April 11, 2012
The F-word is back on Wall Street. No, not that F-word – that one never went away. We mean “fear.”
After a relatively comfortable few months that saw the Standard & Poor’s 500-stock index gain 12 percent, investor worries about the economic outlook in the U.S. and overseas are rising again. Today’s early gains notwithstanding, stocks have pulled back sharply this month, posting five consecutive losing sessions capped by their worst day of the year on Tuesday. The S&P 500 lost 1.7 percent yesterday and the index has slumped more 4.26 percent since last Monday. The Dow Jones industrial average, meanwhile, also sank 1.7 percent, bringing its five day skid to 4.1 percent. The CBOE Volatility Index, also known as the fear index, jumped 10 percent on Tuesday and has shot up a record eight days in a row. It has rocketed 32 percent since March 28. And the yield on 10-year Treasuries dipped back under 2 percent as investors flocked to the safety of U.S. bonds.
Maybe this pullback was bound to happen. After all, the S&P 500’s recent closing high of 1,419.04, reached way back on April 2, represented a 29 percent gain from last October’s lows. Since 1945, severe corrections or mild bear markets have been followed by an average six-month gain of 24 percent and an average 12-month gain of 32 percent, according to Sam Stovall, chief investment strategist at Standard & Poor’s Capital IQ. With the market running that hot, a look at the S&P 500’s 200-day moving average suggested stocks were due for a downturn, Stovall noted in a market report released this week.
Beyond such technical indicators, or valuation metrics or profit-taking, the slump has been the result of a handful of fundamental concerns that have re-emerged -- unpleasant reminders that, despite the recent rally, a number of uncertainties are still clouding the market picture. ”These are the same issues that unsettled investors during 2010 and 201,” writes strategist Ed Yardeni in a note out Wednesday. “They may be getting very stale, but they are back on our plates.”
1. The Fed: The stock market’s losing streak started last Tuesday after the Federal Reserve released the minutes of its March 13 Federal Open Market Committee meeting, which showed that the central bankers saw less need for another round of monetary stimulus. A shocker? No. But investors hooked on Fed-fueled liquidity started experiencing withdrawal pangs anyway. Yardeni says that investors hoping for another round of quantitative easing by the Federal Reserve have adopted a sort of Goldilocks mentality: “The action over the past week suggests that investors want the economy to be weak enough so that the Fed will provide another round of QE, but not too weak. That’s a very strange version of the Goldilocks scenario: Cold, but not too cold.”
2. The U.S. Economy: It wasn’t just the headline number of 120,000 new jobs created in March – the lowest number since October – that disappointed investors. The weakness in Friday’s jobs report extended deeper into the data. As Bank of America Merrill Lynch economists Neil Dutta and Ethan Harris described it: “Softer payroll growth? Check. Shorter work week? Check. Soft earnings? Check.” On top of all that, average hourly wages are up just 2.1 percent over the last 12 months, meaning that workers (read: consumers) may be losing ground when inflation is factored in. Rising gas prices aren’t helping consumers either. The mounting economic pessimism was also reflected in Tuesday’s release of the monthly NFIB Small Business Optimism Index, which slumped 1.8 points to 92.5 in March after six straight months of improving sentiment.
3. Spain, Italy and Portugal...Again: In case anyone had forgotten, the Eurozone’s debt crisis didn’t disappear with last month’s deal to keep Greece afloat and part of the EU. “The reality is that Greece is not ‘fixed’ in any way, Portugal likely will need a new support program next year, and both Spain and Italy are borrowing from the markets at unsustainable rates,” Carl Weinberg, chief economist at High Frequency Trading, wrote in a weekly overview released Tuesday. Investors have been dumping Spanish and Italian bonds, driving rates higher and reigniting concerns that Europe’s most troubled governments won’t be able to finance their debt as austerity measures make growth harder to come by. Right now, “the first worry among investors is that Spain is now under suspicion of being unable to implement budget reforms and reduce its debt ratio,” Weinberg writes today. The effectiveness of Italy’s reforms are also being questioned. And just slightly further out on the horizon, Greece has an election slated for next month, raising the prospect that a new government could renege on the hard-fought bailout deal. “In any case, Greece is unlikely to achieve promised reforms and may fall short of its targets as soon as the August review,” Weinberg writes.
4. China: Beijing last month lowered its GDP growth target to 7.5 percent, and a reading of first-quarter growth is due out on Friday. Economists on average expect the number to come in at around 8.4 percent, down from 8.9 percent for the fourth quarter of 2011. There are already other signs that the Chinese economy is feeling the effects of the slowdown in Europe. China reported a surprising trade surplus of $5.35 billion for March, and while exports for the month rose 8.9 percent over the prior year’s levels, the surplus was also driven by relatively weak growth in imports, which could be a sign of slowing domestic demand. Adding to the concerns, inflation crept up to 3.6 percent in March, up from 3.2 percent in February, according to a report out this week from China's National Bureau of Statistics.
5. Earnings: Alcoa’s Tuesday surprise gave investors reason to hope, or at the very least, reason to take a pause from their pessimism. Still, the outlook for earnings has gotten much bleaker in recent months. On average, analysts now expect the S&P 500 to grow earnings by about 1 percent, a few percentage points less than they had been looking for at the beginning of the year. The questions for investors will be whether companies can beat those lowered expectations, and whether clearing a lowered bar will be enough to produce a real pop.
“On a more fundamental basis, the big concern is that if the U.S. economy stalls during the summer months, as it did over the past two years, then we are doomed to have yet another nasty correction, as we did back then,” Yardeni writes. “Without good news out of the U.S., there isn’t much to get excited about.”