Investor Alert: Ready for Another Summer Swoon?

Investor Alert: Ready for Another Summer Swoon?

Getty Images, iStockphoto, TFT

The economic numbers released late last week were downright ugly. First-quarter GDP growth at 1.9 percent wasn’t quite as robust as everyone had assumed. A mere 69,000 jobs were created in May, the lowest level seen in the last year, and April’s job creation numbers were revised downward. The unemployment rate – which already understates the real level of unemployment by excluding those disappointed workers who are no longer searching for jobs – edged back up to 8.2 percent. And the weakness isn’t confined to one or two industries, but is seen across the board. Those people who still do have jobs are seeing their employers cut back on the number of hours they work – an early warning signal that those employers are worried about an actual or potential falloff in customer orders or demand.

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Unsurprisingly, those unpleasant job numbers were the last straw for stock market investors, whose nerves were badly rattled throughout May by everything from JPMorgan Chase’s (JPM) trading loss and the bungled Facebook (FB) IPO to the steady stream of bad news coming from Europe. The Dow Jones Industrial Average sank 275 points, or 2.22 percent, relinquishing what was left of its gains for the year. The index is now down 0.81 percent in 2012, while the S&P 500 remains up just 1.63 percent. The yield on 10-year Treasuries hit a record low below 1.5 percent.

Is a double-dip recession brewing? Is the American century at an end? The prophets of doom are taking to the airwaves, to be sure, arguing that everything from our own spending habits to the paralysis among our politicians unable to come to grips with the government’s debt problems all doom us to years of economic trouble and strife.

That may be an overly melodramatic view of the situation, but the truth is that we’re facing, for the first time, the downside of what it means to be part of a global economy. Up until now, it has been our own problems that have caused us to struggle economically and slip into recession – whether it’s irrational lending practices by banks or irrational exuberance with respect to fledgling dotcom companies’ growth prospects. We have tended to slip into recession first, and when we sneezed, the rest of the world came down with a cold or even pneumonia. Now, instead of the United States pulling the rest of the world into a recession, we are finding that we can’t immunize ourselves from problems in other parts of the world any more. We’re part of a global economy, and that global economy is struggling, too, perhaps even more than is the U.S. economy.

Take Brazil, for instance, which on Friday reported some very worrying economic numbers: The country’s GDP grew only 0.2 percent in the first quarter, not the 0.5 percent that economists had expected, despite a series of hefty interest rate cuts that began last summer. Industrial production there has stalled. India’s growth rate has been cut nearly in half as its manufacturing sector contracts. Even China is focused more on making sure its landing is a soft one that doesn’t ignite social and political strife than on fulfilling what some once imagined might be its role – to buoy the global economy when developed markets in North America and Europe stalled.

RELATED: World Growth at Risk as U.S. Employment Stumbles

And speaking of Europe…. Every time a new poll indicates Greek voters appear likely to cast their ballots in favor of Syriza, the anti-austerity group, whose election may well precipitate Greece’s departure from the Eurozone, shudders run throughout the continent and spread overseas. Earlier this week, a new wave of panic was sparked by the sudden resignation of Spain’s central bank honcho, whose comments on departing his post a month ahead of schedule seemed to indicate that no one yet has a firm idea of the magnitude of the problem loans on the books of troubled Spanish banks – and that there’s no obvious strategy for fixing those banks. In combination with what during a more “normal” environment might be seen as merely lackluster domestic economic data, those European events have spelled the difference between a mild retreat and a major selloff on the part of U.S. investors.

We can’t shield ourselves from what is happening in Europe when it comes to our economy, any more than we can protect financial markets from the impact of panicky over-reaction on the part of traders and investors desperate to dump assets that they view as too risky and flee to the safe haven offered by U.S. and German bonds and a tiny handful of other assets. We’re seeing the downside of the globalized system that we have encouraged and profited from over the last 25 years, without wondering what might happen when problems within the global economy were so significant that buyers for General Electric’s (GE) turbines or Boeing’s (BA) aircraft might pull back. We’re not seeing that happening yet, of course, but it’s the prospect that it can – and the reality that U.S. consumers, on their own, can’t fill any gap in demand that is created – that is at the root of the fear that has gripped U.S. financial markets.

Anyone looking for clarity in this kind of environment will seek it in vain. True, Goldman Sachs (GS) believes that this is a once-in-a-lifetime buying opportunity for stocks, given the gap that has emerged as real bond yields have plunged and the MSCI world earnings yield (calculated by taking the inverse of the forward price/earnings ratio for the index) has risen. The equity risk premium – a measure of the excess return that stocks offer investors above the ‘risk free’ return on bonds, as compensation for the additional risk they take – now is more than double its long term average. But against a background of fear and uncertainty, investors simply don’t behave rationally, as one academic study after another has proved and as current market events demonstrate.

A few months of subpar employment gains don’t radically alter the picture of the jobs market – after all, investors spent most of the first quarter cheerfully ignoring the warnings signs that the rate of long-term unemployment offered. It may not be rational to react to the upward jump in the unemployment rate to 8.2 percent by fleeing into the bond market, where yields on the 10-year bond are already at 60-year lows and where all too soon investors will end up paying the Treasury (in inflation-adjusted terms) for the privilege of keeping their money safe. But that doesn’t mean that anxious investors will stop doing so any time soon.

The headlines – whether they revolve around economic data at home or the dramatic events unfolding in Europe – will continue to drive investor sentiment, and thus investors’ decisions, for the foreseeable future. So we might as well brace ourselves for a hot, humid and ugly summer.