Made in the U.S.A.
The S&P 500 closed within a percentage point of the conventional definition of a bear market Monday, down 19.4% from the April 29 high. Other measures are off much more, such as the Russell 2000 index of small-capitalization stocks, which is down nearly 30%.
The putative reason for the declines has been the political wrangling on both sides of the Atlantic, fought mainly over fiscal matters, that would qualify as farce if it weren't so deadly serious and indeed tragic. America saw the loss of top triple-A credit rating following the unfunny spectacle of the debt-ceiling bluster talk during the summer while Europe remains enveloped with the never-ending efforts to stave off a default by Greece and a debacle of the Continent's banks.
But the proverbial observers from outer space, agnostic in their expectations or presumptions about economies and markers, would likely have come to a simpler explanation for the gyrations in financial markets. The decline in U.S. stock prices (and in bond yields) has roughly paralleled the slowing in the American economy, as measured by the gauges from an outfit that has reliably called turns in the business cycle.
The Economic Cycle Research Institute Friday declared that a U.S. recession was all but unavoidable, as reported in the Current Yield column of this week's print edition of Barron's. ECRI's call is based on a compilation of measures from the firm founded by the late Geoffrey Moore, who was called the father of leading indicators.
ECRI's Weekly Leading Indicator plateaued last April and began to show serious signs of deceleration in May, coincident with the peak in the stock market, which itself is supposed to be a leading indicator. Of course, stocks supposedly have forecast something like nine of the past five recessions, according to the quip by the late economist, Paul Samuelson.
This time, however, stocks' slide has been corroborated by the sharp drop in industrial commodities, notably copper, and the action in the bond markets. The plunge in Treasury yields, with the benchmark 10-year yield cut by more than half, from 3.74% in February to 1.77% Monday, anticipated the continued torpor in the economy. That contrasted with the conventional wisdom earlier in the year that a smart rebound would be under way by now. Moreover, credit spreads -- the extra yield on speculative-grade bonds to compensate for their greater risk -- also have widened to levels associated with a significant downturn in the economy.
Even though the near-bear market in U.S. stocks is entirely consistent with the deterioration of growth prospects in the American economy, the connection is denied. The S&P 500 no longer moves in lock-step with U.S. gross domestic product, which is the result of nearly half of those companies' revenues coming from overseas. But the bigger decline in the Russell 2000 small-cap stocks, whose business comes primarily from within U.S. shores, would seem to reflect more accurately the state of the domestic economy.
The explanation offered daily is the European situation is what's taking a toll on Wall Street. The inability to come up with a solution to Greece's debt problem (after the first two bailouts) weighs on risk assets, especially financials. The mantra is repeated continuously until it is accepted uncritically.
The situation in Greece is hopeless, but not serious, as David Goldman has brilliantly observed. The former head of credit research at Bank of America contends this is not a rerun of the Lehman Brothers collapse in 2008. Nobody knew then what lurked on the balance sheets of major banks in terms of mortgage derivatives, least of all their chief executives, who were particularly clueless.
That's not the case this time. "This is NOT a crisis," Goldman asserts, "but a negotiation, in which the main issue is who will own Europe's productive assets when all is over," he writes on his Inner Workings blog at Asia Times (www.atimes.com.)
That other Goldman -- Goldman Sachs -- Monday wrote that the effects of Europe's credit woes will shave more than one percentage point from U.S. growth in 2012. Weaker export growth, tighter financial conditions and reduced availability of credit will constrain the U.S. economy next year. Europe will slip into recession as global growth slows, Goldman economists predict.
The fault for the stumble in the U.S. economy lies closer to home than Europe. Massive monetary and fiscal stimulus staved off a second Great Depression after the 2008 credit collapse. The Federal Reserve no longer is expanding its balance sheet, just reshuffling its assets. Deficit-cutting is the order of the day for the federal budget while austerity has arrived for many states and localities. The puzzle is why anybody would be surprised the economy could slip back into recession.
Withdrawal of the palliatives that eased the pain of the credit bust has to hurt. Easier to blame Greece instead.