Two and a half years ago, before the U.S. subprime crisis went viral, many economists and market strategists were hopeful that the rest of the world would be sufficiently strong to withstand U.S. credit woes. Now that the shoe is on the other foot, with Europe's sovereign credit problems rattling markets around the globe, today's talk of the "decoupling" of world economies may prove just as foolish.
The U.S. stock market has been under severe pressure since late April, when doubts about the efficacy of a European rescue for Greece's sovereign debt crisis surfaced, but on June 4, the Standard & Poor's 500-stock index dropped 3.4 percent in response to a dismal May jobs report and words from a Hungarian government official that talk of a debt default for that nation "was not an exaggeration." A second-straight month of improvement in German factory orders, thanks to a greatly weakened euro, was reported on June 7, briefly sparking optimism in European and U.S. markets. By the close of trading, U.S. stock indices had all turned negative again: The S&P 500 suffered its worst two-day loss since March 2009.
Bruce McCain, chief market strategist at Key Private Bank (KEY) in Cleveland, views the elevated volatility and 167-point loss in the S&P 500 index over the past six weeks as a short-term correction, a process that may yet inspire further conviction among investors that the bull market is sustainable.
"We haven't seen market or economic evidence to [confirm] that the global expansion or global rallies are over and we're headed into a new bear market," he says. "If we solve some of the longer-term problems, there could be a continuation of the rally that began last year".
If some of the problems develop to the point where they pose a threat to global growth, "we could get a failed rally that isn't very strong and [takes the market] lower and perhaps breaches [prior] lows," McCain says.
That's precisely the scenario that Gerry Jordan, manager of the $90 million Jordan Opportunity Fund (JORDX), anticipates. Earlier this year there was a lot of optimism about growth in U.S. gross domestic product returning to levels above 4 percent. With the strength of exports in doubt, amid a 7.8 percent gain in the U.S. Dollar Index and news of slowing growth in Europe and China, the forecast for the second half of 2010 is much less rosy, he says.
Earlier this year, "people had been talking about how strong the [U.S.] economy is. That's over. It ended with [the debt crisis in] Greece in January or February, but everyone ignored it," says Jordan. "What's finally started to leach into people's [consciousness]—and the May jobs number cemented it because it was godawful—is that it's no longer just a European problem or a China-slowing-down problem. Now it's a U.S.-wasn't-as-good-as-we-thought-it-was problem." He says he thinks "economic growth rates for this year and next year have to be taken down meaningfully."
Jordan predicts that Europe will be back in recession by the second half of this year, or the first part of 2011 at the latest, as austerity programs implemented by governments in the euro zone impose a drag on those economies. He says he's stunned by arguments that the U.S. can decouple from economic ills in the rest of the world, given how intertwined the world's economies are at a fundamental level. "Europe is 30 [percent] to 40 percent of global GDP. If Europe goes into recession, you have to take a haircut to your global GDP estimates, and if European sales account for 30 [percent] to 40 percent of U.S. companies' revenue, you have to take a haircut to U.S. earnings estimates."
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