Stock markets seem to have been trying to separate the euro zone crisis from economic fundamentals elsewhere in the world.
Back in August, financial markets were grappling with three big risks: a double-dip recession in the U.S., a total implosion in the European banking system and a hard landing in the Chinese economy. Events since the shakeout suggest that the market was too pessimistic about the outlook and has come to terms with the fact that the European crisis has not driven the U.S. into a recession.
Our Global Investment Strategy service argues that the U.S. economy is probably gravitating toward its trend growth of 2.5%. The possibility of even stronger growth should not be dismissed. The large accumulation of liquid assets on corporate balance sheets suggests that companies have much “dry powder” to increase capital outlays. Of course, political and policy uncertainty is a roadblock, but solid profits are also a powerful incentive for companies to invest.
As for China, financial markets have slowly realized that the slowdown in growth is cyclical in nature and the government is well equipped to navigate a “soft landing”. Nevertheless, lingering concerns still exist and many analysts continue to predict that the economy could soon hit a brick wall. The improving picture for the U.S. and Chinese economies has probably put a floor beneath stock prices, especially the S&P 500.
Nevertheless, it will take a decisive solution to the euro zone crisis for risky assets to make a significant breakthrough on the upside.