Upheaval in Europe won't derail US economy

Markets show resilience 2 years after the flash crash.

By MoneyShow.com May 8, 2012 3:40PM

By Igor Greenwald, MoneyShow.com

Sunday was the second anniversary of the flash crash, when the Dow, already deeply in the red, plunged 1,000 points in minutes as bids vanished. The market revived just as abruptly, ending with a loss of 3.2% on the day.

The causes of the mini-crash, including the culpability of high-frequency computer trading algorithms, remain in dispute. But the incident does offer a useful reminder that the market is under no obligation to act rationally at any given moment, on any given day and, often enough, over considerably longer stretches.

People are under no such obligation either, but eventually common sense tends to prevail. That was the case this week in France and Greece as politicians who had toed Germany's line on the failed economic policy of austerity were turfed out by angry voters in favor of outsiders, even though the outsiders have not presented a credible alternative.

In France, Socialist Francois Hollande unseated President Nicolas Sarkozy, the first defeat of an incumbent in 31 years. Sarkozy's fate was sealed by unemployment pushing 10%, as the economy teeters on the brink of a recession.

In Greece, the mainstream parties that had acceded to the punitive "bailout" terms lost so much support in parliamentary elections that they now lack the votes needed to continue on the present course. The winners were a motley crew of communists, other leftists, and ultra-nationalists, all of them running against the cuts mandated by Europe.

Predictably, the markets' initial response was harsh: Dow futures were down as much as 130 points at their overnight lows. But this time, rationality seems to have returned sooner rather than later. European markets turned around early heavy losses to trade higher, tellingly led by gains in Spain and Italy.

The policies of austerity have proven disastrous to investors in the stocks and bonds of the growth-starved eurozone members. The prospect of change, however chaotic, simply isn't much scarier than same old same old, and only one of those two paths holds any promise of a recovery.

Hollande is not as radical as his campaign rhetoric implied -- in fact, he's an economic moderate broadly within the European mainstream. He's also a staunch advocate for a united Europe, and so is highly unlikely to wreck the 60-year-old Franco-German alliance at its core.

At the same time, he has a clear electoral mandate to remind Germany of austerity's costs, and refocus it on the necessity of growth -- not in five years after the hoped-for structural reforms, but soon, before capital flight and an unsustainably expensive currency bankrupt Spain and Italy.

As for Greece, it's already been written off -- literally, on the books of European banks, and figuratively as the catalyst for a wider European crisis. The leverage of any government in Athens to seek improved terms from Europe is close to nil, while the costs of defiance in terms of failed banks and rampant inflation are sky-high.

So why isn't the U.S. following the European averages higher just yet? The S&P 500 is at a pretty important juncture near the bottom of its two-month trading range, following up its failed rally to new high by knifing through its 50-day moving average.

Last Friday's plunge in response to a mildly disappointing jobs report was part of that, even though upward revisions for the prior two months brought the net new payrolls within a rounding error of the consensus estimate.

The bears' working theory seems to be that turmoil in Europe and the slowdown in China will derail the U.S. recovery. This recovery has been nothing to write home about as is, and is headed for the famous "fiscal cliff" next year, as tax cuts expire and automatic budget cuts take effect.

In fact, exports account for just 13% of the U.S. GDP and just one-third of the economy's modest recent growth, so it would take a real collapse in overseas demand to stop the economy from continuing to slowly heal.

Unemployment remains unnaturally high, and housing prices at historically low levels relative to income and rental rates. Whoever is in power come November will have powerful incentives to keep homegrown austerity at bay, the more so given Europe's bad example.

A recession is more than just two quarters of negative GDP growth. It represents a sea change in expectations about future demand (leading businesses to retrench and lay off workers) and the direction of asset prices (spreading fear though capital markets).

The Great Recession featured both in spades, and the economy has yet to regain its equilibrium. But the pendulum has certainly begun to swing toward a reversal to the mean, and those swings rarely stop a third of the way through.

This entire hedge-fund shakeout has barely registered for Home Depot (HD), trading just 2% below the 11-year high reached on May 2. Fortune Brands Home & Security (FBHS) is less than 2% below a record it set the same day, after raising its annual sales and profit forecasts.

That's more telling about the economy's prospects -- and the market's -- than anything going on in Europe.

May 9, 2012 12:07AM
Well, technically, you're right, Mr. Greenwald. The political changes in Europe won't really "derail" our economy. Our own political nonsense right here at home is doing a great job of that all by itself. It's our high unemployment/underemployment, low wages, collapsing real estate market, astronomical national debt, massive regulation, ascendant government, a progression towards full statism, and the general ignorance and incompetence of both our politicians and the broader populace that will ultimately continue to derail our economy. 

Europe ought to be the least of our worries.
May 8, 2012 4:49PM
Once again, the far left bent of the Money Show tells us about rounding errors and a "slightly disappointing" jobs report.  So what has $5 trillion got us in stimulus? Nothing  And what will higher tax rates on investments give us? A reduction in stock values of 30%.  I am positioned in B rated bond funds until this insanity rights itself (pun intended).
May 8, 2012 8:33PM
Great recession, is terminology for a Great depression for idiots. This is far worse than the 30s. This time it includes the entire world.
May 9, 2012 8:46AM
I can think of no time in history where the economy has been good when Copper, Oil, Gold and Farm commodities are all falling in price.  This is signalling a recession LOUD and clear.  No amount of FED printing can maintain the stock market bubble.  It seems to be the last leg standing.  The democrat/socialist Debt bomb is going off...
May 9, 2012 10:42AM
The US economy is already derailed, da.
May 9, 2012 11:43AM

"Usual suspects", you need to go read a history book. The Great Depression DID hit the whole world. Some European countries were affected more than others, and some longer than others, but they all took a big hit. Developing economies were decimated even worse.


Also the "Great Recession" so far is nowhere near the Great Depression--but things can get worse from here. We'll see if it goes so far, or further. Right now, saying that "this is the worst recession since the Great Depression" is like taking a truckload of dynamite out to the old atom bomb testing ground and blowing it up, then saying that it's the biggest explosion there since the atom bomb. It's literally a true statement, but doesn't convey truth.

May 9, 2012 11:23AM

Actually, the assertion that "Greece has been written off" is not really true. True, the debt-reduction deal wrote off a large percentage, but only on some of their bonds. That didn't apply to a lot of Greek bonds--those held by the ECB for instance. The way the Greeks are going, this is going to impact the ECB balance sheet much worse, and bodes badly for the future of Portuguese, Spanish, Italian, and even Irish bonds.


Ironically, this will lead to even greater Greek austerity. They are in the process of negating the debt deal they just made, so they are going to default, which will mean no more borrowing from any sensible lender. So they are going to have to balance their books even if they default on the debt, which will be more austerity than they had agreed to before in the debt deal.

May 8, 2012 5:22PM

"the far left bent of the Money Show"


Ha ha, that's one of the funniest things I've ever read, insane.  Just read those words, smh 

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