Stock Market Held Hostage by Eurozone Uncertainty

eurozoneThe stock market continues to be in correction mode and so are gold and oil prices. But, the trading action in the equity market isn’t that bad at all; the down days aren’t that pronounced and we’re seeing solid rebound days, which signals that buyers are definitely out there. Daily investor sentiment is no doubt affected by developments in the eurozone and I think it’s fair to expect things to get worse regarding the sovereign debt crisis. European policymakers are likely to apply another round of “patches” to the problem; but, next year, I think the eurozone will be in for some real turmoil.

This combined with the usual geopolitical concerns and slow growth in the U.S. economy means that there is no rush for stock market investors to take action. It’s like the domestic stock market is in some sort of holding pattern, waiting for a shock to occur. Regardless, investment risk remains very high.

The S&P 500 Index is now in danger of giving up all its gain since the beginning of the year. I suspect we’ll get some consolidation around 1,300 on the index, but if this breaks, we’re back to where we started. The stock market was due for a correction after this year’s solid price move. The problems in the eurozone are now compounding the pullback.

It’s my expectation that second-quarter earnings season will be just as solid as the first quarter. The stock market, however, just might look right past the numbers if problems in the eurozone get worse. It’s the uncertainty of it all that is keeping domestic investors from betting on domestic fundamentals, which are better than those in the eurozone. I repeat my view that stock market investors should be watching their favorite large-cap, dividend paying stocks closely for new entry points. I think the correction has further legs, but price-to-earnings ratios continue to be fair.

I’ve learned over the years that anything can happen in capital markets and that, very often, price extremes are the norm. With the stock market being emotionally driven (just like the rest of the world), you have to expect the market to overdo the underlying fundamentals. I suspect that it won’t be too long before we get a small rally in the share prices. I don’t expect any major shock like a debt default in the eurozone to all of a sudden just happen. My best guess is that we’ll get a slow but continuous deterioration of investor confidence in eurozone bonds, which will precipitate a political crisis before a debt default or currency breakup. Institutional investors are just about done buying the bonds of weaker eurozone countries.

We’re in for a lot of change over the next 18 months and it isn’t going to be pretty. The stock market is rightly stalled over all the eurozone uncertainty, while domestic fundamentals slowly improve. If there was one industry where I’d like to see further price correction, it’s that of railroad stocks. (See U.S. Economy: What Freight Haulers Are Saying About It.) This is one sector where companies keep saying that the operating environment is getting better and, to be frank, I’m becoming less enthused about investing in businesses that operate outside of North America.