, IMF and ECB, however. The government fears being tossed out of office because it has told citizens none would be necessary–and because a bailout would come with externally imposed conditions.
Late last week the European Central Bank began to discuss how to achieve a bailout without a new austerity regime coming from outside Spain–which is, after all, doing all the right things anyway. Assistance will come, but in a face-saving way, as soon as this weekend.
3. World stock markets were roiled last Friday by the Labor Department’s Employment Situation report, which showed a second month of lackluster employment gains in the US. The report seems to suggest that the unemployment rate will remain higher than the market had been expecting, and for a longer time. In other words, the US will have, say, 4 million more unemployed workers than normal for a considerable period.
Since then, the Fed has released its latest Beige Book report. It’s a compilation of regional economic conditions made by the Fed’s regional banks. The current Beige Book shows the other side of the employment coin. The 133+ million employed members of the workforce are achieving steady economic growth. Maybe it’s slower than we’d like, but it’s there. The Beige Books portrays the US economy as more solidly grounded than pessimists have assumed.
4. China doesn’t have the sophisticated tools for macroeconomic control of its economy that the US or EU have. It tends to lurch from one economic extreme to another. It has just lowered interest rates by .25%, thereby signaling a major shift in government policy from a contractionary, inflation-fighting stance to stimulating economic activity.
where to from here?
I regard all these developments as positives. But each also has its dark side.
Yes, German appears to finally be coming to the aid of its neighbors in a way it has been reluctant to do before now. But this must mean the festering EU problems have gotten so bad that Berlin sees no other alternative.
The same for Spain.
In China, too, we have to expect some ugly economic numbers to appear before the stimulative effect of lower rates, and looser controls on lending, take effect.
What the issue comes down to is how the discounting mechanism will work in today’s equity markets. In a weak market, participants continue to discount–like Groundhog Day–the same bad current news over and over again. In a strong market, participants look through today’s news and begin to incorporate into prices new, more positive developments that may only appear in corporate earnings in six months or a year.
I think it’s too much to ask to expect that traders who react to news rather than anticipate it will change their stripes overnight. So my best guess–maybe “hope” is a better word–is that the US stock market moves sideways from here for a while, maybe making some upward progress, but with 1270 on the S&P 500 as a floor. If so, performance will be made through good stock and sector selection rather than a strong upward movement in the averages.
In the US context, this will mean betting on the 133 million who are employed rather than the 4 million who aren’t.