Economic Uncertainty Generates Stock Market Volatility

By: Sy_Harding

The stock market loathes uncertainty.

Twelve months ago the market was in the midst of the January-February mini-crash to its March low. The S&P 500 lost 25% of its value in those final two months of the 2007-2009 bear market. Its problem was uncertainty over whether the aggressive government stimulus actions rushed into place could possibly work fast enough to prevent the recession from worsening into the next Great Depression.

Six months ago the market was in the midst of a strong new bull market that had the S&P 500 up more than 50% off its March low and, having wiped out the loss of January and February, up more than 20% for the year to date.

The catalyst for the continuing rally off the March low? Economic uncertainties were fading away. Home sales were rising month after month. Monthly job losses were slowing dramatically. The third quarter had arrived, with indications that the recession was over and positive GDP numbers for the third quarter would confirm that. And sure enough, after four straight quarters of decline, U.S. GDP grew 2.2% in the 3rd quarter. The recession was over.

One month ago the news seemingly got even better, when it was reported that GDP grew 5.7% in the fourth quarter, the fastest quarterly growth in 6 years.

But instead, uncertainties came crowding back in, and the stock market has been having problems.

The uncertainties included concerns that if global economies were doing so well, when will central banks, including the U.S. Federal Reserve, begin reversing their stimulus efforts and easy money monetary policies? And if and when they begin, can they succeed in doing so without stalling out the economic recovery?

On the other hand what if the economic recovery is only temporary, the result of government stimulus programs that are scheduled to end, and temporary inventory rebuilding by corporations in the last half of last year?

Unfortunately, a month ago, before markets had enough evidence to be certain of one or the other scenario, they were surprised by monetary moves made by China to rein in its economic growth to avoid potential inflation. The rest of the world had been banking on their economies being able to feed off the strong demand for commodities and products created by China’s exceptional growth.

Markets were unnerved by the news, and declined for three of the next four weeks, giving back approximately 7% in the process.

The uncertainties increased this week with reports of potential debt emergencies in several European countries, most notably Greece, but including Iceland, Portugal, and Spain.

And on Friday came news that Chinese regulators have again raised the level of cash or equivalents Chinese banks must hold, taking money out of circulation, as they continue efforts to slow the country’s economic growth, specifically pointing to preventing potential bubbles in speculative investments and real estate.

It was also reported Friday that the economic recovery in Europe stalled in the fourth quarter, with GDP in the 16 Eurozone countries rising only 0.1%. That raises concerns that Europe may be slipping back into recession, and has European economists pointing out that Europe’s recovery in the third quarter had been due to temporary catalysts, including government stimulus spending and temporary inventory building.

The additional uncertainty for the U.S. market is that those are the same factors that have many economists expecting the U.S. economy will slow in coming quarters. More than half of the exceptional GDP growth in the U.S. in the fourth quarter was also due to inventory re-building after companies had allowed their inventories to fall to record lows in the recession, and to government stimulus packages, including rebates to first-time home buyers, and the Federal Reserve’s purchases of mortgage-related assets, which are scheduled to expire over the next two months.

So economic uncertainty has returned, and with it market volatility.

Technical analysis of the market may soon provide some indications of what to expect. As shown in charts on my free blog that you might find very informative, in their three-week decline the major stock market indexes became short-term oversold beneath their 21-day moving averages. As the charts show that almost always brings a short-term oversold rally back up toward the moving average. And that happened this week.

The critical question is whether the market can break out above the moving average and resume the bull market, as it has done several times in the last ten months, or with the return of economic uncertainty, will the moving average will now be overhead resistance on rally attempts, as happens when more serious corrections are getting underway.

My advice is to watch the technical charts. At this point they are likely to be more informative than trying to sort out the conflicting economic debates that are going on.

Sy Harding is president of Asset Management Research Corp, publishers of the financial website www.StreetSmartReport.com, and the free daily market blog, www.SyHardingblog.com.

© 2010 Copyright Sy Harding- All Rights Reserved

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