Volatility Rules

Has anyone else noticed that volatility has picked up in the stock market?   
 

It started on April 23, when the S&P 500 closed at 1,217. On that day in Daily Profit, I mused how investors were looking past the Icelandic volcano and the SEC charges against Goldman Sachs and simply buying stocks.   

I also discussed the possibility of a trend change that day. And I think it may be prudent to revisit that discussion today…  

There’s no question that investors have been taking some profits from the rally of the February lows. There’s also no question that investors have been getting defensive and the bears have been getting more aggressive. We haven’t seen 3% drops for the major indices since stocks were seeking out the early February lows.  

And the news flow has gotten decidedly more negative. The Greek bailout is being ignored because investors are now focused on potential problems in Spain, Portugal and who knows where else.  

It’s clear to me that the EU completely botched the Greek bailout. In the early days of the Greek debt crisis, the EU waffled. It showed fear that Greece wouldn’t be able to cut its debt and that other countries might need assistance, too.   

If the EU had acted quickly, it might have given investors confidence that problems would be dealt with swiftly. After all, at the end of the day, confidence is the single most important factor for investors.   

But by showing fear, the EU sent the message that it didn’t want to support Greece and it may be even more hesitant to help Spain or Portugal or whomever.   

That sends the message that sovereign debt issues are a big concern.   

We know that stimulus policies must end and deficit spending must be reversed. And we know that the process will likely be painful. But human nature puts off the day of reckoning to some murky point in the future. Like when interest rates rise.   

So Greece has been forced to start unwinding deficit spending. Does the mean the race is on?   

The news from China is also weighing on the market. In case you missed it, China raised loan reserve requirements for banks again. The changes are very small, and they don’t take much money out of the system. But the intent is clear – slow down the real estate market.   

It might seem unrelated to Greece, but China’s moves to stave off inflation in its housing market is another form of stimulus reduction. The only difference is that China didn’t have to engage in deficit spending.   

So again, the question is: Is the race to rein in stimulus monetary policies getting started?   

I don’t see how we can answer this question with anything but a “yes.” It’s being forced on Greece. And China is doing it voluntarily.   

China deserves some praise for acting proactively and incrementally to rein in stimulus. Yes, it probably means slower growth for China. And a manufacturing survey for China that came out today showed a small drop, from 57 to 55.   

China’s actions should help avoid any seriously de-stabilizing events. But it does mean slower growth.   

The Fed has also made some incremental moves to rein in stimulus policies. For instance, emergency lending programs have ended.   

But the Fed’s balance sheet remains inflated, and it’s only dipped its toe in the water of unwinding positions via reserve re-purchase agreements. There’s a lot more the Fed needs to do. And raising interest rates is probably the last stimulus policy that will be reversed.   

I would suspect that Bernanke is hyper-aware of not rattling investors’ confidence right now. The last thing the global economy needs right now is a rush to for exits.   

We may hear some bullish comments from the Fed in the next day or two.