In recent weeks, stocks have sold off from their recent highs. It appears that the enthusiasm that drove equity markets higher since last March may have run its course.
I’ll stick out my neck, and pronounce an end to the ’07–’10 market cycle. This was a market cycle that began with a peak in global stock prices in October 2007, reached its low in March ’09, and finally partially recovered through early 2010. This was a market cycle whose theme was systemic financial risk and financial Armageddon—an emerging worry in early 2008, the imminent threat later that year, and then a receding risk. Now, with the systemic risk cycle seemingly at an end, investors are increasingly preoccupied with a new market theme: persistently weak economic growth.
The recent drop in the Dow has been ascribed not to the general economic outlook, but to the possibility of a sovereign debt default in Europe. A collection of countries—Portugal, Ireland, Greece, and Spain—have run up unmanageable debt loads in the wake of the financial crisis. A default by any one of these countries might lead to a “Lehman Brothers II” scenario: a debt default leading to cascading losses in the global banking system.
That scenario seems unduly alarmist. I view the sovereign debt issue as something akin to the U.S.’s current economic dilemma. Today, most American workers are employed; most mortgage holders are making timely payments. But a particularly large group of workers and mortgage holders are in trouble. As long as high levels of unemployment and mortgage problems persist, it is hard to see a path forward to sustained economic growth in the U.S.
The same is true of governments. Most will make timely debt payments; a few are teetering at the edge. We face, in the event of a sovereign debt default, less a risk to the global financial system, and more a risk to a resumption of robust global economic growth. As in the domestic scenario, it’s hard to envision a sustained global recovery when the EU and markets are preoccupied with debt restructuring.
So, markets are nervous. Not because of another financial crisis, but because of worries over a protracted workout period for individuals and governments alike. This is likely the theme that will dominate investor sentiment—and drive investor nervousness—for the foreseeable future.