Investors entered 2011 with no shortage of bullish optimism. The market had nearly doubled from its 2009 lows and was well positioned to continue upward. I, like most other analysts, firmly supported this bullish stance, expecting the market to grow 11%-13% by the end of 2011. However, I noted in my post back in January that this growth would only be attainable without global disruptions, such as: European bankruptcies, terrorist attacks, or natural disasters. Now 3.5 months into the new year, the market has been stricken by a variation of these three elements.
The DJIA and the S&P 500 have retracted their early year gains and are right back where they started the year. Strong earning reports and
declining jobless claims have not been enough to keep the market resilient through the recent global turmoil. North Africa and the Middle East have been a hotbed of political unrest as citizens have clashed with their political superiors. Revolution and whispers of revolt of have dominated the countries of Tunisia, Egypt, Libya, Bahrain, and Saudi Arabia. The oil exposure of some of these countries has sent oil prices well over $100 a barrel. A continued price escalation could stunt global growth. Companies unable to parlay the cost of rising commodity prices onto consumers will be the most adversely affected. High prices at the pump will also put a pinch on consumer spending. The only benefactors of this price hike will be the oil juggernauts, but high profits will be offset by decreased demand. Increasing oil prices do not bode well for a bull market.
Adding to the burden of expensive oil are the failing economies of several eurozone countries. The PIIGS (Portugal, Ireland, Italy, Greece, Spain) are squealing again, confirming investor fears that their economies are closer to default then recovery. Greece, Spain, and Portugal are going nowhere fast as Moody’s slapped all three with downgrades this past week. Buying up the debt of these countries appears to be more of a donation rather than an investment. Their borrowing power is near nothing, suggesting that bailouts may be necessary. A lack of competiveness in these economies deters any foreign investment and will have a negative impact on their growth. As the markets become more globally integrated, the failure of one country will hinder the growth of all markets.
Completing the trifecta of negativity is the recent tragedy in Japan. The country has been devastated by one of the worst earthquakes in the world’s history. The natural disaster has resulted in billions of dollars in damage and will require billions more for rebuilding. Additionally, nuclear meltdown fears have crippled Japan’s energy supply and have forced thousands of people to evacuate. Many people are without homes and jobs, and have little idea when their lives will regain normalcy. These uncontrollable factors leave Japan’s economy hanging in the balance. Being the 3rd largest economy in the world, Japan’s recovery will be crucial for not only Japan, but for all markets. Fortunately, Japan has one of the best performing economies and has considerable cash on hand to confront these challenges. However, they may need to free up more cash to pump back into their economy.
Since Japan is the second largest holder of American debt, there is speculation that they will sell off American treasury notes to increase their money supply. This would dramatically hurt the value of the dollar and put a clamp on U.S. borrowing. An outcome like this will send the American market downward and have a ripple affect through all global markets. This is speculation for now, but the events in Japan will continue to dominate U.S. and global markets. In the short-term, if they can alleviate the radiation risk at the nuclear power plants, much of the existing fear will be taken out of the market. But until then, fears of nuclear catastrophe will drive investors away from the market. Japan is a strong economy and it will recover, but the road to recovery may be a long and painful one for investors.
It is rare that the market sees a combination of three separate and very negative events happening all at the same time. The events in Japan are the most driving factor in the markets right now, but concerns over expensive oil and debt-ridden euro nations will continue to suppress the market. These events will dominate economic headlines and provide a harsh reality for investors. The bullish optimism that started the year has evaporated and it is time to get defensive. In my next post I will discuss some potential investment options to keep your portfolio stable amongst all this turmoil.
AH
The Stock Sensei 