Debt, China, Unemployment and Sentiment—Certainty Is Becoming a Scarcity

sovereign debtThe sovereign debt issue has to be put to bed for stock prices to really accelerate in a meaningful way. It may take fourth-quarter earnings season to get investors distracted from the issue, but it has to be dealt with in order for equities to begin a sustainable new trend. This is a lingering issue and will remain a significant risk to global capital markets over the next few years. Governments just have too much debt and large, annual deficits for any investor to disregard the issue. Someday it will become a currency breaking event if not dealt with.

In this equity market, it’s pretty clear that China is running the show now. By this I mean that domestic and foreign equity markets are trading off China’s economic data. That country’s stream of news is now a leading factor shaping domestic investor sentiment and it’s now affecting day-to-day trading action.

One of the things we have to keep in mind as investors is that the stock market always likes to speculate on the future. This means that stock prices can go up, even when unemployment goes up or housing prices go down. This is what’s happening right now. The key going forward is corporate earnings and the outlook for corporate earnings in 2011. Currently, the outlook is quite favorable and many large-cap businesses cited improving business conditions in the third quarter.

In the absence of earnings reports, the market does tend to overemphasize other news, because it has no choice. But, the most important news we can go on as investors is what corporations say about their businesses. The investing marketplace is a fickle bunch and memories are very short. Domestically, all you really have to do is listen to what the railroad companies are saying and you’ll have a great sense as to the current state of things.

The stock market can experience solid near-term uptrends in an environment that’s full of confidence-sapping investment risk. There’s a reason why individual investor participation is low in equities and it’s that there’s no real certainty to go on. There’s no defined trend to latch onto (other than gold) and individual investors are rightly sitting on the sidelines.

In the majority of cases, all the action that European leaders have taken to get a handle on the sovereign debt crisis has been met with selling by large, institutional investors. I wouldn’t be surprised at all that a whole new set of rules is created over the next few years to govern the euro currency and a new central bank for the entire block. Without it, the currency may very well come apart and create havoc in global capital markets.