Whether the recent pullback will prove prescient, or become yet another premature over-reaction, remains to be seen. The ferocity of Tuesday's selling -- declining stocks outpaced advancing ones, 10 to 1 -- certainly suggests a vigilant crowd sniffing for the first whiff of trouble.
"That intensity has less to do with the market's fundamentals than its mindset -- the mindset of a market looking for a crisis," says James Paulsen, Wells Capital Management's chief investment strategist. He ticked off a litany of "crises" that had menaced the economy since this bull market began, including the Iraq war, the jobless recovery in 2003, interest-rate hikes that began in 2004, the bird-flu scare, the oil-price surge, Hurricane Katrina, the 2006 inflation scare, the flat-yield curve and, now, the subprime spill. "Each time, caution has persisted, and that has allowed the bull run to persist," he says.
While the housing and auto segments contracted by an alarming 10% last year, these make up 9% of real gross domestic product. The rest of the economy expanded 4.3% in 2006. "For widespread fears of continued economic weakness to prove correct, both housing and autos will need to keep collapsing this year," Paulsen says.
This article highlights two important trends. The first is simple US market strength. When the big financial heads talk about the US markets being deep and robust, they are talking about a combination of factors -- overall confidence in the economy, sophisticated analysis, overall a pretty good spreading out of risk etc... When the author above notes all of the problems the US market has weathered in the last 5-6 years, these factors are an underpinning of his statements.
In addition, the damage from the housing and auto sector's problems has been contained. I should add the important caveat: so far. We still have a while to go before either of these sectors hits bottom, so it's still possible the negative effects will bleed into the national economy.
So -- the US markets are resilient.
HOWEVER, the subprime problems of the last few months have once again raised understandable concern about how resilient the US economy is. When the author is talking about people sniffing around for problems, this is what he is talking about. Right now the market is still trying to figure out the complete impact of the subprime shakeout. Frankly, we don't know its complete impact, so everybody is looking for signs that problems have bled into another area.
Psychologically, these are the two forces competing righting now.
