Stocks Get Euro-Trashed

Posted by: Ben Steverman on May 4, 2010

On May 4, major U.S. stock indexes fell farther and faster than on any day in the last three months. The Dow Jones industrial average fell 2%, the S&P 500 dropped 2.4% and the tech-heavy Nasdaq composite lost 3%. Market pundits quickly identified a culprit: Greece.

We can never know for sure what is driving the market on any particular day, but the situation in Europe certainly sounds scary. Says Jamie Dannhauser of Lombard Street Research in a May 4 note:

Have policymakers actually done anything to avert the looming crisis? The markets don’t believe so; and they are right!

Dannhauser warns about the near-term “contagion” of Greece’s problems to other debt-heavy nations, while also painting a bleak longer-term future for Europe’s economy. Not just Greece but Spain, Portugal, Ireland, Britain and others must take action to fix their public finance. And, “widespread deficit reduction across Europe could send the [European area] economy back into recession.”

A troubling scenario, surely, but what does this mean for U.S. stocks?

Of course, U.S. companies do plenty of business in Europe. No American executives or investors will be cheering another European downturn.

Another worry: Just as the U.S. housing market created problems for the world’s credit markets (starting almost three years ago), Europe’s fiscal nightmare can inspire similar market jitters now. Markets are hurt by “the fear of fiscal deficits and the ability of governments to service that debt,” John Brady, senior vice president at MF Global told me.

Fine, but let’s not exaggerate the impact of Europe’s problems on U.S. stocks, especially on this one day. Some bullish investors have been turning more pessimistic, but Greece isn’t necessarily the main culprit.

Mike O’Rourke, chief market strategist at BTIG, last night shifted his stance from “bullish” to “neutral.” Though he told me he thinks the Greek situation merits concern, the reason for his switch was actually some good — yes, good — economic data on May 3.

The ISM Manufacturing Report posted a reading of 60.4, which means the manufacturing sector in April grew faster than at any point in the past six years. (Anything about 50 is positive on the ISM scale.) Yet to O’Rourke, the strong data is a sign that investors are already expecting a strong economic recovery. They’re unlikely to be impressed by further improvement, he says, pointing to relatively weak results after the ISM index passed 60 in the last several decades.

The report “provides the signal that the recovery rally from the March 2009 low is essentially over,” he wrote in a May 3 note.

Look at this chart, showing the S&P 500’s performance from the beginning of the year to May 4.

YTDMay4thS&P500.JPG

Even after the sell-off today, the S&P 500 is simply back to its trading level on Mar. 31, 2010. The market is holding onto big gains - 11% — from its 2010 low on Feb. 8.

“We went up in a straight line from the middle of February,” says Michael Church, president of Addison Capital Group. A pause in the rally “was going to kick in at some point.” To Church, further declines in U.S. stocks could be good buying opportunities.

Though Greece ruined Tuesday for stock investors, there might still be better days ahead.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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