We've become conditioned over the last few years of this Great Recession to negative data, but S&P's downgrade of U.S. debt securities—following an ugly fight in Washington over lifting the debt ceiling—seems to have marked a turning point in global markets. Of course this happened at the same time Europe's sovereign debt crisis threatened to spread its contagion to Spain and Italy—countries thought "too big to bail"—so the increased level of shock sent a powerful market signal to run for cover.
After all, government debt securities of advanced market economies were always seen as the conservative floor from which investors could securely venture out to riskier assets. When "safe" investments become scary, it eventually must affect the psyche of the investor.
In this context, weak home sales, new unemployment claims, sluggish manufacturing, signs of inflation and forecasts of imminent recession become more than just the same-old, new-normal bad data. The market blithely ignored such data in the huge bull runs of 2009 and 2010. The trouble is today's environment is starting to feel an awful lot like 2008.
Eminent voices on Wall Street are capturing this zeitgeist. DoubleLine's Jeffrey Gundlach has warned of a "serious possibility of a global banking panic" like we had in 2008. He notes that European banks sitting on mountains of toxic debt are closely tied to U.S. banks through swap contracts as we saw three years ago with AIG. He called this week's market mayhem a "small drop" that should not be seen as a buying opportunity.
Economist Nouriel Roubini, in a video interview with the Wall Street Journal a week ago, was among many others counseling investors to avoid stocks at this time. He said: "We don't know whether this volatility is temporary and things are going to improve or whether there's going to be a nasty recession and another 30-40% fall in equity prices. So until the fog of uncertainty is resolved, my view is that it's better to be safe rather than sorry. This is not the time to be in risky assets."
To anyone who has been following the world economic situation recently, it seems hard to dispute this. But consider the fact the economy and markets don't track each other perfectly in the short-term. If they did, the market should have plummeted in 2009 and 2010. Far too many poor suckers were "right" about the market crash a year or two or three in advance.
