The Worry Level Rises

Share this article

We are now nearly two months into a remarkable period of time for global stock markets.  The strongest of the developed country economies, Germany, has seen its DAX fall by more than 30% in recent weeks.  China’s Shanghai Composite is down more than 15% from its 2011 high, and it is hard to understand why stocks in the emerging world’s leading country are still down almost 60% from their highs of four years ago. Strong profit growth notwithstanding, do investors in these important markets see something dire ahead?

Major U.S. markets collapsed by almost 20% from late July through early August.  As the graph from the excellent DecisionPoint website demonstrates, prices have soared and dived in six legs since the August 9 bottom. Today the S&P 500 closed on the supportive trend line connecting the lows of August 9, August 22 and September 6.  While today’s close of 1154 marked the lowest of the week, it was marginally above Tuesday’s intra-day low.  The net loss for the week was -1.7% on the S&P 500.

The week ended on a note of great uncertainty with the focus still on Europe.  As leading finance officials met in Marseilles, France, rumors were rife of an imminent Greek default–possibly even this weekend.  Greece denied it, but the bond markets argued that it was inevitable.  One-year Greek notes approached a yield of 100%; the two-year topped 65%; and the ten-year sold at more than 21%.  Nobody expects to collect all that income.

There were rumors that Germany was preparing a plan to rescue at least the German banking system in the event of a Greek default.  Evidence that all was not completely harmonious, however appeared with the sudden resignation of Juergen Stark from the European Central Bank’s Executive Board.  Further rumors had Angela Merkel forcing him out because of his reluctance to approve additional purchases of the bonds of financially endangered countries.  There is no clear plan to calm these turbulent waters.  Should Greece be rescued in some fashion, with appropriate haircuts for its bond prices, it’s hard to imagine that Portugal, Ireland and possibly others would not expect similar treatment should their finances reach a comparable breaking point.  Expectations of contagion would infect world markets.

So we head into the weekend with far more questions than answers.  Yesterday and today investors around the world sold stocks to lessen the risks of what might unfold in the boardrooms of Europe.

Today’s public appearances by leading politicians and bankers all had an upbeat tone.  These officials must try to generate confidence.  They can’t allow the markets to expect the worst, which would promote a self-fulfilling negative feedback loop.  There is real doubt, however, that these officials have much effective and mutually acceptable ammunition left in their possession.  They will certainly attempt to craft a solution that at least defers the pain.  We’ll see if they can succeed.

In the meantime, investors must remain conscious of the dangers of these problems overpowering the available political solutions.  Should investors start to factor in failure, stock prices could fall dramatically.  While contributing to longer-term problems, a rapid price collapse could present an attractive short-to-intermediate-term opportunity for a significant bounce-back rally.  At the very least, the weeks ahead should be exciting.