Friday's volatility added to stocks having the worst week of 2010, mostly tied to PIIGS jitters, though economic news continues to be positive.
Thursday's UK elections failed to create a buzz, or an outright winner.
A weak showing from the Liberal Democrats was a surprise.
Though both Labour and Conservatives want to form an alliance with the minority Lib-Dems, a likely outcome will be a Conservative/Lib-Dems coalition.
A down Friday capped the worst week for stocks in 2010 thus far, as markets entered correction territory. Setting aside what many view as a series of trading glitches on Thursday (and some exchanges have even reversed trades they saw as erroneous), most market action this week was likely tied to continued PIIGS jitters. However, on Friday, Germany finally agreed to the Greek bailout—alleviating one source of concern that's likely been weighing on stocks lately. Even Spain—one of the maligned PIIGS—posted positive GDP growth for the first time in seven quarters, and Portugal and Spain had oversubscribed debt auctions at unremarkable rates.
In fact, economic news has been overwhelmingly positive and continues to be. German industrial production smashed estimates, Canadian unemployment fell 10 bps to 8.1%, a net change quadrupling expectations. In the US, payrolls climbed 290,000, beating forecasts and signaling job growth. The Fed's mid-day consumer credit report showed a consumer credit increase of $2.0 billion in March, beating expectations for a $3.7 billion decline. The nature of a correction is its driven by sentiment, not fundamentals, and that's likely what we're experiencing now. However, eventually, at some unpredictable time likely not too far off, the market should return to focusing on fundamentals that underscore evidence of continued global recovery.
Meanwhile, almost lost in the shuffle was Britain's PM battle. Though the Conservatives, led by David Cameron, won more seats than existing Prime Minister Gordon Brown's Labour party, they fell short of a majority. Without a clear majority winner, UK is left with a hung Parliament—a very rare outcome in British politics, last occurring in 1974 when voters were back at the polls within months.
Perhaps the biggest surprise was a weak showing for the Liberal Democrats led by Nick Clegg, who failed to capitalize on his popularity after the first-ever televised national debate, as his party lost seats—which mostly accrued to the Conservatives. Had Labour or the Lib–Dems produced a stronger result, an alliance between the two parties would have been possible. Now, such a coalition would fall short of the 326 seats needed for a majority, and the only way Labour stays in power is by rounding up the Nationalists and other "fringe" parties along with the Lib-Dems—possible, but unlikely. Despite the surprisingly weak Lib-Dem performance, the most likely outcome might still be what everyone expected—a Conservative/ Lib-Dems coalition.
One thing is clear—in a push for power, both Brown and Cameron want to appear to be working in the national interest and both have expressed their desire to form a coalition government (reminiscent of Obama's bipartisan approach during his campaign). Cameron plans to offer the Liberal Democrats a "big, open, and comprehensive" offer to garner support for what will be a politically difficult fiscal consolidation in the coming years. In return for their support of his fiscal policies, he's expected to make concessions on electoral reform and immigration.
If no decision is reached (which is unlikely), the Queen can intervene. Theoretically, she could call for another election. However, in our view, the most likely scenario is a Conservative/ Liberal Democrats coalition, with David Cameron moving into 10 Downing Street—though, anything could certainly happen.
The mere fact a brewing battle for Prime Ministership in one of the developed world's largest economies barely registered with investors today tells us there's far more sentiment driving recent market action than fundamentals. And, fortunately, sentiment is fleeting. While near-term volatility can be painful, it's typically most prudent to turn a hard shoulder to it and wait it out.