Stocks are up today, so far. Speculation that the Fed will not be able to resist more quantitative easing is putting a floor under stock prices. And the news that Qaddafi is just about defeated in Libya is helping the good vibes.
But clearly, this market will need more than speculation about the Fed and the easing of some geopolitical tension. We need some economic data to show a little growth, and ease the worries that the U.S. economy is slipping back into recession.
In general, recessions are caused by shocks to the economy that put fear into consumers and corporations alike. The resulting layoffs and tighter spending habits cause the economy to move in reverse. We have not been hit by such a shock recently (even though the situation in Europe could become one). The issue today is that growth is so weak, even a cyclical decline in economic activity could put us back into recession.
Still, the odds of this type of cyclical recession are small. It’s the debt issues in Europe and their effect on European bank balance sheets that’s the problem.
European banks hold of sovereign debt. And if that debt gets restructured, already weak banks will take losses and become weaker, perhaps to the point that they have to raise cash on the open market.
It’s being reported today that U.S. banks and corporations borrowed $1.2 trillion in emergency loans from the Fed during the financial crisis. Without that capital, it should be clear the crisis would have been far worse.
Now, if a similar crisis revisits Europe, where will the cash these banks will need come from? The European Central Bank has made it clear that it will not open the vault to prevent disaster. Neither will Germany.
Regardless of the actual economic situation, this makes European banks more vulnerable than U.S. banks.
That, in a nutshell, is what investors are worried about.
Profits at retail companies rose 11% in the second quarter. That’s the slowest rate of profit growth for retailers in 8 quarters.
Now, clearly, profit growth rates can’t ever continue at a fixed or expanding rate. As they say, trees don’t grow to the sky. Profit growth must slow.
Interestingly, the drop in profit growth rates at retailers has coincided with weaker economic numbers. These two items are related. And that’s not necessarily a bad thing.
We saw economic data weaken last summer, too. And even thought the Fed stated QE2 as a response to that data, I don’t think we can say that QE2 also helped economic data improve.
Quantitative easing is a monetary game. It adds liquidity which boosts asset prices. But quantitative easing does not boost demand. It doesn’t flow into consumers’ pockets.
What we need is real improvement to economic data.
We’ve got Durable Goods data coming up on Wednesday. That’s a big one to watch. You may recall it was the last Durable Goods number from July 27 that started the sell-off.
The market is currently expecting growth of 1.9% for Durable Goods. That seems optimistic. But surprisingly, there are even more optimistic estimates, even as high as 2.5%. Needless to say, a beat for Durable Goods would be very helpful. And it could even mark the end of the sell-off on Wall Street.
I hate to put too much weight on one data point, but these days, we need every bit of good data we can get.