The stock market is trading on fear and has been for quite some time. There are reduced expectations for the economy, corporate revenue growth, investment returns, and even the political will to create more certainty in capital markets. No doubt, it’s just an awful environment for stock market speculators.
The structural failure of eurozone leadership is increasing the odds of another global recession and, without decisive action from policymakers, financial markets will gain the upper hand with their own market-based resolutions. In fact, this is already happening with significantly increased bond yields throughout eurozone countries. Even the Netherlands and Finland (AAA-rated countries that are well-managed, mature economies) are seeing their sovereign borrowing costs increase sharply. The marketplace is imposing these financial conditions throughout the eurozone because of the failure of cohesive political leadership. It’s not about austerity measures anymore—it’s about confidence in the entire economic system. Accordingly, the U.S. dollar is strong and the stock market is not.
The healthiest part of the system is large-cap companies. Corporations are doing their duty—they are keeping healthy balance sheets, producing good earnings reports, and paying their dividends. But the stock market isn’t much interested in corporate profits; how can it when we have the prospect of the entire eurozone monetary system falling apart? No wonder stock market investors are sitting on the sidelines; investment risk for equities remains very high.
Stock market valuations are very reasonable at this time, but this alone doesn’t make a bull market. You know you’re in trouble in financial markets when investors look to policymakers for action. But this is where we’re at now. Eurozone leaders have to be decisive and bold or the remaining confidence within the system will very soon disappear.
A stock market investor like Warren Buffett is right to be buying eurozone and Japanese value stocks. But, as we all know, he’s already made his billions and he has the benefit of a very long-term time horizon for investment. For most individuals who participate in financial markets, the goal is to build at least a little wealth to help with retirement. We’re in a situation now where a debt-induced eurozone failure may just be responsible for another major stock market correction.
Negative sentiment is now pervasive and getting out of this cycle is going to difficult. Because the eurozone debt crisis has the potential to be cascading, no one solution is going to restore confidence to financial markets. In addition, now that U.S. sovereign debt has been given a negative outlook by ratings agencies, the prospects for the stock market seem extremely limited. This is why higher-dividend-paying stocks will continue to outperform.
In this high-risk environment, a strong defense is the only strategy. If U.S. and eurozone countries turn to printing more money to get out of the sovereign debt crisis, then the next major problem will be with inflation. (See Debt Crisis in Europe Highlights Continued Strong Fundamentals for Gold.) The silver lining in all this, if there is one, remains the commodity price cycle.