Why markets ignore good news from U.S. to focus on bad news from Europe

October 16, 2014

A trader watches the screen at his terminal on the floor of the New York Stock Exchange in New York

What’s spooking the markets?

One thing we can say for sure is that it is not the slightly weaker-than-expected retail sales that triggered the mayhem on Wall Street on Wednesday morning. Most U.S. economic data have actually been quite strong in the month since Wall Street peaked on Sept. 19.

So to find an economic rationale for the biggest stock-market decline since 2011, we have to consider two other explanations.

The first is the collapse of oil prices, down almost 30 percent since late June in response to Saudi Arabia’s apparent decision to wreck the economics of U.S. shale oil. Falling oil prices are generally beneficial for the world economy — and for most businesses outside the energy sector.  But investors now fleeing from natural-resource stocks will take time to recycle their money into other industries, such as airlines, retailers and auto manufacturers. Until this rotation happens, broad stock-market indices are dragged down by the plunging oil shares, a process visible almost every day in the past two weeks, especially in the last hour of trading.

A trader watches the screen at his terminal on the floor of the New York Stock Exchange in New YorkIf falling oil prices were the main causes of the market setback, it would not be a big problem. There is, however, a far more worrying explanation: Europe. Not just the obvious weakness of the European economy, but the inability or unwillingness of European Union policymakers to agree on a sensible response.

Europe’s economic weakness was already evident several months ago when the Ukrainian crisis and Russian sanctions broke the momentum of German industrial growth, which had been a rare bright spot in the continent’s economic outlook.

But investors and business leaders were not too worried by the prospect of a sanctions-related slowdown in Germany because they assumed that Europe’s politicians and central bankers would respond with stimulative policies similar to the ones that had pulled the U.S. economy out of several “soft patches” in the past five years.  Because of this confidence in policy stimulus, global and U.S. stock markets were able to keep hitting new records in the summer, despite bad news from Europe.

For most of the period since 2008, Europe’s miserable economic performance did not seem to bother investors — as long as the U.S. economy was doing all right. Even at the height of the euro crisis, global stock-market performance has been more influenced by the gyrations of U.S. economic statistics and Federal Reserve policy than by anything happening in Greece, Italy or the European Central Bank.

European Central Bank (ECB) President Mario Draghi looks on at the monthly ECB news conference in FrankfurtIn the past few weeks, however, bad news from Europe seems suddenly to be having far more impact than the generally positive news from the United States, where economic growth is accelerating and expectations of interest rate hikes have been pushed back from next spring to September or beyond.

Why has this happened?

In previous columns, I have explained the lockstep gyrations of the U.S. economy and global stock markets by the demonstration effects of U.S. monetary and fiscal policy. Because the United States pioneered the policy responses to the 2008 economic crisis — quantitative easing, near-zero interest rates and unprecedented budget deficits — investors assumed that the success or failure of these policies in the U.S. economy today would eventually spread to the rest of the world.

When the U.S. economy seemed to be moving toward a sustainable expansion, it seemed reasonable to suppose that the rest of the world would follow, with a lag of a year or two. When, however, U.S. growth suffered an unexpected setback — as it did last winter and in the summers of 2011 and 2012 — investors and businesses would turn pessimistic around the world.

After all, if the United States was unable to pull convincingly out of recession after $3.5 trillion of quantitative easing, five years of near-zero interest rates and budget deficits worth 10 percent of gross domestic product, what hope could there be for other countries implementing half-hearted versions of the same program?

A  traders works on the floor of the New York Stock ExchangeOnce each of these U.S. growth scares turned out to be just a temporary aberration, bullish sentiment returned. Not only on Wall Street, but also in Europe and emerging markets, on the view that if monetary and fiscal stimulus were shown to be working in the U.S. economy, other governments and central banks would eventually follow similar policies and achieve similar results.

