This week provided a clear picture of what is moving the U.S. equity market. Economic news was almost universally bad. Most distressing to many analysts was the worsening unemployment claims reading. Improvement in the employment picture has been the touchstone of the economic recovery argument. Greece might leave or be forced out of the Eurozone. Europe is sinking further into recession. And China is clearly slowing.
Notwithstanding the growing list of negatives, the S&P 500 improved by 1.3% for the week, with a 3.2% advance coming in the week’s second half. All it took was an unconfirmed rumor that the world’s central banks were planning coordinated action to provide further liquidity following this Sunday’s Greek election. Never before has the fate of stocks so depended upon government support.
While liquidity certainly is a problem with some major banks and countries, the bigger question is whether the issue is really solvency. Central bank action might help current liquidity shortfalls, but it is of dubious value if the issue is insolvency.
The stock market has bounced after each major central bank stimulus action, yet the world economy continues to slow. The law of diminishing returns presents itself as logical. And great danger exist that investor confidence in the effectiveness of central bank rescue actions could wane quickly. If that occurs, investors beware!