Parsing the Market’s Slide

Just two weeks after the Dow Jones Industrial Average hit a three-month high, today’s sharp drop in major market indices effectively erased stock market gains for 2011. What has prompted the abrupt shift? Chief amongst the reasons, investors are increasingly concerned about the potential for a relapse into global recession, internalizing weak US economic data that was overlooked in the days and weeks preceding the resolution of the debt impasse.

While the Budget Control Act has been passed into law, the crisis itself has reinforced that policymakers remain a driver of uncertainty, undercutting businesses’ readiness to undertake new investments and hiring. Elected officials have reaffirmed their desire to refocus attention on fomenting job growth. Still, dysfunction in Washington has undercut private sector momentum.

There is ample evidence that private investment and consumption respond positively to businesses’ and consumers’ expectations of market stability. But the opposite is true, as well. The handling of the budget crisis has shown that, roughly two years after the recession’s technical end date, policy activities are potent threats to normalcy and have the potential to disrupt the recovery.

The headwinds facing the economy are of immediate relevance for commercial real estate market participants. For investors and lenders alike, rising confidence in our sector’s recovery belies its decoupling from the dimmer economic landscape. Real estate can only outrun the fundamental drivers of value for so long; over the long run, an imbalanced recovery is an unsustainable one.

European and US Growth

Apart from concerns about inflation in India and the potential for a hard landing in China, does the global data reflect the change in mood? In Europe, many investors are unconvinced that the most recent stability measures will stave off a wider sovereign debt crisis. The potential for contagion still exists, even if only as a tail risk, given that Europe’s stability program is underfunded as compared to the size of the bond markets in some of the larger, at-risk economies. The combination of austerity programs and drags on investment resulting from the sovereign debt crisis is weighing on the overall growth outlook.  In our baseline forecast, the Euro Area is projected to grow by 1.9 percent in 2011, slowing to 1.7 percent in 2012. The moderation reflects an expected drop in Germany’s enviable growth rate up to now.

As for the United States, the Bureau of Economic Analysis’ advance assessment of second quarter GDP received scant attention in the days leading up to the budget cap deadline. That report, based on incomplete data and subject to revisions, nonetheless showed that the economy expanded at a paltry annualized rate of 0.4 percent in the first quarter and by just 1.3 percent in the second. Public and private sector forecasters have reigned in their projections for 2011 growth on evidence that lower consumer confidence and the disappointing jobs market has hurt personal consumption activity. Overall, the baseline continues to anticipate slow growth and a heightened probability of recession. In the market’s current estimation, the downside risks to the forecast feature more prominently than the upside.

Look to the Jobs Report

By the time this column circulates, the jobs data for July will have been released. If the debt impasse prompted firms to postpone hiring decisions until after the immediate uncertainty had resolved, net job creation in July may well have fallen short of economists’ modest estimate of between 70,000 and 85,000 jobs. While those projections are already reserved, a significantly lower result for private sector jobs will further damage confidence in the recovery. Should firm hiring beat expectations – three of four have already beaten earnings estimates, in part by holding the line on jobs – the market may just seize upon the silver lining.