Corporate earnings are coming in strong. The Federal Reserve says the economy is still on its recovery path. But, investors are having none of it.
On Thursday, even from the opening bell, the market acted as if a dark cloud had descended on Wall Street. And, throughout the day, stocks remained under pressure.
An afternoon rally fizzled and the Dow Jones Industrial Average finished the day down 376.36 to close at 10,068.01 off 3.6 percent for the day. That was the largest percentage drop since March 5, 2009.
Indeed, investors appeared to be focused on events across the Atlantic where financial regulators struggled to find the right formula for convincing investors that sovereign debt owed by countries such as Greece would be repaid. But instead of being assuaged, investors fretted that unless more is done to shore-up European economies there could be a new version of the 2008 Lehman Brothers credit market meltdown.
Their fears were somewhat justified when Federal Reserve governor Daniel Tarullo, testifying Thursday before a House subcommittee, “the European sovereign debt problems are a potentially serious setback.”
And, he said, “One avenue through which financial turmoil in Europe might affect the US economy is by weakening the asset quality and capital positions of US financial institutions.”
The US stock market was not the only market affected by the gloom. Oil prices fell over $2 a barrel, gold was down over $10 per ounce, and copper prices, reflecting worries about the world economy, dropped to their lowest level in over three months.
The tone on Wall Street was not helped, either, when the government reported new claims for unemployment climbed by 25,000 last week. Wall Street had been expecting a drop of 4,000.
“The number kind of jumped out of the blue after all the indicators seemed to be showing that the jobs market seems to be improving,” says Robert Brusca of Fact & Opinion Economics in New York.
He says it could be a signal that something is starting to go wrong in the economy or it could just be a one week blip. “We really have to wait another week to see if it’s confirmed,” he says.
In the meantime, despite the bad news in Europe and possibly in the labor market, some investment managers believe the fundamentals that drive Wall Street have not changed.
Mr. Saut notes that corporate America, without a lot of choices, has improved its productivity so much there is a “profit explosion” taking place. At the same time with inventories drawn down, companies have to restock – as has taken place in the last two quarters. “That’s what drives capital expenditures,” he says. “And, once capex (capital expenditures) pick up, people start to get rehired.” With more people in the workforce, he says consumption then quickens, driving the economy.
In fact ShopperTrak, which follows retail trends, reported Thursday that retail sales rose 6.5 percent year over year for the week ending May 15th. However, the improvement, like some parts of the economy, may be a bit bumpy. “We expect sales and traffic will slow a bit this week before picking back up for Memorial Day and graduation spending at the end of May,” says Bill Martin, co-founder of Chicago-based ShopperTrak, in a statement.
While shoppers may be getting back to the malls, investors were also distracted by an increasing number of issues, such as tension between North and South Korea over the sinking of a patrol boat, the nuclear standoff with Iran, and violence in Thailand. “The geo-political stuff is starting to rise,” says Mr. White.
But, most of the attention will be focused on Europe, where he says it would not be surprising to see some government or central bank action over the weekend to calm the financial markets. If that happens, White would not be surprised to see the market reverse itself.
“We are definitely oversold here,” he says.