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10.17.11

No Financial Armageddon

The sharp selloff of almost 2 percent is not a good barometer of the global economy, and does not signal that a financial collapse based on a European meltdown will happen, says Zachary Karabell.

Once more into the breach we go. After a strong week where markets regained some footing, Monday once again saw a sharp selloff of nearly 2 percent. These wildly volatile days have been the norm since mid-summer, and as any market maven will attest, such volatility usually means that there is more to come.

Markets may have jumped the rails, but they aren’t good barometers of the real world either. The global economy, let alone our national one, did not suddenly change from good to bad over the weekend, just as it did not suddenly shift from dire to OK two weeks ago when the markets reversed weeks of precipitous decline.

The U.S. economy remains sluggish at best, and as the Occupy Wall Street protesters have duly noted, regardless of whether GDP expands 2 percent, or flatlines, regardless of whether companies make a mint, and whether or not the Dow soars or slumps, tens of millions of Americans have seen no income growth for at least a decade, and a few million others have done exceedingly well. The euro zone is similarly stuck in low or no growth, with high affluence and very high unemployment, but that was true six months ago, and six weeks ago; yet markets have swung widely even so.

The mood swings of investors—oscillating between fear that American debt will crush the economy and that the euro zone will collapse under the weight of Greek and other sovereign debt and hope that Angela Merkel and Nicolas Sarkozy will announce bold plans to save the world, Americans will get in touch with their better angels, and the Chinese will quietly rescue the globe—have become their own self-fulfilling phenomenon. Volatile and highly unpredictable markets keep people from investing in stocks and accelerate the race into no-yielding Treasuries and that shiny metal known as gold.

You’d think from the financial news media that there are daily stampedes of greedy or scared investors. But no. As sharp as the market swings have been, the actual volume of trades has been modest. That is proof that the more the bulk of investors—and hence money—stays out of the markets, the more market movements are driven by short-term trades and programs executed by computer algorithms. It might surprise the Wall Street protesters, and pleasantly, to recognize that banks profits are down significantly because trading volumes are so light and even the professionals manning those desks have been stymied and hurt by the incessant and unpredictably sharp moves.

At the same time, there is continued evidence that companies are seeing a more stable world than popular opinion or market prices would indicate. IBM reported its quarterly earnings late Monday afternoon, modestly surpassing expectations, announcing that it had taken in $26 billion in revenue, or more than $100 billion annually, larger than two-thirds of the world’s countries. The market reaction? The stock sold off 4 percent. You could substitute dozens of companies with the same story, from Amazon to Google to Caterpillar. Only Apple seems (for now) immune. It will report just how many millions of iPads and iPhones it sold in a few days, and it would come as no surprise if it too sold down on the news that more people than ever are buying its products.

At some point, whether tomorrow, or months from now, the underlying fundamentals of all those companies will become too attractive to ignore and all of that capital sitting in Treasuries and in cash earning nothing has to find some rate of return to ensure that pensions get paid or 401(k)s have some future value.

In the meantime, the need of the investing community for simple plot lines, easy-to-digest stories, and unrealistic certainty makes financial markets a good gauge of sentiment and a lousy barometer of what is happening economically in the world. Yes, both stock and bond markets do at times have a “wisdom of crowds” anticipating issues and factoring in strengths that may not be apparent to any one individual or group or from any one data point. Markets are certainly no worse in forecasting and gauging what is happening in the world than politicians or congressional budget offices and the like around the world, but nor are they much better.

What does seem clear from the past weeks, however, is that a feared financial Armageddon based on a European meltdown will not come to pass. Nor for that matter is there an imminent U.S. financial meltdown spurred by S&P’s spurious downgrading of U.S. debt over the summer or by political gridlock now and into next year. As we know, the primary result of the downgrade was to drive interest rates lower, the precise opposite effect that many feared it would have. And nothing either political party has proposed in terms of job creation will do more than maintain a minimal cushion for those without jobs, but nor are more jobs in danger because of government ineptitude. And finally, China, with its $3.5 trillion in reserves, may be slowing down, and its housing market may be bumpy, but that is not the same as a house of cards falling down and bringing the global system down with it.

As sharp as the market swings have been, the actual volume of trades has been modest.

The manic volatility of markets will continue… until it doesn’t, and as long as it does, it will be hard to break out of the cycle. That adds fuel to already testy sentiment and supports the widespread belief that our current economic system is flawed, and our political one along with it.

Finally, the only other certainty is that markets will begin to do better long before those tens of millions who are doing poorly in this economy see any change. Capital is in a privileged global position, though you wouldn’t know it given how fearful many of its holders are. Large global companies are thriving even as national economies falter, and capital is begetting capital even as wages are stagnant and shrinking in the developed world. These trends have been in place long before the current financial crisis and its aftermath and they are unlikely to change.

I began by saying that markets are not good gauges of our economies. The positive of that is that even as markets go mad, the actual implications for the real world are minimal—unless they completely unravel, in which case we have a September 2008 moment all over again. The negative, in addition to that ever-present risk, is that even if markets and companies stabilize and thrive, effects on wages, consumption, standards of living for most people are muted. These—more than daily market noise—are facts of the world we live in. It’s time to get used to it.