Don’t be fooled by global stock stumble

August 17, 2009

Don’t blame global stock markets for being skittish. It is August, after all, a month that has spelled trouble in the past two years.

Recall that, a year ago, Fannie Mae and Freddie Mac started wobbling at the precipice while AIG, desperate for cash, began paying junk-like yields in the corporate bond market. A month later, all hell broke loose.

In August 2007, a shutdown in short-term lending markets forced global policy makers to rush in with a flood of liquidity to keep the lifeblood of the financial system from clotting.

So it’s only natural that, this year, sellers are trigger-happy at the slightest whiff of trouble.

Problems surfaced in the United States last week, when a double-whammy of soft retail sales followed by a drop in consumer sentiment reignited worries that for all the good cheer about an emerging recovery, the exhausted American shopper is still unfit to carry the economy.

These concerns carried over into Monday trading in Asia, where they mingled with homegrown worries. In China, a drop-off in direct foreign investment helped fuel a nearly 6 percent decline in the Shanghai stock index and concerns about the Japanese economy helped trim more than 3 percent from the Nikkei.

U.S. stock indices have followed suit, with the S&P 500 off 2.43 percent and the Dow Jones Industrial Average off 2 percent.

Monday was an ugly day, but investors should try to rein in their anxiety about what it means for such big-picture questions as what shape the economic recovery will take. That’s because a battle between bulls and bears, which typically emerges at economic turning points, has taken hold of financial markets — meaning today’s worries about the global economy are likely to morph into tomorrow’s worries about too much stimulus creating dangerous asset bubbles.

It’s a constant tension and one that will continue to push and pull financial markets for some time to come.

“The markets have very selectively reacted to economic data,” says Stephen Stanley, chief economist at RBS. Little more than a week ago, for example, the S&P 500 hit a 10-month high after the U.S. reported “only” 247,000 workers were dropped from payrolls in July.

Given the big run up in risky assets like stocks and corporate debt since March, and last week’s data, it’s not surprising that investors are now worried that the rosier outlooks failed to take into account the growing fixation of the U.S. consumer on savings.

Take price-earnings ratios. Bespoke Investment Group noted last week that the P/E ratio of companies in the S&P 500 climbed to its highest peak since 2004, as earnings failed to keep pace with the optimism that fueled a 50 percent jump in the S&P 500 stock index since March. For earnings to catch up, the consumer will have to shake off worries about high unemployment rates and pitch in with good old-fashioned shopping. So far, that’s looking like a stretch.

So, chalk up the stock declines to correcting what had become overbought conditions and get ready for more choppiness ahead.

This is the messy reality of turning points, not necessarily the foreshadowing of something truly ugly to come. Even if it is August.

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