Now it appears that this linkage may have broken. The European Central Bank bitterly disappointed investors who had expected the bank to follow the Federal Reserve’s example and announce dramatic monetary measures, combined with a convincing recapitalization of the European banking system, at European Central Bank President Mario Draghi’s press conference on Oct. 2.

The rout in global stock markets began the day after. Meanwhile, the German government has continued to demand immediate spending cuts from France and Italy while hobbling German industries with Russian sanctions — despite the evidence that both its European austerity drive and diplomatic policies were economically damaging and counterproductive.

It has begun to look as if Europe may stubbornly refuse to follow the U.S. roadmap for economic recovery. If that happens, the improving U.S. economy can no longer be treated as a leading indicator of European recovery.

With this, the prospects for the global economy would be much diminished. While the chances of a renewed financial crisis in the euro zone are greatly increased.

Many investors are starting to assume that, even if the U.S. economy moves into a self-sustaining expansion, Europe will condemn itself to permanent stagnation or recession. Then prospects for the world economy, and for globally exposed companies, will be far weaker than expected a few months ago, when Europe looked like it was following the U.S. policy game plan. But will Europe really be so foolish?

The answer should soon be clear. The European Commission will publish its review of the French and Italian budgets on Oct. 29, Ukraine’s election on Oct. 26 will provide an opportunity to start dismantling the self-destructive sanctions and on Nov. 6 the European Central Bank will hold its next policy meeting.

We should therefore know within a month whether Europe will save itself or sabotage the world economy by ignoring U.S. policy lessons. These decisions in Europe will probably determine whether the current market setback turns into a buying opportunity or a 1987-style meltdown.

 

PHOTO (TOP): A trader watches the screen at his terminal on the floor of the New York Stock Exchange in New York, October 15, 2014. REUTERS/Lucas Jackson

PHOTO (INSERT 1): A trader bites his nails as he watches the screen at his terminal on the floor of the New York Stock Exchange in New York, October 15, 2014. REUTERS/Lucas Jackson

PHOTO (INSERT 2): European Central Bank President Mario Draghi looks on at the bank’s monthly news conference in Frankfurt, March 6, 2014. REUTERS/Ralph Orlowski

PHOTO (INSERT 3): A trader works on the floor of the New York Stock Exchange, October 15, 2014.  REUTERS/Brendan McDermid

5 comments

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Wow.. EUROPE-BAD! USA-GOOD! USA-EXAMPLE! EUROPE-STUBBORN! BAD BAD BAD!!

Posted by JohJac | Report as abusive

JohJac: Europe is the land of endowed wealth, royalty and imperialism. The fascist factions in the US would like us to be that too. As we in the US are evermore driven toward the fiefdom state it is europe that is our model. Yes, that is BAD! On the other hand we may or may not be “GOOD!”, for the “Business Plot” remains as a point of discussion and hope amongst our industrial masters.

Posted by brotherkenny4 | Report as abusive

Kaletsky’s silly apologetics for Putin’s destructive antics and the resultant damage he caused to the Russian economyu plus his attempt to paint a rosy picture of the “resolution” of the Ukraine crisis (“Why this Ukraine Ceasefire Will Stick”–what ceasefire?) will not make bad news from Europe go away.

Posted by bluepanther | Report as abusive

Kaletsky’s silly apologetics for Putin’s destructive antics and the resultant damage he caused to the Russian economyu plus his attempt to paint a rosy picture of the “resolution” of the Ukraine crisis (“Why this Ukraine Ceasefire Will Stick”–what ceasefire?) will not make bad news from Europe go away.

Posted by bluepanther | Report as abusive

The USA has done nothing but cook the books on its own econometrics: it has made negative progress in reversing the conditions, policies and practices that led to the recession in the first place. Palaver.

Posted by MArktwain02 | Report as abusive

[…] Neuromarketing Course! Why markets ignore good news from U.S. to focus on bad news from Europe. What’s spooking the […]

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