- Global indexes uniformly finished Tuesday solidly down, seemingly over three events: weak US consumer confidence, an expiring European Central Bank (ECB) lending facility, and a downward revision to a Chinese leading economic indicator.
- It's also possible banks, hedge funds, and corporations are taking de-risking measures in a window-dressing fashion ahead of quarterly reports.
- It's normal in a correction for the world's woes to seem insurmountable—but that's not confirmation they are.
Given market movements Tuesday, investors might be forgiven for thinking the sky was falling—global indexes uniformly finished the day solidly down. But do the market moves indicate real troubles ahead, or did other factors have a hand in the declines?
Looking at the headlines, it'd seem investors were chiefly concerned over three events: The Conference Board reported US consumer confidence weakened a lot more than expected in June, a European Central Bank (ECB) lending facility with €442 billion (~$542 billion) in loans outstanding is set to expire this Thursday, and a Chinese leading economic indicator for April was revised down to 0.3% from 1.7%.
Those were the headline items, but it's possible other forces are also playing a role in stocks' pullbacks. The second quarter is coming to a close, and for the past few years, quarter-ends have seen weak days for seemingly inexplicable reasons—possibly the results of banks, hedge funds, and corporations taking de-risking measures in a window-dressing fashion ahead of quarterly reports. This would explain the recent large moves in the Treasury market, which have pushed two-year Treasury yields to a record low.
As to consumer confidence, it's always been a coincident (if not lagging) economic indicator. Released at a month's lag, it's pretty reliably tracked with the stock market. If stocks rise a lot in the near term, consumer confidence tends to rise. If stocks fall (as they have just recently), consumer confidence falls. But confidence has been an exceedingly poor forward-looking indicator. Plus, the Conference Board's survey is subjective, not to mention prone to statistical errors. And worries weaker sentiment will lead to a contraction in spending isn't supported by recent retail sales data showing consumers continue to spend. Pullbacks or gains in confidence typically don't portend drastic changes in future consumption behavior.
Second, European banks have known the ECB loans were coming due for a year and should have access to plenty of cash to repay them. Though concerns over a few problem spots here and there could be valid, the eurozone banking sector overall isn't as weak as headlines portray. Euro LIBOR spreads and other measures of European bank risk aren't showing concerns about bank health. Interest rate swaps' rates, which are normally sensitive to worries about credit risk, haven't budged much, with the 2-year swap spread less than 0.01% wider and the 10-year swap unchanged. And though various forms of European debt are getting all the attention, credit conditions worldwide are brightening.
It's very likely the fall in commodities stocks is directly related to the downward revision of Chinese growth, but a slight slowdown in the Chinese economy doesn't mean it can't clock still-strong expansion—it could mean the economy will grow at speeds more comfortable for the Chinese government. (Remember, the Chinese government took robust steps recently to curb the Chinese real estate market and overall lending.) Fundamentally, prospects for the Chinese economy look good: The country is expanding trade with Taiwan and other trade partners, inflation remains relatively tame, and the Chinese middle class keeps broadening and could be helped by a stronger yuan making imports cheaper.
Large swings in the Chinese stock market are to be expected— Emerging Markets generally tend to have more volatile stock markets by nature because they typically carry more perceived risk and are, in fact, narrower and less diversified. But the sizes of the swings don't always correlate to economic activity—and they can swing heavily the other way too. Overall, it's more likely China will continue to grow and demand raw materials as it builds infrastructure to catch up with the developed world—same with other booming Emerging Markets.
The extent of market reactions to perceived bad news today is likely a function of sentiment. But these sentiment-based reactions—typical of a correction—don't reflect existing positive fundamentals, which still point to global economic expansion. It's normal in a correction for the world's woes to seem insurmountable. That's not confirmation they are—that's typical correction psychology. Strong fundamentals globally and overwhelming historic precedent continue to point to a bullish completion to the year. Typically, stocks reward the hardy of spirit—and some patience is definitely required now.