INVESTING
AUGUST 7, 2011.
A World of Worries: Markets Fall, New Recession Feared
By DAVE KANSAS
So much for that summer vacation.
Concerns about global economic growth, the sovereign debt crisis in Europe and the budget fracas in the U.S. all coalesced last week into a fierce storm that drove the Dow Jones Industrial Average to its biggest loss in nearly two years.
On Thursday, the Dow skidded 512.76, or 4.3%, to 11383.68, wiping out the year's gains. The drop punctuated two weeks of terrible trading, with the Dow falling nearly 11% from its April 29 high, placing the blue-chip measure firmly in "correction" territory and threatening a new bear market -- a 20% drop.
Volume soared on Thursday as usually sleepy August trading turned chaotic. Nearly 14 billion shares changed hands -- almost double the year's daily average. The Chicago Board of Exchange Market Volatility Index, or VIX, a measure of fear, rose a whopping 35% to its highest level since June 2010. It was the busiest options trading day in history.
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U.S. Bonds, Gold
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Frightened investors scrambled into Treasurys and gold to find safety amid the carnage. At certain points Thursday, short-term Treasurys traded at negative yields, meaning buyers had to pay for the privilege of owning the super-safe assets. The yield on the benchmark 10-year Treasury slid to 2.3%, its lowest level since the height of the financial crisis.
So much money poured into cash accounts that Bank of New York Mellon said it would start charging big depositors -- a stark reversal of paying interest on deposits. And globally, $70 billion fled money-market funds, according to Bank of America Merrill Lynch. It was the biggest such outflow since Lehman Brothers collapsed in September 2008.
"A return to recession obsession has gripped the financial markets," says Jim Paulsen, chief investment strategist at Wells Capital Management. "Angst surrounding the U.S. government debt ceiling, intensifying stress in the never-ending European crisis, a significant downward revision of real GDP growth for the first half of this year and a large drop in the July ISM manufacturing survey have combined to reignite U.S. recession fears."
Those fears eased a small bit Friday after the July employment report showed a better-than-expected 117,000 jobs added. But the day still had enough swings to qualify as a carnival ride. After rallying on the jobs news, stocks swiftly sold off, only to rebound late in the day on hopes that Italy and the European Central Bank had hatched a plan to solve Italy's fiscal crisis.
The Dow traded in a 400-point range during the day as bears and bulls battled for control of the tape. The bulls ultimately carried the day, with the Dow gaining 60.93 points, or 0.5%, to 11444.61. But it felt like a slugfest with both sides exhausted and warily eyeing the coming week.
Darker Mood
Even with Friday's gains, the pummeling of the past two weeks has darkened the mood on Wall Street. And the rally, once again, stemmed more from policy intervention than from a fundamental shift in the outlook.
Economic concerns have risen in the past two months, and chatter of a possible return to recession has intensified. There's a gnawing sense that without extensive government action, the economy won't get on track. While Friday's jobs news beat expectations, in absolute terms it wasn't great. A broader measure of unemployment, which captures part-time and underemployed workers, came in at 16.7%. Nearly half of workers unable to find jobs have been looking for more than six months.
The jobs picture connects to the other major faltering portion of the economy: housing. Without a job, acquiring a home is extremely difficult. Home values continue to drop and home sales are at historically low levels.
Banks, lugging lots of troubled mortgages and owning a raft of foreclosed homes, are finding the going particularly tough. The financial sector of the Standard & Poor's 500-stock index slid more than 8% last week and is down 15% year-to-date, making it the worst of 10 sectors in the index. The S&P 500 is down 4% for the year.
The economic malaise coincides with rising concerns about the ability of Washington to act in a cohesive, decisive manner. The raucous debt-ceiling debate ended with a deal that would permit more borrowing. But the results of the deal remain murky.
Some fear that moves to cut spending will harm the economy. Others feel that the spending cuts won't effectively address America's growing debt pile, sowing the seeds for bigger problems. In short, the U.S. debt situation has become an increasingly thorny problem -- all the more after Standard & Poor's downgraded the government's credit rating late Friday.
Concerns about the U.S. economy and debt situation are compounded by the problems in Europe. For more than a year, European policymakers have struggled to solve Greece's debt crisis. But those attempts haven't worked or mollified markets.
In the past two weeks, much bigger economies, notably Spain and Italy, have come under fire for their own fiscal problems. Given the difficulties Europe has had dealing with tiny Greece, the prospect of tackling Spain or Italy raises existential questions about the future of the common currency. Most of the darkest global market scenarios include a forced dismantling of the euro.
Currency Moves
On top of the fiscal crises, nations are intervening in the foreign-exchange market in a fight to keep their currencies from appreciating. Such interventions are rare, but in the past week both Switzerland and Japan made moves to tamp down their own currencies.
In the markets, investors have shifted into defensive mode. Consumer staples, such as Procter & Gamble, Coca-Cola and Kraft have held up better than consumer discretionary companies such as General Motors, Whirlpool and Goodyear Tire.
With Treasurys paying rock-bottom yields, big dividend payers are in vogue. Pharmaceutical companies like Pfizer and Merck, utilities like Southern Co. and American Electric Power, and telecommunications companies AT&T and Verizon Wireless have all outperformed the broader market in the past week, though they, too, got dinged in the selloff.
Investors hunting for safety have also returned to highly rated municipal bonds. The iShares SP National AMT Free Muni Bond ETF has risen to its highest levels since November.
And, of course, safety hunters have continued to embrace gold. The precious metal has gained 7% since April as stocks have tumbled.
After the past two weeks, divisions among market experts have sharpened. Jack Ablin, chief investment officer at Harris Private Bank in Chicago, told clients Friday morning that it was time to back away from the stock market. "We are reducing our portfolio risk across strategies," he wrote. "Thursday's move pushed us below our breakdown band, prompting risk reduction."
Others think the selling stampede has created opportunities to get into the stock market, ultimately seeing the downdraft as driven more by fear than fundamentals.
"Two weeks ago, we did not think that stocks were expensive," said BlackRock strategist Bob Doll. "Now, with markets lower by 10%, stocks are pricing in a more negative scenario than we expect. To us, this suggests that the present market could represent an opportunity to accelerate moves out of cash and Treasurys and into risk assets."
Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved
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