The US stock market continues its decline as fears over the stability of European banks continue. Is this the start of an extended decline for US equities, or just a minor hiccup in a rising market?
First, let’s take a look at the bears’ argument for a decline in the market:
Investors have become more and more worried about Europe. Rumors that Greece may leave the Euro, which may cause a run on European banks and potentially destroy the Euro, are everywhere. Gold prices, which have been in a steep decline since March, are starting to rise again. Gold investors are hoping that Europe’s problems will force Federal Banks around the world to provide massive amounts of liquidity to global markets. In addition, doom and gloom investors are buying gold in fear of another global meltdown as they view gold as a safe haven asset.
The fear that Europe’s problems will spread around the world is already having an impact on copper prices. Readers of this blog will remember that the price of copper was one of my themes in my 2012 outlook. The price of copper is viewed as an early indicator of the strength of the global economy as copper is in just about everything electronic we buy.
Lastly, investors are worried about what will happen at the end of the Fed’s current economic stimulation – aka “Operation Twist”. The US stock market has clearly been helped by the past stimulus programs introduced by the Fed. Everytime a stimulus package ends, it seems problems start to arise that may dip the economy back into a recession. As a result, a very distinctive trading pattern has emerged:
All This Bad News May Help The Bulls
Don’t forget this is an election year. The economy is going to be the main topic. If recent polls are an indication, it is more on the mind of voters now than it was in 2007:
As a result, President Obama’s chances of re-election will be closely tied to the strength of the economy on election day. Approval ratings are already closely tracking the ups and downs of the US stock market as investors are becoming worried about Europe’s impact on the global economy.
Luckily for the bulls, the incumbent party has the economic tools at their disposal to help “nudge” the economy in a positive direction before election day. The Fed has already hinted at a future stimulus package, as seen in April’s meeting notes. The meeting notes highlighted the Fed’s concern for slowing momentum in the US economy and stated that additional actions may be needed to keep the recovery going. Even before April’s meeting, analysts were predicting another round of stimulus in 2012 (however, they were hoping it would have started back in March).
Investors should keep an eye on what the Fed says and does. I suspect that if Europe’s problems continue, we will see the Fed jump into action. If the Fed does introduce another round of stimulus, these are the areas to watch:
As of now, it seems that the outcome of the bull-bear argument lies in the hands of Ben Bernanke and the Fed. I have a feeling that we will start to see a much more vocal Bernanke as we get closer to November’s elections. Until then, the US stock market may be stuck in a sideways trading problem as investors wait to see what the Fed will do.
(bull image via http://www.flickr.com/photos/katedahl/152908147/)
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