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Stock markets have been swinging wildly of late. Even though corporate earnings have shown strength over the past year and not all economic indicators have been gloomy, investors are on edge. Uncertainty looms on several fronts – from concerns about the basic health of the economy to doubts about fiscal policies in the United States and Europe. Here’s a look at the forces weighing on investors’ outlook:
1. The euro mess
If you’re a market bear, Europe is the gift that keeps on giving. One day leaders announce some step forward, the next day it’s often two steps back as financial analysts renew their doubts about whether high-debt members of the currency union will be able to service their debts.
A key problem – already visible in Greece – is that austerity measures designed to put the fiscal house in order simultaneously suck wind out of the economy. Consumers (many of them paid directly or indirectly by the government in the past) have less to spend; businesses think about moving elsewhere; and tax revenues don’t increase along with tax hikes. Stock market jitters rise as policymakers grope for a solution.
The problems are not insurmountable, but the options come with political and economic hurdles. One is to see weak nations default and exit the euro zone entirely. Another is to restructure their debts – with bondholders taking “haircuts” or losses. Those bondholders are in many cases private sector banks, which might then need rescues along the lines of what happened on Wall Street in 2008, with the Treasury’s Troubled Asset Relief Program (TARP) fund. Another option for the eurozone is to try to keep muddling along with austerity measures in countries like Spain andItaly matched by rescue funds from the likes of Germany and the International Monetary Fund.
At least things aren’t so bad in the US, right? Maybe, but …
2. Political gridlock in the US
The US dollar may be the world’s great “reserve currency,” but Washington is hardly looking like a bastion of stability. President Obama andRepublicans in Congress trade barbs in campaign mode about who is standing in the way of job creation or failing to be fiscally responsible. In late July and early August, consumer confidence tanked as the partisan bickering over increasing the national debt limit led the US to the brink of technical default on its debts.
Approval ratings for Mr. Obama sagged, with those of the politically divided Congress moving even lower. Bickering in Washington is nothing new. But many Americans now wonder if gridlock, seen in better times as a buffer against policies that might mess up the economy, is now a significant roadblock to progress on fiscal reform and agreeing on policies to encourage private-sector job creation. All the political chaos has dampened the confidence in the private sector. Which leads us to the next challenge …
3. Consumer economy fades
In the world’s largest national economy, consumers have long been the engine of growth. As they earn more and spend more, corporate profits go up and the stock market rises. That’s still true, but America‘s consumer engine isn’t running nearly as well as it should, for two big reasons. One is unemployment, the other is the issue of mortgage debt and the housing bust.
A high jobless rate means many households face a big income cut. People who do have jobs worry about their employment security and prospects for raises.
The housing bust, meanwhile, pushed down the net worth of millions of families. Some 11 million mortgage borrowers were in a “negative equity” position in the middle of this year, with loan balances larger than the value of their home.
Many households have made progress in paring their debt obligations, such as by refinancing at lower interest rates. But economist Gary Shilling says that what he dubs the “age of deleveraging” will be here for a while.
All this means that the US economy, like those in Japan and in advanced European nations, seems to be moving in slow gear or worse. But the world economy will keep growing because so-called emerging-market nations are an important bright spot, right? Well….
4. China uncertainty
Even China and other emerging markets, viewed often as the high-growth alternatives to stagnant markets in the US and Europe, carry risk. The potential of emerging markets is clear: They have growing populations of increasingly educated consumers and workers, and these nations tend to have lower debt loads than the US or European nations.
But leaders in China and other upcoming nations are struggling to hold inflation in check and contain unemployment, while managing the transition from an export-fueled growth to a new era driven more by domestic demand from consumers.
Fans of China’s prospects, like Stephen Roach of Morgan Stanley, predict this giant economy can weather the challenges as leaders execute their vaunted five-year plans for development. Some bears say the long boom could turn to bust – or at least run off track for a time.
Food for thought: From late April to mid-September, an exchange traded fund representing Chinese stocks fell about 20 percent in value, more than America’s S&P 500 index. Similarly, an emerging-market index is down much more than the S&P during that time.
