Brace yourself: markets have further to fall
By
MoneyWeek Editor
John Stepek Aug 31, 2010
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The City may have shut up shop yesterday for the Bank Holiday, but it was business as usual elsewhere in the world.
And investors weren't in a cheery mood at all.
The Dow Jones Industrial Average has been unable to leave the 10,000 level behind since it first crossed it back in 1999.
And it looks like the Dow could be seeing 10,000 again any day now.
Global markets had another bad day yesterday
US markets had another bad day yesterday. The Dow is down more than 4% for August so far. That's despite all the current merger & acquisition (M&A) activity – although my colleague David Stevenson has already pointed out why this 'boom' may be overhyped.
Stock markets in Asia followed America lower this morning. And the yen just keeps getting stronger, despite efforts by Japan's central bankers to talk it down.
Yesterday, the Bank of Japan decided to pump more money into the economy. But markets saw the stimulus as being more about political gesturing, than a serious attempt to weaken the Japanese currency. Japan's current prime minister, Naoto Kan, is under pressure from within his own party. So the feeling is that he has to be seen to be 'doing something' to help Japan's exporters, and by extension, the rest of the economy. As a result, sceptical investors effectively ignored the added stimulus, in favour of piling into the 'safe haven' of the yen.
The threat of a double-dip is hanging over the markets
So what's worrying the markets? Well, the same thing that's been on everyone's minds for most of the year – the spectre of a double-dip. Yesterday, the focus of fear was the US consumer. In July, consumer spending rose by 0.4%, stronger-than-expected. Why would that depress the market?
Because it doesn't look sustainable. Spending rose by more than incomes. In July, US household incomes rose by an average 0.2%. That was lower than the 0.3% expected. And more importantly, after you adjust for inflation, and for taxes, US consumers' spending power actually fell by 0.1%. That was the first decline seen since January.
As economist Joshua Shapiro put it in the Financial Times, the spending is being fuelled by government benefits, and by consumers dipping into their savings. Indeed, the savings rate fell from 6.2% in June to 5.9% last month.
"Neither of these is a sustainable source of spending increases, which ultimately must be financed by private sector job growth and consequent gains in wages and salaries."
And the big worry is that private sector job growth doesn't seem to be anywhere on the horizon. Investors are particularly nervy this week ahead of the US monthly non-farm payrolls data on Friday. This will show the overall state of employment in the US. And it's not likely to be pretty, given how weak the weekly jobless claims data has been recently.
Worse still, US housing is undergoing a double dip, which is hammering employment in the sector once again. As the FT notes, "construction and associated businesses were among the hardest hit sectors in the recession, accounting for about 3m of the 6.6m jobs lost after the collapse of the housing bubble in 2006."
And yet the declines are continuing, with nearly 120,000 jobs lost in the sector in the three months to the end of July. Even in 1980, construction accounted for about 6% of overall US employment. Now it accounts for just 5.1% of private sector jobs.
Government stimulus is coming to an end
Until recently, markets would have taken a lot of this bad news in their stride. After all, a weak economy means the central bankers start oiling up their printing presses. The promise of low rates and money pumping are usually enough to put a spring in the step of investors.
But it may not be that easy. The fear among investors now is that central bankers may be reaching a point where they can't do much more to bail out stock markets. For one thing, they've already done a great deal. Interest rates are near enough zero in most developed economies. And trillions of dollars have been thrown at the problem. If that can't inspire a lasting recovery, then what can?
Perhaps more importantly, central bankers no longer seem to have carte blanche to do what they want. Federal Reserve chief Ben Bernanke may be happy to follow in the footsteps of his predecessor Alan Greenspan. But others on the interest-rate setting Federal Open Market Committee are less gung-ho.
As former Fed Vice Chairman Alan Blinder pointed out last week: "If it were just Ben Bernanke acting on his own, some further action might be closer." But "he has some significant resistance from within the FOMC."
What investors can do
What can investors do about this? Well, we'd be surprised if there isn't another bout of quantitative easing at some point. But there's also likely to be another deflationary scare – that's arguably what we're seeing now – before the printing presses are manned again. We'd stick with the high-quality dividend-paying blue-chips for now, and keep a good bit of powder dry for when the markets fall further.
Meanwhile, as stocks slide, yields on US Treasuries and other 'safe' government debt continue to tumble to Japanese-style levels (yields fall as prices climb). This week, James Ferguson and Dr Peter Warburton debate whether or not there's a bubble in government bonds in the next issue MoneyWeek magazine, out on Friday. If you're not already a subscriber, get your first three copies free here.
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