In this column a few weeks ago I likened the economy and markets to being in the eye of a hurricane. There had been some destruction in global stock markets created by the debt crisis in Europe, but the storm quieted down after the surprise EU/IMF announcement of a $1 trillion debt rescue plan. There was hope the danger had passed. But I suggested that, as in the eye of a hurricane, the other side of the storm was yet to arrive, and that sometimes it arrives with more fury than the first side.
It does seem we are now experiencing the back side of the financial storm and that it may indeed result in more serious damage.
The rescue package brought hope that the European debt crisis could be confined to Greece, that the European economic recovery would continue, that European banks would avoid serious fallout from the debt crisis.
The return of a positive outlook was in no small way related to confidence that the economic recovery in the U.S. would continue and become more robust, and that China’s strong economy would also continue to support the global recovery.
The Chinese stock market did not demonstrate the same confidence. It topped out last July and has been in a bear market since, having declined 27%. And in recent weeks it became clear what the Chinese stock market saw coming. The Chinese government has begun taking dramatic steps to take some air out of the Chinese real estate bubble, and stock markets are well aware of what happens to economies when real estate bubbles burst.
Meanwhile, the Greek debt crisis was contagious and spread to Portugal and Spain, with concerns rising about Ireland and Italy.
However, there was still confidence that the U.S. economy would continue to improve, even though some important parts of last year’s stimulus efforts, particularly for the housing industry, had expired at the end of April.
But then the latest economic reports began coming in.
In recent days it was reported that Pending Home Sales rose 6% in April, but that it was likely only due to a rush by home-buyers to get purchase contracts signed before the April 31 expiration of the home-buyer rebate program.
And sure enough, a few days later the Mortgage Bankers Association reported that while overall mortgage applications had increased 0.9% in the last week of May, the increase had been due to existing home-owners applying to refinance their mortgages to take advantage of low mortgage rates. Mortgage rates from those looking to buy a home, so-called ‘purchase applications’, had declined for the fourth straight week since the home-buyer bonus plan expired at the end of April, and are 40% below their level at the end of April. That cannot bode well for the next home sales reports.
Meanwhile, MasterCard’s SpendingPulse reported that retail sales in May were 3.7% below May of last year, the second month of declines after sales improved in the first quarter.
Consumers and the stock market really needed a strong employment report to offset those negative reports, if confidence that the economy continues to improve was to be kept alive.
Unfortunately, the jobs report Friday morning was dismal. The Labor Department reported that only 431,000 new jobs were created in May versus the consensus forecast of 515,000. And most of the new jobs, 411,000, were temporary census-taker jobs. Minus those, there were only 20,000 new jobs created. An awful report.
The unemployment rate did decline to 9.7% from the previous 9.9%. But even that was questionable as a positive, since it was primarily due to 322,000 unemployed dropping out of the unemployment picture because they gave up looking for a job.
Adding to the concerns, ill-winds continued to blow in from Europe with the statement of an official in Hungary that his country now faces a debt crisis similar to that of Greece.
The back side of hurricanes do pass, and the continuation of the financial hurricane will also pass. But the stock market must now worry about the damage that it leaves behind, not so much whether it has raised the odds of the economy sliding back into a double-dip recession, but the damage it has done to forecasts of a V-shaped recovery and the robust improvements in corporate earnings that have been factored into stock prices.
