Sunday, August 15, 2010

Rough times ahead for markets as a very weak U.S. economy becomes reality

This week has been very tough for markets world-wide, as U.S. indices recorded their biggest weekly fall since early July. The S&P 500 fell 3.8% to end at 1,079, while the Dow dropped 3.3% to end at 10,303. Markets' weakness this week was caused by the U.S. Federal Reserve's statement on Tuesday. The Fed promised to use quantitative easing measures, in the form of buying U.S. Treasuries using proceeds it has received from its mortgage-backed securities. 

While the measure was aimed at helping the economy by keeping borrowing costs low, the fact that this far in the recovery, the U.S. still needs quantitative easing measures caused concern among investors. In addition, some investors had expected more aggressive measures from the Fed, so the announcement left them disappointed.

Meanwhile, in the euro zone, Germany posted quarterly GDP growth of 2.2%, which was a 20-year high, and stronger than the 1.4% that was expected. However, off-setting the good news was that Greece posted a GDP decline of 1.5%. Overall, the euro zone posted a GDP rise of 1%, higher than the 0.6% that was expected. U.S. GDP for the same quarter went up 0.7%, which is consistent with recent data showing economic activity in the euro zone being relatively stronger than the U.S.

However, bad news from the euro zone's financial sector caused Western Europe's sovereign CDS to rise 10.5% this week. For example, Spanish banks borrowed $140 billion euros from the ECB this week. In addition, the euro fell 4% versus the U.S. dollar this week, closing at $1.2754 U.S. 

Thus, I expect markets to head lower in the coming, until positive news from the U.S. (very unlikely), the euro zone or China emerges. In fact, with the earnings season coming to a close, the reality of economic weakness in the U.S. might pull markets lower for the next several weeks. This week, retailers including Wal-Mart and Target will be announcing their earnings. 

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