What’s Driving the Stock Markets?

market volatilityVolatility abounds and it is coming from every which direction. The Eurozone’s fiscal problems unfortunately persist. Inflation has become a real threat in China and other emerging markets. The U.S. Federal Reserve’s second round of quantitative easing is controversial and, as such, has only dialed the knob on volatility up.

The Fed has decided to release another $600 billion into the U.S. financial systems in an effort to boost the stalled recovery. It will do so by buying longer-term Treasuries. Even when the speculation around the move that started in August, dubbed QE2, has created much controversy both domestically and internationally.

When the QE2 rumors became fact, the Fed and its chairman Ben Bernanke came under fire, forcing them to fight back and publically defend their decision, which is certainly something you don’t see every day. Now economists, traders and investors are waiting for the minutes from the Fed’s November 3 meeting, which is widely expected to offer clues on whether QE3 or QE4 or QE5 may also be in the cards.

Aside from the Fed’s policies, discouraging economic data are also weighing heavily on the stock markets. While U.S. incomes and spending are expected to move slightly upward, the weekly jobless report is expected to disappoint, as the unemployment rate remains obstinately high, close to 10%.

Then there is the Eurozone’s sovereign debt saga and the news that Ireland was not talking about weather with the EU officials after all. They were talking about the bailout package. While the deal for Ireland is still being worked on, all eyes are already on Portugal and Spain. Europe’s seemingly undefeatable mountain of debt is adding even greater volatility for most asset classes, but equities in particular.

Further worrying equity investors and traders are U.S. municipal bonds. The number of municipalities seeking state permissions to file for bankruptcy is increasing. For the time being, states seem to be denying such requests and offering alternative refinancing arrangements. Regardless, a trend is emerging that points towards severe weakness in this market segment. To illustrate, Moody’s bond rating agency has downgraded the cities of San Francisco and Philadelphia, which, in turn, sent municipal bond prices down and yields through the roof.

Perhaps municipal bond yields are a sign of a similar systemic problem the Eurozone is facing, and perhaps they are not. But, if the fear of default on government debt takes flight in North America, regional stock markets could end up in a world of hurt.

To say that the last few years have been volatile for stock markets around the world would be quite an understatement. In just a matter of months, stock markets have been seen creating and annihilating 20% or more of their value in fell swoops. Such rollercoaster rides have left many ordinary investors bruised, battered, and disenchanted with equities.

Unfortunately, there are no easy markets and there have never been any guarantees when it came to investing in stocks. My usual answer would be to focus on commodities, particularly gold, but even this area is a minefield that needs to be carefully navigated. At this point, I don’t see many viable solutions other than diversification, perhaps, across asset classes, geographic regions and world economies.