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Just like that, it’s 2011 all over again on Wall Street.
That was the year the European debt crisis held U.S. markets hostage, sparking recession-like volatility and dragging the S&P 500 down to its second-worst annual returns in the past decade. Since then, U.S. stocks have flourished, rising to unprecedented heights. At some point, Wall Street simply stopped paying attention to Europe’s financial problems.
That appeared to change last week.
Stocks fell 2.5%, marking the worst week for the S&P 500 in more than two years. One of the major catalysts behind the pullback was news that Portugal’s largest listed bank, Banco Espirito Santo, will require a $6.6 billion bailout. The rescue effort comes just months after Portugal had dug itself out from a three-year, 78-billion-euro bailout courtesy of the European Union and International Monetary Fund.
The bad financial news in Portugal undoubtedly contributed to last week’s sell-off in U.S. stocks. It also helped drive the VIX, a.k.a. the volatility index, to its highest point since April. That U.S. investors suddenly care about Europe’s problems again is a stark departure from the last two carefree years.
No one seemed to care much a year ago when Greece spent 28 billion euros – nearly six times the amount Portugal is spending – to bail out its four largest banks. More recently, the conflict between Russia and Ukraine has failed to scare U.S. investors away.
Even domestic concerns haven’t prevented U.S. investors from buying over the past two years. Sequestration, another near-default, a dramatic decline in first-quarter GDP growth – none of it has done much to slow U.S. stocks over the past 18 months. That’s what makes it odd so odd that Portugal’s debt problems, of all things, are suddenly giving U.S. investors pause.
Perhaps it was merely the tipping point for an overbought market. Analysts have been clamoring for a major market pullback for months, asserting that a correction was long overdue. Every time, stocks have continued to rise to record highs.
Now that the Federal Reserve is on the brink of pulling the plug on quantitative easing altogether, maybe panic has finally set in. Maybe U.S. investors simply aren’t as confident as the Fed that this economy can stand on its own two feet without artificial assistance – especially not after the unemployment rate ticked up a tenth of a percent last week. Maybe last week’s flood of IPOs was a clear sign that the market had reached a top.
Regardless of what spooked investors, the Portugal bailout wasn’t really the symptom; it was merely the trigger. It was a sign that Europe may suddenly matter again on Wall Street. So may the Russia-Ukraine conflict, civil unrest in Iraq, violence in the Gaza Strip and any other geopolitical strife that arises.
Of course, it’s also possible that last week’s decline was an aberration. After all, stocks bounced back with some degree of authority on Monday. Mini pullbacks are nothing new. A sustained correction – a pullback of 10% or more – is something we haven’t seen for more than 1,000 trading days. To presume that one bad week is the definite start of a months-long pullback would mean ignoring the power of this bull market.
Still, cracks are beginning to form in this rally. Even before last week, stocks were having a relatively lukewarm summer, rising just over 2% since the beginning of May. For the past two years, Europe’s mountain of debt problems hasn’t slowed the rally in U.S. stocks one bit. Very little has.
If Europe’s problems start to consistently affect the way U.S. investors are trading again … then this rally may truly be on its last legs.
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