I can’t decide whether it would be better to never take my eyes off my computer screens that monitor the markets tick-by-tick or just turn them off. The markets have been like the old joke about the weather: Don’t like it now? Just wait; it’ll change. Since the last week in July, financial markets have gyrated up and down more violently than any time since the depths of the financial crisis. In fact, the VIX Index, which uses the options market to measure volatility, reached a level this past week that hasn’t been seen since early March of 2009. What’s it all about?
Day-to-day, markets have fluctuated based on bits of hard economic news and fleeting rumors regarding big financial institutions, but I think what’s really unsettling everyone is a realization that the government is limited as to what it can and cannot do to direct the economy. Ironically, the equity markets came unhinged the very day Congress and the President resolved the budget impasse, which kept the U.S. Government functioning. U.S. stocks rallied after the Federal Reserve promised to keep interest rates low for another two years, only to give back more than they gained the following day before regaining most of that day’s loss the next day (getting dizzy?).
Apart from washing a lot of political linen in public, the budget deal was notable for making it clear that the federal government is in neither a financial nor a political position to stimulate the economy if it falters. In fact, the deal leaves income and payroll tax increases in place for this year and next, cuts the rate of spending, and threatens even more draconian spending cuts if a longer term debt reduction plan isn’t in place by December of this year. Further tax cuts weren’t even on the table.
The parallel drama that’s playing out in Europe raises similar questions about what governments can and cannot do to stop the spread of financial panic. At the moment, the European Central Bank is ahead by a goal, but events and rumors are testing the stamina of their German goalkeeper. I still expect to see the European Union hold together and further centralize, but the deceleration of the strongest economies is shortening its reach.
At the risk of repeating myself, it’s all about growth and the ability of the developed economies to build on their strength and produce. As we try to do this largely without the crutch of government, expect our confidence to rise and fall, and for the markets to do much the same.