Not Fade Away: European Debt Crisis Hits Markets
Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
November 29, 2010
Key points
- Sentiment is getting better: In other words, optimism is waning alongside the market correction.
- Global concerns are taking center stage, notably in the euro-zone.
- Investors shouldn't be complacent, but should heed the more-positive message coming from the US economy.
In my most recent report, I wrote about how when market sentiment stretches too far toward excessive optimism, the market can become more vulnerable to bad news.
Although much of the domestic economic news has been of the good variety, the market has had much to contend with:
- The European debt crisis, lately afflicting Ireland.
- Monetary tightening in China.
- North Korea's artillery attack on its southern neighbor.
- FBI raids on a couple of well-known hedge funds for possible insider trading.
"Wall of worry" comes back
It's not difficult to argue these were sufficient-enough pressures to inflict some damage even if sentiment wasn't stretched. What's been remarkable is the rapidity with which sentiment excesses were pared back along with the correction that, as of this writing, has shaved about 4% off the S&P 500® index.
In my last report, I noted the steep ascent of bullishness as measured by the American Association of Individual Investors poll and why this posed a risk for the market. We quickly saw that risk become a reality. Immediately following that jump to 60% bullishness, though (as you can see in the chart below), we witnessed a sharp 30% drop to only 40% bullishness, a relatively rare decline of that magnitude.
Bullishness Less Excessive
Click to enlarge
Source: American Association of Individual Investors (AAII) and FactSet, as of November 19, 2010.
Typically, after a steep drop in bullishness, the market finds its legs before too long. What it does highlight (and you can see how it's been fairly prevalent since the market's low in March 2009) is that the wall of worry—rising stock prices in the face of negative uncertainties—has come back with a vengeance with any bad news. As long as we don't lose that wall of worry, the market will likely do its contrarian thing and defy the skeptics … though maybe not quite yet.
I'm going to summarize my thoughts on global concerns, but you can also read more from Michelle Gibley both in her Market Insight articles, as well as within our Schwab Market Perspective.
China and North Korea
I've heard from many investors that they're concerned about a boom/bust scenario with all the makings of a classic bubble.
We have a more sanguine view:
- China's latest tightening was of reserve requirements for banks, with the goal of reducing banks' excess reserves that could pour into the financial system and create asset bubbles.
- Bank Credit Analyst's (BCA) China strategists believe there's little risk of a draconian policy tightening given that the cycle started from a very stimulative point.
- China's tightening is also targeted at real-estate speculation and not the overall economy.
- Although commodity inflation is heating up, core inflation in China remains well-contained because higher commodity prices are not feeding into end goods and services.
China will also likely be a key player in eliminating the risk of a second Korean War. In its interest to keep a rash of North Koreans from immigrating into China, the Chinese government has been relatively supportive of the current regime. But the government did call a meeting during the weekend to ease tensions and is rushing to establish some new ground rules for North Korea in the face of global criticism.
European Financial Stability Facility is launched
It doesn't appear the North Korean attack will have lingering implications for the world economy or global stability.
Ireland is a different story and represents yet another of the rolling debt crises afflicting the euro-zone. Apparently, everyone took out their credit cards this weekend. The International Monetary Fund and European Union (EU) put together a $113 billion bailout package for Ireland, representing about 60% of its gross domestic product (GDP).
