Stocks are supposed to go down, but they don't want to just yet.
World stock markets declined sharply Monday. The trouble started in Shanghai, where the benchmark index fell 5.8 percent, its biggest loss since November. The Dow Jones industrial average's 2 percent decline that day actually understated the weakness here in the U.S.
The widely stated reason for the tumble was renewed worries about the strength of the global economic recovery. But there doesn't have to be an official reason. In my view, it was simply a matter of overdue profit taking.
After all, news on the economy has actually been improving. And the profit taking lasted just one day. U.S. stocks have since made up for Monday's lost ground. At today's market close, the S&P 500 was actually slightly higher than its closing level last Friday.
My long-term view for both U.S. Treasury securities and the dollar is unfavorable. In both cases, it reflects concerns about the massive amount of debt in the U.S., exacerbated by the necessary but costly government programs to bail out the troubled economy and financial system. This makes our government debt securities and our currency relatively unattractive.
For Treasury issues, there are also worries about the large quantity of them held by foreign investors. It's generally in the interest of these investors to support their large Treasury stakes. But there are also signs that they want to diversify away from Treasury issues, and that they won't be as willing to buy as much as before even as new issuance will jump in order to fund our mounting debt.
But sometimes short-term trends run counter to the long-term ones.
China and Japan, the world's largest creditors to the U.S., bought longer-term Treasury notes and bonds at a record rate in June. It's also worth noting that demand for Treasury securities has risen from U.S. households, which have finally started to save more after years of spendthrift behavior.
China and Japan were heavy sellers of short-term T-bills in June. But total foreign net buying of Treasurys excluding Treasury bills hit $100.5 billion in June.
So while we continue to worry that the U.S. government's aggressive stimulus program will eventually fuel inflation, this is not yet a major concern for foreign buyers.
In June, yields on Treasury notes and bonds hit their highest levels for the year, with the 10-year yield briefly climbing above 4 percent. That yield has now fallen to below 3.5 percent amid strong buying. Yet investors supposedly are turning more bearish on Treasuries based on the belief that yields will rise (will lower prices) as the economy gradually improves
Meanwhile, the dollar benefited in 2008 as a safe haven amid a risk-averse, global flight to quality during the economic crisis. But as the world's investors regain a taste of risk, they tend to move out of dollars and into other vehicles that offer better profit potential, particularly in a recovering economic environment.
For the dollar, the direction is more clear: down. While demand for Treasury issues has remained relatively strong despite perceived economic improvement, that same factor is putting pressure on the greenback
The Dollar Index, which the Intercontinental Exchange (a publicly traded global electronic marketplace) uses to track the dollar against six major currencies, is now at its lowest level in almost a year. Stronger economic data tend to weaken the dollar as investors became more comfortable buying riskier, higher-yielding assets elsewhere.
A potential catalyst for a higher dollar would be if the Federal Reserve were to start raising short-term interest rates again. But that's not in the cards yet.
The big picture for the world's economy is this. First, many emerging-markets economies are doing well. Second, the economies of many more mature nations stabilized in the second quarter. The U.S., however, continues to lag, although growth is expected to return in the current quarter.
The Organization for Economic Cooperation and Development said this week that its 30 members, developed-market nations, collectively should start to grow sooner than previously expected. But the group's economic recovery will probably still be weak.
The OECD said its member countries stabilized in the second quarter, led by export growth in Germany and Japan. The OECD's report said that gross domestic product (GDP) of the OECD's major seven countries (Canada, France, Germany, Italy, the U.S., the U.K. and Japan) slipped 0.1 percent from the previous quarter between April and June after dropping 2.1 percent in the first quarter. The U.K. and Italy lagged the most behind, followed by the U.S. at a 0.3 percent drop.
The outlook from Europe, where the OECD is based, is much the same as it is here. For example, the International Chamber of Commerce there said that high unemployment rates and rising public debt in many countries bring concerns about a sustained recovery in the global economy.
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