For the last 3 weeks the Dow Jones has ended the week higher than the previous week. The volatility index (VIX) is measuring below 12, more than 8 points below its long term average[1]. So why is this current stability something to be concerned about???
Exports
During the 4th quarter exports represented a drag on GDP at -2.7%[2]. As the paths of the current recovery diverge for the US and EU we could see the Euro fall to the Dollar, making our exports even more expensive to consumers overseas. This drag on exports could bleed into other areas of our economy and cause headwinds for employment, manufacturing, and importantly business investment domestically as goods become cheaper abroad.
Why are the paths of the US and EU diverging?
The US has reached a phase of stability with regards to economic stimulus. Employment has become more manageable setting a new record of 138.5 million employed[3]. Inflation is now hovering just shy of the Federal Reserve Boards (FRB) desired 2%. At this point the private sector is not looking to Washington for help, but rather begging the question, when is the FRB going to start tightening the belt?
The EU, in contrast, has seen advances in Germany and many periphery nations with regards to manufacturing, consumption, and consumer confidence. France has been lagging as of late and more importantly inflation, 0.5% year over year, has been dragging the EU into a precarious situation[4]. While the overall economy has been on the mend, demand and business investment have not been strong enough to keep inflation growing. Last week Mario Draghi, the president of the European Central Bank (ECB), announced several measures as well as alluding to additional measures that should encourage small business lending, consumption, and financial sector stability. The ECB actions speak to an economy still on the mend and willing to throw money at the problem.
With the EU having a more accommodative recovery based stance and the US moving more towards a mid-expansionary stance the Dollar will undoubtedly gain strength against the Euro. Which would be great for anyone looking to travel to Europe, but creates a different kind of headwind for our economy.
Stock prices should become more volatile in coming months as economic reports begin to reflect this divergence. The VIX measuring in at 12 represents that the markets are stable… this stability typically means volatility will follow, especially with how far the VIX is below its long term average.
Our economy has faced its fair share of headwinds during this expansion and this one should not prove to be the proverbial nail in the coffin. Why? While exports are a drag on GDP and cause a contagion to other areas of the economy, the consumer is much like the O’Doyles in Billy Madison; the “Consumer Rules!” As long as the consumer, roughly 70% GDP, stays strong then our economy will continue to persevere minor changes in headwinds.
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Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long term holding strategy is the best strategy in any market environment. Any and all third-party posts or responses to this blog do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy.