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Economic Storm Clouds

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It’s hard to know whether the recent global stock market selloff simply is another bump in the road or the sign of something more dreaded.

When it comes to the economy, perception and confidence frequently are more important than numbers. Recently, however, key economic figures also have faltered.

Looking back on April halfway through May, several important indicators were less than rosy. Although there has been a measured advance in factory orders and consumer spending since the beginning of the year, April saw a slump in the issuance of new building permits and little letup in firings.

Few economists expected an instant turnaround from the deepest recession since the 1930s. But since the beginning of the year, the steady rise in global stock prices has reflected a growing resurgence in investor confidence.

The Fleeting Bump

While investors were shaken by the sudden May 6 plunge on the Dow of nearly 1,000 points, most appeared ready to accept this as nothing more than a freaky and otherwise anomalous one-time event. Yet combined with the backdrop of the disturbing developments unfolding in Europe, investors now appear to be more skittish than at any point in the recovery.

This investor angst is reflected in the Chicago Board of Options Exchange (CBOE) Volatility Index also known as the VIX. In the past two weeks, the VIX has moved from placid readings between 15 and 18 to a nerve-wracking high near 44 today. A higher VIX indicates the likelihood of increased market volatility and variability.

Along with the drop in building permits and a jump in initial jobless claims last week by 25,000 to 471,000 nationwide, there also has been a fall-off in retail earnings. In an economy where consumer spending generally comprises 70 percent of our prosperity, investors are finding it hard to digest a drop in profits by major retailers like Kohls, whose second quarter earnings significantly trailed initial projections. While Target, the nation’s second largest retailer, showed better than expected earnings, same-store sales at Wal-Mart were down by about 1.5 percent.

This nosedive in global stock prices also has been driven by the perception of disarray in Europe.

Chaos Seems to be the King

Chief among those concerns is Germany’s recent knee-jerk action banning contracts speculating on European sovereign debt. Instead of quelling investor worries, the move by German Chancellor Angela Merkel prohibiting so-called naked short-selling of bank stocks and the outlawing of speculation on government bonds using credit-default swaps has shaken investor confidence.

In the absence of debt insurance instruments like swaps, corporate borrowing costs in Europe and elsewhere have lurched higher. By all accounts, Merkel’s unilateral actions effectively have wiped out the gains that followed the announcement last week that the European Union would provide up to $1 trillion in aid to several of its most debt-laden members such as Greece, Spain and Portugal. This perceived rift in European unity has been underscored by recent statements that neither the French nor the Dutch plan to follow Germany’s proscription against short-selling.

This murky outlook combined with the precipitous slide in the euro currency against the U.S. dollar has prompted a mounting concern that American exports – one of the few consistent bright spots in the economy – will start to tail away. Like everything else in this still-fragile recovery, a projected retreat in exports to our largest trading partner has started to undermine the budding exuberance the stock market displayed during the first four months of the year.

Like the clouds from the Icelandic volcano, it seems that a residual of uncertainty will govern the markets for the foreseeable future.

John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com