So the whole world is awash in risk. There’s a potential monetary fix, though, if you believe in printing presses …
5. Central bank policy
Actions by the Federal Reserve and other central banks – or their failures to act – are another source of investor anxiety. In surveys, many economists say the Fed is getting its policy balance about right. But some think the Fed has been doing too much. Bond-buying programs with nicknames like “QE2,” and an adjustment of that strategy known as “operation twist,” make the Fed look panicked, this camp argues.
One risk is that monetary ease is fueling inflation and potential commodity bubbles. But another sizable group of economists says the Fed should be doing considerably more in efforts to rekindle economic growth. The idea is that with the jobless rate so high, there’s room for more monetary stimulus before inflation becomes a big problem. Similarly, many argue that the European Central Bank should be less focused on inflation and more geared toward fending off recession risks.
Bottom line: There are differences of opinion even within the Fed itself. Rightly or wrongly, many investors figure central banks are nearing the limits of their ability to coax the economy to grow. Meanwhile the Fed has downgraded its outlook for the economy, and talked about “significant downside risks” in a statement released after its Sept. 21 policy meeting.
Despite all this, there’s still the old idea of letting “the market” work things out. The only potential problem is …
6. The system is rigged?
OK, this more an allegation from stock market critics than a proven fact. But concern among investors has grown that market volatility is being fanned by firms engaging in tactics such as “high-frequency trading” (HFT), and that these firms are essentially gaming the volatility to their own advantage.
Whether HFT is a huge problem or not, the perception hasn’t done much for the confidence of ordinary investors – whether of the 401(k) or day-trading variety. HFT means very fast trades, carried out by powerful computers that are located close to financial exchanges, can take advantage of small share-price moves in milliseconds. Critics say the result is simply enriching some firms on Wall Street, without any larger benefit to the liquidity and transparency of financial markets.
All this seems a far cry from the 1990s, when prosperity on Wall Street seemed to go hand in hand with rising balances in 401(k) retirement accounts. Oh, and about those accounts….
7. Baby boom demographics
Some market analysts have long warned that as the baby boom generation nears retirement, they’ll shift from being buyers of stock to sellers (on average), and that this may put downward pressure on stock prices. Some researchers believe this phenomenon is already affecting share prices.
“The demographic changes related to the retirement of the baby boom generation are well known,” they write. “This suggests that market participants may anticipate that equities will perform poorly in the future, an expectation that can potentially depress current stock prices. In that sense, these demographic shifts may present headwinds today for the stock market’s recovery from the financial crisis.”
The demographic shift may have a depressing effect on the “price-earnings ratio” for stocks – meaning that share prices will be lower relative to the earnings power of publicly traded companies.
Not everyone agrees this is a big deal, or that it’s already visible in stock prices. But the researchers at the San Francisco Fed argue it could have a negative effect on stock prices over the next two decades.
Yikes, maybe investors just want to stuff their money in certificates of deposit. But wait …
8. Few alternatives
If stocks look risky, so do bonds and cash and lots of other investments. The depth of the 2008 financial crisis, and the follow-on efforts by theFederal Reserve to prop up the economy, have left short-term interest rates in the US near zero. So people have gotten used to earning next to nothing on savings or money-market accounts. Interest rates on 10-year Treasury bonds, which had edged up amid signs of tentative economic recovery, sank to historic lows as of September 2011. And bond prices could dive, eventually, whenever the economy firms up.
Other alternatives like real estate and commodities can bring returns to savvy investors, but can be as volatile as stocks. Gold soared to record prices this year, but earns no interest and could plunge in price if the sense of economic crisis eases.
The upshot: An investment landscape that’s all about picking lesser evils won’t feel very inspiring.
On another level, though, the problems with fixed-income and alternative investments simply nudge investors back toward stocks. After all, why earn 2 percent on a bond when some blue-chip stocks are paying more in dividends? Many investment strategists believe stocks will outperform bonds handily over the next decade, even if the returns may not be stellar.